Dividend Policy at Linear

Technology
Group 2I | Case Analysis

Case Synopsis:
Linear Technology was found in 1981 by Robert Swanson and it focused on
designing, manufacturing, and marketing integrated circuits or semiconductors
that had electronic applications like in cellular telephones, digital cameras,
complex medical devices and navigation systems. In 2002 its customers included
communications industry, computers, automotive and others and no single
customer accounted for more than 5% of its business.
It focused on analog segment which were custom-designed for each application
and the technology could be used for more than ten years unlike analog fabs and
the R&D expense was also modest at $102 million in FY 2001. It competed with
Maxim, Analog Devices and National Semiconductor. It is the seventh largest
company by market capitalization in Philadelphia SOX.
It had went public in 1986 and had split four times since its IPO. Its sales, gross
profit and net income peaked in 2001 when technology spending worldwide was
all-time high. Sales fell down in 2002 but it was still able to maintain good cash
flows by holding its margin through cost cutting and work shutdowns. It had
established a variable cost structure early in its existence because a large
fraction of employee compensation was through profit sharing and employee
stock options. But due to declaration of war by US on Iraq the scenario seemed
unclear.
They had declared a dividend of $0.05 per share so that they could get access to
a new set of investors. Even after sales drop in they decided to continue to
increase their dividends to validate their ability to be profitable and cash flow
positive.
They went for positive cash flow to return additional money to shareholders. As
the cash not earning interest income in high grade securities they were
encouraged to buy back shares. They still had large cash balances as the cash
was managed very conservatively in short term securities, interest income
earned $52 million.

Various Levels of Problems/Issues:

Dividend payers were mostly seen as ones with slower growth and fewer future
growth opportunities. Also as most investors were looking for higher share prices
rather than dividends.
In 1999 only 21% of firms were dividend payers. Growing rate of dividend was
seen by market as signaling slowing growth rate. However by buy backs not only
were they able to come up with better earnings per share but also as managers
themselves held bulk of their pay in options they had little incentive to pay
dividends.
Due to government regulations dividends and capital gains were taxed twice at
investor and corporation level but there was a bill which proposed reduction of
tax rate of 15%. There was market reversal in market from early 2000 when
nonpayers were the star performers.

Analysis:
By not returning cash Linear was able to save the double tax which is levied on
dividend payouts. The company has to pay the corporate tax on EBIT, it saved
the personal tax which shareholders on dividend amount. By varying the
dividend in the given range the tax outflow could be saved by around $1.87-$2.8
million.
This tax saved can be used for exercise repurchase option which is used to offset
dilution of shareholding through employee stock options.

Recommendation:
The alternative of dividends payout would attract double taxation by the
government and proportionate transfer to shareholders wouldnt happen
compared to buy back. Also the shareholders were mostly interested in share
price growth rather than dividends.

Tax Consequences of Dividends (All figures

are in $Million)
Outstanding New Total Total Tax
Shares Dividend Dividend Paid
Paid
312.4 0.04 12.496 1.8744
312.4 0.045 14.058 2.1087
312.4 0.05 15.62 2.343
312.4 0.055 17.182 2.5773
312.4 0.06 18.744 2.8116

The option of paying dividends would attract institutional investors but the
market conditions had changed and non-payers were going well and were the
star performers.

Dividend

Cash paid
as dividend 1565.2

Tax paid 234.78

Dividend 5.0102
per share 43
Dividend
received by
shareholde 4.2587
r 07

New Share 26.611

Price 29

Change in
value of 1330.4
the firm 2

Repurchase would allow the company transfer its profits to the shareholders
without paying too many taxes to the government. Also as the management
were holding the stock options it was more logical to buy back shares from
employees than increase the dividend which would also reduce the EPS ratio.

Repurchase

Cash used for

repurchase 1565.2
No. of shares
repurchased 50.7029478
No. of
outstanding
shares 261.7
Net Income (for
2002) 197.6

Net Income (for

2003 at 3%
growth) 231.9
Net Income (for
2003 at 7%
growth) 233.95

EPS (for 2003 at

3% growth) 0.88613914
EPS (for 2003 at
7% growth) 0.89397262

P/E (for 2003 as

referenece) 56.534
New Price of
Share (for 2003
at 3% growth) 50.09699
New Price of 50.5398482
Share (for 2007
at 3% growth)
Change in Value
of the firm (for
2003 at 3%
growth) 3466.4466

Change in Value
of the firm (for
2003 at 7%
growth) 3582.3413

Conclusion:
The company should go share buybacks instead of any increase in dividend
payouts. However if the tax rate reduces to 15% then it should go for the
combination for shares buyback and increase in dividend payout.