Case Review: Linear Technology Essay

unidimensional Technology was base issue of Silicon V wholeey and founded in 1981. The confede dimensionn fussyized in design, manufacture and marketing of analog combine circuits. running(a) enjoyed a diversified customer base, with 33% of its crinkle advent from the communications sector, 27% from computers, 6% from automotive, and 34% from various different applications. With their rivet on the analog segment of the IC sector, which was characterized by custom designed products, it was imperative that elongated hires and retains talented people who were accustomed to out-of-the-box thinking and who could quick develop innovative techniques and products that would keep them competitive.Going IPO in 1986, one-dimensional operated with a modest CAPEX. Addition exclusivelyy they enjoyed rugged obsolescence of equipment and techniques. This combined with their low R&D expenses led to margins that exceeded that of competing digital IC products. This is supported by li nears 7th seat positioning on the Philadelphia shoot Exchange Semiconductor Index (SOX).analogues net income was at its highest in 2001, when global technology spending was at its highest, and its lowest gross revenue the following year. They unsounded maintained positive coin flows and strong margins this was stark(a) through various mechanisms such as cost cutting assist by their variable cost structure. As of 2003 Q3, unidimensional was emerging out of the recession with strong financials. However, top line sales and net income remained cut back than their high point in 2001. Due to political unrest throughout the World, the future of the tech manufacture remained un taint the farm. Year all over year maturement in 2003 when comp ared to 2002 was good, only when the family didnt run into a clear path to reaching 2001 levels. At the same time, they didnt want to relinquish margins in natural markets like Asia.By 1992 Linears forethought was comfortable in their a bility to sustain future exchange flows, having been hard coin flow positive since IPO, and began issuing dividends of $.00625 per disperse (payout ratio 15%). In 2002 LLTC continued issuing dividends, despite the higher payout ratio (27.24%), as they didnt want to lose favor with seators. It is likely that Linear viewed dividends as a expression to stay in the portfolio of mutual funds and EU investors who strongly favored dividend- remunerative stock certificates.Simultaneously, Linear excessively began to buy back packets when interest judge were low or/and when market valuation of Linear stock was low. They were doubting about paid out all or more of their cash in in dividends as this could prefigure lack of process potential. It is notable that well-nigh(prenominal)(prenominal) institutional investors held Linear stock, largest among which was Janus Capital. Linear wanted to be sure to channelize positive signals to their investors. With a large cash b alance ($1.5 billion) and no debt, Linear was at a crossroads they needed to know what to do with their cash. Their options were 1) authorize in new projects, 2) Payout via dividends and/or purchases, and 3) Save it for future investments in launching and diversification. In this p per, we go out analyze three different approaches in decidingLinears payout for Q3. nest 1 Cent Dividend add-onThe summary infra assumes the decision to buyback 165.7 million in stock provide not be gear uped. The decision to be made is to all raise our dividend by one cent per treat, or leave the ternary quarter dividend of .05 per appropriate intact.Payout DecisionHistorically Linear has not adjoin dividends in Q3, so a hidebound approach for the board would be to approve the continuation of the dividend policy from Q2. Continuing the status quo of .05 per percentage, the payout ratio would adjust to 27.48 pct of Net Income. Increasing dividend by one cent per share would ontogenesis the YTD payout ratio to approximately 29.31 percent for the three quarters (Exhibit 1), a modest append.At $0.06 dividend per share, the total Q3 dividend payout go away be $18.7 million, which volitioning inactive be considered small by our institutional investors, given our large cash position. The adoption of the 1-cent increase will provide a full religious offering of 215.70 million dollars back to our investors in the form of dividends and stock repurchases as shown belowPaying the additional 1-cent would still be lucid with our long-term dividend strategy, but the total package will not be aligned with the requests of some of our largest investors.Available exchange to DistributeAt this point it is important to mark that the firm will be paying out more to the shareholders via share buybacks and dividends, than the firm has available to the equity holders through its operations. This overpayment holds true if the firm holds the dividend at .05, or increases it to .0 6. The firm has generated a total of 207.5 million FCFE dollars, but would be choosing to payout a total of 215.7 million given the decision to increase the dividend by one cent. Staying committed to the .05 dividend reduces this figure by only three million.Cash Needs and Agency issuesSurplus cash to address any unexpected needs will readily be available by adopting the conservative one-cent increase plan. Increasing the dividend to .06 includes holding on to almost c percent of a truly large cash position, and at that placefore provides little extort to identify such future cash needs.SignalingLinears sales are trending upward since the 2002 decline, but the immediate future is still not clear. The adoption of this conservative plan would continue their strategy of systematically signaling a message of safety and consistency of cash flows to their investors, yet provide options for our turbulent times. Other uses for this cash such as change employee incentives, training, and workplace improvements should also be considered.Other ConsiderationsThe drawback for adopting the conservative plan without addressing the c oncerns of Janus and separate like-minded investors could signal that they are not quite ready to apprise that their recent troubles are behind them. If we do choose this plan, a conservatively crafted message to address investor concerns should be communicated to investors as quickly as possible. Additionally, anformer(a)(prenominal) approaches such as one-time share buybacks and superfluous dividends should be considered to address the concerns of Janus and other firms that share their view on Linears current cash position. We address these in Approach 2, 3 outlined in the sections that follow.Approach 2 Payout all of Linear Technologys Cash 1In this section, we consider an alternate payout strategy in which Linear returns all of its 1.5 billion to its shareholders, by either (a) Paying a fussy dividend of $5.01 per share, or (b) Repurchasing about 50 million shares.(a) Special Dividend of $5.01 per shareOne aim of the special dividend will be to show investors that Linear is in a good position and to buy shares from Linear Technology is not corresponding with the risk normally associated with the purchase of shares from technology companies. Additionally it signals to the market that Linear is serious about sharing its wealthiness with its shareholders. With these higher overall payouts, Linear Technology bum reach investors that shake off specific income goals. section chargeIn case of a dividend announcement, demand for shares will rise. If investors know that a authoritative dividend amount will be paid, the share price increases by that amount (Law of One price). In this case, the current share price is $30.87 and dividend inform will be $5.01 hence the share price cum dividend washstand be expected to increase to $35.88.1 Exhibit 4 shows calculations for add up presented in this sectionFirm t hink ofDepending on the time until the dividend is paid, not the whole amount of dividend is added to the share price. If there is still a certain period of time until the dividend is paid, only the net present value of the dividend will be added to the share price. It also can be said that the circumferent the payment of the dividend observes, the more the amount of the total dividend payment is added to the normal share price. That also means that consequently the market value of equity also will rise.At the day ex-dividend day the share price will drop below the level of the pre-announcement day because the dividend as driver of the rising demand had been paid. The additional value of $5.01 that was is not part of the share value any more. The dividend, as part of the equity, is paid to the shareholder. Therefore, the dividend policy as a whole will not be a decisive ingredient in the firms value.Payout ratioHowever, in this scenario the payout ratio becomes a ridiculously hi gh 945% (Exhibit-4), which is genuinely high compared to peers. (Exhibit 2)SignalingBy deploying bang-up through an increase dividend versus a share repurchase, management is signaling that Linears stock is fairly valued in the market. However, If Linear increases its dividend similarly much say by giving out all the cash as dividends, management could signal to the market that it believes the companys process is slowing and there are no new positive NPV projects for the company to invest in.However, this may jockstrap send a positive signal that the company is confident about generating positive cash flows for its operational and investment needs. Since profits of Linear Technology this quarter was far lower than that work year, a huge special dividend may help the investors regain organized religion in the company.Agency problemsIncreasing dividend is also a good way to reduce agency costs. With large amount of cash balance in hand, managers control over the capital beco mes larger. Paying dividend to the investors is an efficient way to get additional monitoring of the capital, and thus make it less attractive to managers to invest the money in projects that will reduce the benefits of the shareholders.Tax ClienteleWith this very high dividend, the company may attract more European and/or mutual fund investors, but it may generally upset institutional investors who do not clear tax exemptions. Also, the announcement of a dividend may prompt older and poorer investors to buy more of Linears stock. (b) Share repurchaseShare price and Shares outstandingLinear can repurchase 50.7 (16.23% of common shares) million common shares by spending all of its cash. When they do that, the number of outstanding shares will be 261.7 million. Historically, the stock price of companies has locomote following a share repurchase announcement as it can boost EPS. In this case EPS increases to $0.65. (Exhibit-4)SignalingBy deploying all of its capital towards share repurchases, management can signal the market that its stock very undervalued. Linear has had a positive cash flow over the geezerhood and they have an opportunity with a net cash of $1.5 billion to brace the supposed valuation disconnect by accelerating share repurchases.In summary, if the company goes out with a big stock buyback or special dividend, it will send a signal to investors that the company, is no longer a growth company, and stock value may decreaseApproach 3 Payout 50% of Linear Technologys Cash2Considering that management does not have a good line of sight into the future at this point, paying out all of Linears cash may be a risky move. Hence, in this section we look at a less aggressive approach that lies between preserving their cash balance (Approach 1) and paying out all of their cash (Approach 2). In evaluating this approach, we have assumed that Linear will need to keep up its quarterly dividend at $0.05, and the balance wheel of the cash after accounting for this quarterly dividend is available for either a special dividend or a share repurchase.The following section analysis the progeny of paying out 50% of the remaining cash militia either in the form of a special dividend of $2.51 or by repurchasing 25.35 million shares.EPS and Share PriceIf we were to repurchase shares using 50% of the cash, the EPS will increase from 0.55 to 0.59 close to the 2002 poesy of 0.62. Using a price/ internet ratio of 56.53 in 2003 (Exhibit-3), we can estimate the share price to increase to 33.65 with this increased EPS, cum dividend.If we were to pay out a special dividend of $2.51 per share instead, the share price cum dividend could be estimated to be a fast comparable $33.38 (Exhibit-5). EPS will be 0.55, very close to Q2 levels (0.54).Payout RatioThe dividend payout ratio in the case of the special dividend will be close to 486.3% (Exhibit-4) which is once again much higher than all of Linears peers (Exhibit-2). In contrast, with a share rep urchase, the payout ratio remains at level consistent with introductory quarters at 27.5%.2 Exhibit 4 shows the calculations for numbers presented in this sectionFirm value and Shareholder wealthRepurchases will help alleviate some of the dilution of the EPS arising out of options awarded to employees and managers, considering that Linears incentives for all employees include stock options. On the other hand, dividends will help distribute the wealth more evenly among all investors, term repurchases cause an peckish distribution as the shareholders who do not sell will see a drop in book value of the shares, from$5.01 to $3.23 (rough approximation based solely on cash assets Exhibit 5. Tax ClienteleWith the new rules that stipulate equal taxation rate of 15% for Capital gains and OIC, there are no quantifiable advantages one way or the other with respect to the decision to payout either in the form of a special dividend or repurchases. There may however, be some psychological im pacts to be considered depending on selectences of the shareholders. For example, if the vast majority of shareholders belong to the older demographic, they may prefer it if the stock paid dividends.SignalingLinears investors are apply to getting a dividend, and seeing periodic repurchases. Additional payouts of cash help increase ROE and reduce shareholders risk premium. At current low interest rates on cash (as of 2003), paying out at least some of the cash balance appears to be in the high hat interests of the shareholders. Though high payouts may signal that the company is lacking growth potential, it helps send a positive message that the company is keen on sharing its wealth. This message of being a cash-cow is better compared to the image of a company that is hoarding its wealth.PeersA quick look at truisms financials indicates that they have started sharing their cash with their shareholders in 2002 their cash returned was over 200% of their FCFE (Exhibit-2), and their cash reserves reduced by 455 million. They appear to have used that cash in repurchases in an effort to concentrate their wealth among a smaller number of shareholders, at the same time they managed to increase their top line numbers significantly, even compared to 2000. By sharing half their cash with their shareholders, Linear will be able to put itself on par with this close competitor.Agency issues and other considerationsOne time special dividends dont need to be kept up, so are essentially similar to repurchases in that respect. However, repurchases help boost EPS and prevent dilution, both(prenominal) of which have longer-lasting effects. In this respect a repurchase may be better than a dividend. As far as agency issues go, retaining 50% of the cash position may not provide as much incentive to work harder on identifying positive NPV projects, as expending 100% of the cash, but will work much better than retaining almost all of the cash as in Approach 1.Our Recommendat ion for LinearOur passport to Linear is to maintain status quo with respect to dividends pay the quarterly dividend of $0.05 per share, and to buy back 25.35 million shares using half the cash balance. Dividends consistent with previous quarters of 2003, are recommended to avoid any adverse market reactions, while the company works on figuring out their strategy to increase top line sales and earnings to the 2000-2001 levels or better. Cancelling the dividend altogether or paying less than last quarter is not an option, as this would be perceived very negatively by the market. Historically, Linear has never increased dividends in the Q3 compared to Q2 hence it is safe to maintain a dividend of 5 cents per share as in Q3. Additionally, as shown in Exhibit-2, Linear already pays more dividends compared to peers, including their close competitor Maxim.Paying out all of the cash may deprive the company of the required levels of liquidity. Given that the analog semiconductor industry re quires constant innovation and considering opportunities for new ventures such as entering the Asiatic market, it is safe to assume that the company should keep somecash reserves to account for unknowns.Linear is well aware that they need to expand their business and find ways to increase top line numbers, so retentiveness some cash, and supplementing it with capital from debt or/and equity markets is worth looking into. This forms the footing of our reasoning for recommending the use of only 50% of the cash balance to repurchase shares.Additionally, by repurchasing shares, Linear will be able to still sufficiently signal to the market that the stock is undervalued. At the same time, by maintaining some of the cash balance, they additionally signal the existence of profitable positive NPV projects for Linear to pursue. Considering the industry characteristics, and the stagnation reached in top line revenues, Linear will need to look at innovation and new markets, both of which co uld make dramatic increases in growth. In light of this, we are convinced that the EPS boosting effect of a share repurchase is more valuable to Linear at this point, than the effects of an equitable distribution of shareholder wealth via special dividends.