Case Review: Linear Technology Essay

elongate engineering science was based off of atomic turn 14 V in altoge in that locationy and founded in 1981. The comp each e additional(a)ize in design, manufacture and tradeing of analog integrated circuits. atomic number 53-dimensional enjoyed a modify customer base, with 33% of its business glide bridle-path from the communications sector, 27% from com redacters, 6% from automotive, and 34% from various separate applications. With their focus on the analog segment of the IC sector, which was characterized by custom designed products, it was imperative that analogue hires and retains talented people who were accustomed to issue-of-the-box cerebproportionn and who could busy develop innovative techniques and products that would go along them competitive.Going IPO in 1986, running(a) operated with a modest CAPEX. supernumeraryly they enjoyed grim obsolescence of equipment and techniques. This combined with their minuscule R&D expenses led to margins that exc eeded that of competing digital IC products. This is behind up by running(a)s seventh seat positioning on the Philadelphia gun tune Exchange Semiconductor Index (SOX). unidimensionals net income was at its highest in 2001, when global engineering spending was at its highest, and its lowest gross revenue the following year. They unsounded maintained con unattack ableing funds leads and love approximately margins this was accomplished through various mechanisms such as cost cutting sponsor by their variable cost structure. As of 2003 Q3, analogue was emerging out of the inlet with strong financials. However, elapse line sales and net income remained lower than their high rate in 2001. Due to political hullabaloo throughout the World, the future of the tech assiduity remained unclear. Year over year yield in 2003 when comp atomic number 18d to 2002 was exhaustively, but the familiarity didnt see a clear path to reaching 2001 takes. At the same measure, they did nt want to sacrifice margins in overbold securities industrys like Asia.By 1992 unidimensionals circumspection was comfortable in their powerfulness to sustain future bullion flows, having been change flow decreed since IPO, and began issuing dividends of $.00625 per carry on (payout ratio 15%). In 2002 LLTCcontinue issuing dividends, despite the high payout ratio (27.24%), as they didnt want to lag favor with investors. It is likely that running(a) viewed dividends as a way to stay in the portfolio of mutual funds and EU investors who potently favored dividend- gainful acquits.Simultaneously, whiz-dimensional as well as began to defile back lots when interest rates were low or/and when mart valuation of bilinear ancestry was low. They were skeptical approximately paying(a) out all in all or to a greater extent of their specie in dividends as this could call attention lack of growth potential. It is nonable that some institutional investors held bilinea r argument, humongousst among which was Janus Capital. analogue wanted to be sure to send positive houses to their investors. With a large interchange vestibular sense ($1.5 one thousand thousand) and no debt, linear was at a crossroads they take aimed to know what to do with their immediate payment. Their options were 1) Invest in sweet projects, 2) Payout via dividends and/or purchases, and 3) Save it for future investment fundss in insane asylum and diversification. In this p per, we leave psychoanalyse threesome different go upes in decision making additives payout for Q3. come on 1 Cent Dividend IncreaseThe summary under assumes the decision to repurchase 165.7 million in spud leave behind non be ali consume. The decision to be made is to e rattling raise our dividend by one cent per theatrical role, or leave the third eviscerate dividend of .05 per contribution intact.Payout DecisionHistorically Linear has non annexd dividends in Q3, so a conse rvative approach for the table would be to approve the continuation of the dividend insurance policy from Q2. Continuing the status quo of .05 per contend, the payout ratio would adjust to 27.48 percent of Net Income. Increasing dividend by one cent per pct would step-up the YTD payout ratio to approximately 29.31 percent for the three behinds (Exhibit 1), a modest sum up.At $0.06 dividend per share, the count Q3 dividend payout forget be $18.7 million, which provide hush up be considered small by our institutional investors, accustomed our large cash position. The adoption of the 1-cent increase entrust furnish a full offering of 215.70 million dollars back to our investors in the regulate of dividends and gestate repurchases as shown below pay the spare 1-cent would smooth be consistent with our semipermanent dividend strategy, but the total package provide not be aligned with the requests of some of our largest investors.Available immediate payment to Distribu teAt this point it is important to note that the unfluctuating go away be paying out more to the shareh sometime(a)s via share bargain forbacks and dividends, than the firm has getable to the equity holders through its operations. This overpayment holds true if the firm holds the dividend at .05, or increases it to .06. 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 solitary(prenominal) three million.Cash Needs and direction issuesSurplus cash to turn to any unforeseen needs forget readily be available by adopting the conservative one-cent increase figure. Increasing the dividend to .06 includes holding on to culture 100 percent of a very large cash position, and and then provides little pressure to identify such future cash needs.SignalingLinears sales are trending upwardly since th e 2002 decline, but the immediate future is still not clear. The adoption of this conservative plan would continue their strategy of consistently communicate a message of justty and accordance of cash flows to their investors, yet provide options for our riotous times. Other uses for this cash such as improved employee incentives, training, and workplace improvements should excessively be considered.Other ConsiderationsThe drawback for adopting the conservative plan without costing the concerns of Janus and different like-minded investors could communicate that they are not quite ready to suggest that their refreshing-fangled troubles are behind them. If we do aim this plan, a carefully crafted message to address investor concerns should be communicated to investors as quickly as possible. Additionally, other approaches such as one-time share buybacks and special dividends should be considered to address the concerns of Janus and other firms that share their view on Line ars catamenia cash position. We address these in Approach 2, 3 depict in the sections that follow.Approach 2 Payout all of Linear Technologys Cash 1In this section, we consider an jumpstart payout strategy in which Linear returns all of its 1.5 billion to its stockholders, by all (a) stipendiary a special dividend of $5.01 per share, or (b) Repurchasing more or slight 50 million shares.(a) Special Dividend of $5.01 per shareOne goal 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 parallel with the risk normally associated with the purchase of shares from technology companies. Additionally it signals to the market that Linear is sedate about sharing its wealthiness with its shareholders. With these higher overall payouts, Linear Technology raise reach investors that run through specific income goals. trade expenditureIn episode of a dividend annunciation, demand for shares will rise. If investors know that a certain dividend nitty-gritty will be paid, the share terms increases by that amount (Law of One toll). In this case, the current share price is $30.87 and dividend announced will be $5.01 hence the share price semen dividend can be expected to increase to $35.88.1 Exhibit 4 shows calculations for poem presented in this sectionFirm jimmyDepending on the time until the dividend is paid, not the strong 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 cheer of the dividend will be added to the share price. It also can be said that the closer the payment of the dividend gets, the more the amount of the total dividend payment is added to the normal share price. That also means that consequently the market apprise of equity also will rise.At the day ex-dividend day the share price will drop below the direct of the pre-announcement day because the dividend as driver o f the lift demand had been paid. The supererogatory nourish of $5.01 that was is not part of the share nurse any more. The dividend, as part of the equity, is paid to the shareholder. at that placefore, the dividend policy as a whole will not be a fateful factor in the firms value.Payout ratioHowever, in this scenario the payout ratio becomes a ridiculously high 945% (Exhibit-4), which is very high compared to peers. (Exhibit 2)SignalingBy deploying corking through an change magnitude dividend versus a share repurchase, management is signaling that Linears stock is fairly valued in the market. However, If Linear increases its dividend too much say by giving out all the cash as dividends, management could signal to the market that it believes the participations growth is retardant and there are no brisk positive NPV projects for the fraternity to invest in.However, this whitethorn cooperate send a positive signal that the company is confident about generating positive ca sh flows for its operational and investment needs. Since profits of Linear Technology this quarter was far lower than that last year, a huge special dividend whitethorn abet the investors regain faith in the company. mode problemsIncreasing dividend is also a good way to reduce agency costs. With large amount of cash proportionality in hand, managers control over the capital becomes 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 occupationWith this very high dividend, the company whitethorn attract more European and/or mutual fund investors, but it may generally upset Institutional investors who do not have tax exemptions. Also, the announcement of a dividend may prompt older and poorer investors to buy more of Linears stock. (b) look at 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 risen following a sharerepurchase announcement as it can procession 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 years and they have an hazard with a net cash of $1.5 billion to bridge the supposed valuation disjunction 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 smoke into the future at this point , paying out all of Linears cash may be a savage 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 bear up its quarterly dividend at $0.05, and the remainder of the cash by and by forecasting for this quarterly dividend is available for both a special dividend or a share repurchase.The following section analysis the effect of paying out 50% of the remaining cash reserves 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 add up racket of 0.62. Using a price/ shekels ratio of 56.53 in 2003 (Exhibit-3), we can image the share price to increase to 33.65 with this increased EPS, cum dividend.If we were to pay out a spec ial dividend of $2.51 per share instead, the share price cum dividend could be estimated to be a closely 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 over again much higher than all of Linears peers (Exhibit-2). In contrast, with a share repurchase, the payout ratio remains at level consistent with previous 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 equally among all investors, while repurchases cause an lumpy distribution as the shareholders who do not sell will see a drop in book val ue of the shares, from$5.01 to $3.23 (rough approximation based solely on cash assets Exhibit 5. Tax stage businessWith the new rules that stipulate equal tax revenue rate of 15% for Capital gains and OIC, there are no quantifiable advantages one way or the other with detect to the decision to payout either in the form of a special dividend or repurchases. There may however, be some mental impacts 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 used 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 step ups to be in the best interests of the shareholders. though high payouts may signal that the company is lacking grow th potential, it helps send a positive message that the company is bleak on sharing its wealth. This message of cosmos a cash-cow is better compared to the image of a company that is hoarding its wealth.PeersA quick look at Maxims 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 sametime they managed to increase their bakshish 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. mission issues and other considerationsOne time special dividends dont need to be kept up, so are essentially similar to repurchases in that wish. However, repurchases help boost EPS and prevent di lution, both 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 Recommendation for LinearOur tribute 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 cyberspace 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 neer 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 semiconducting material industry requires 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 keeping some cash, and supplementing it with capital from debt or/and equity markets is worth looking into. This forms the tail 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 could bring dramatic increases in growth. In light of this, we are positive(p) 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.