Dividend policy at Linear Technology analysis Group: G05

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Case Submission by: Tarun KSG (10DM-162), Saurabh Thadani (10FN-102), Srikanth Konduri (10FN-109),

Tushar Gupta (10FN-115), Nikhil Gupta (10FN-121)

1. Management is debating on the amount of dividend to be paid, corresponding to Q3 FY2003

Purpose: To create a perception (+ve) of its growth prospects among investors

It’s a sign of strong +ve cash flows, profitability of the firm

So firms remain cautious about their pay-out ratio, to sustain their payments in long-run

Ultimately, to maximize the value of shareholders

2. Findings of Academic research: A +ve link between dividend yields & future returns

Probably because: Paying out dividends increases tax burden on the firm

Which encourages management to make better investments with available cash

3. Incentivised to pay dividend only when firm is confident of the future

So that investors will be sure of receiving regular dividend even during downturns

As during downturns interest rates outside fall to low-levels, even 1% dividend yield looks gr8

Propels to increase its market/book ratio relative to non-paying ones

Many Mutual Fund companies & Euro Investment firms prefer stocks with regular dividends

4. Restraint from Executive level employees:

These days technology companies follow a variable cost structure

By making ESOPs as a considerable portion of their compensation & pay as per earnings

So, those guys will try to exercise their options only when the stock price is at higher levels

They will not be interested in the incentive of dividend payment

As that exercise creates dilution, firms will buy-back the shares to offset that effect

5. It will not pay dividends if there are not enough cash-earnings (after off-setting dilution )

Paying dividends without buy-backs will suffer its EPS, though provides cash to investors

6. Restraint generated from its own dividend payment policy during downturns: (along with Iraq war)

For paying dividends, firms need cash reserves

During economic slowdowns, interest rates will be pretty low, rules out short-term investments

In order to maintain cash position even at that time, firms will tend to buy-back shares

7. Restraint to dividend pay-out ratio from its strategic growth pursuit: (Analog-semiconductors)

Looking out for opportunities in Asia while being cautious about bottom-line margin

Investment in R&D($102mn in FY 2001), retaining talent, building fabrication facilities($200mn)

8. In the wake of tax reforms, institutional investors welcome dividend payment

As it reduces the equity risk premium associated with the stock

Corporate scandals like ENRON,WORLDCOM have reinforced this notion

9. If the tax rates are expected to be constant at least for a complete financial year

Institutional investors would rather prefer buy-back than dividend payments(to prevent tax)

Putting it in other way, they expect special dividends if firm’s cash reserves are huge

Dividend policy at Linear Technology analysis Group: G05

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10. Few feel dividend policy as company’s acceptance of the fact investors can gain more elsewhere

11. Let’s see the policy of its benchmark competitors:

Intel, Maxim & Microsoft all have been following regular stock splits

Maxim & Linear have got many similarities, along with institutional investors

Microsoft promised to shift towards dividends after settling its legal claim worth $1.1bn

Linear’s position is 7th in terms of Market Capitalization on Philadelphia SOP index

12. Keeping in mind its : objective of maximizing share-holder value

For long-term relationship maintenance with investors who are bottom-line concerned

Share price of Linear Technology at the end of Q3 FY2003: $30.87

Market Capitalization at the end of Q3 FY2003 is: 312.4*30.87 = $9643.788mn

Net Cash flow during Q1-Q3 of FY2003: $13.2mn; (POR) 2002=54/197.6=27.33%

Total Cash & Short-Term Investments till Q3 FY2003: $1565.2mn

EPS during (Q1-Q3) = 170.6/312.4 = 0.5461

If the Cash flow is used to buy-back shares:

No. of shares brought back = 13.2mn30.87 = 427,600

New No. of shares=312.4-0.4276 = 311.9724mn

As share price remains intact, new Mkt. Cap. = 311.9724mn*30.87 = $9630.588mn

Post buy-back EPS = 170.6/311.9724 = 0.5468

(∆EPS) post buy-back = 0.00075;(∆Mkt. Cap.) post buy-back = -$13.2mn

As Mkt. Cap. Is reducing with this option, only buy-back policy is ruled out

If the cash reserves are used to declare special dividend:

Let’s assume special DPS to be $2.5

2.5*312.4mn=$781mn has to be taken out of their cash reserves

Share price will fall by $2.5 and new share price = 30.87-2.5 = $28.37

(∆EPS) post buy-back = 0; (∆Mkt. Cap.) post buy-back = -(311.924mn*2.5)= -$779.81mn

As Mkt. Cap. Is reducing with this option, only special dividend policy is ruled out

If part of cash reserves are used to buy-back & part to declare special dividend:

Let’s assume that $500mn is used each for dividend payments & buy-backs

For a person holding 100 shares of LLTC, now 5.18 shares will be brought back

(Calculations are present in the attached excel), person’s initial stock value:$3087

Cash obtained from buy-back: 5.18*30.87 = $159.9066

Now, cash earned from dividends declared for remaining 94.82 shares is: $160.06

Ex-dividend date value of the stocks held =94.82*(30.87-1.688)=$2767.04

Person’s new share capital value:159.90+160.06+2767.04= $3087

As the shareholder value is remained same, while holder’s risk premium associated with

LLTC is reduced, part buy-back & part dividend payment policy is most welcomed

However, if the Bush’s 2003 tax reforms were delayed, this option may not be attractive

than that of share repurchase