Dividend policy at Linear Technology analysis

Group: G05

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 Its 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 firms cash reserves are huge 1|Page CF-2 Assignment

Dividend policy at Linear Technology analysis

Group: G05

10. Few feel dividend policy as companys acceptance of the fact investors can gain more elsewhere 11. Lets 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 Linears 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: Lets 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: Lets 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), persons 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 Persons new share capital value:159.90+160.06+2767.04= $3087 As the shareholder value is remained same, while holders risk premium associated with LLTC is reduced, part buy-back & part dividend payment policy is most welcomed However, if the Bushs 2003 tax reforms were delayed, this option may not be attractive than that of share repurchase

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CF-2 Assignment