Linear Technology Dividend Policy

Linear Technology Dividend Policy

Executive Summary

Paul Coghlan, the CFO of Linear Technology, needed to make a recommendation in front of the board whether or not Linear Technology should increase its dividend this quarter. The technology industry was struggling to emerge from a recession so it was unclear how strong business would be for the year. Linear Technology was known for designing, manufacturing, and marketing integrated semiconductor circuits that would be used in various electronic applications such as cell phones, cameras, medical devices, and navigation systems. Linear’s customer base spanned across many industries; no single customer made up more than 5% of the business. Coghlan believe that buying shares in Linear was not as risky as buying shares in most technology companies and that offering a dividend would give Linear a pathway to a new set of investors that had income and growth goals. Linear Technology announced its first dividend in 1992 because of the positive expectations of the future and the company had positive cash flows since their IPO. Even when the industry was in a recession in the early 2000s, Linear Technology still had a positive net income and net cash flow.  

1. Linear Technology announced their first dividend in 1992, because of their positive forecasts, best position in their industry and positive cash flows. The company’s payout policy is dividend payouts and stock repurchase. Their payout ratios has been growing ever since up to around 25% in 2003.

1. Linear Technologies has virtually no financing needs because of their internal factors. Since the IPO, the company had stable income and revenue growth for about 10 years (1992-2002) until the dot-com bubble.  Despite the economic decline, Linear was still able to have a positive income and net cash flow. As far as external risk factors go, Linear may need to need outside financing because of market risk as well as economic uncertainty. They may also want to use outside financing to fund future projects.

Linear should return some cash to its shareholders as long as it continues a continuous positive cash flows. This will keep investors satisfied and send positive market signals. In addition, returning a steady to shareholders reduces agency costs since the company will not be able to use internal funding for projects that do not bring value. Because of above mentioned external factors, it would be wise to retain some cash to use in case of future economic downturns or unexpected expenses.

The tax consequences of keeping cash inside the firm would prevent Linear from being able to deduct any debt and interest payments from the company’s net income, that otherwise could be used to reduce their taxes payable with debt financing.

1. If Linear were to pay out its cash balance as a special dividend its effect on its market value would increase due to the increase in the share price. The share price would increase from $30.87 to $35.88.Which will raise market value to $11,208,912. The earnings would also increase to $184.23 and the earnings per share would increase from $0.55 to $0.59. If Linear conducted a share repurchase it would also see positive results. The company would repurchase 50.7 million shares and lower its shares outstanding to 261.7 million. With three percent interest, there is only a slight difference in the loss of interest income between a special dividend and share repurchase.  Earnings will be the same as a special dividend payment but earnings per share with a repurchase would jump to $0.70 due to the fewer amount of shares outstanding. See Appendix 1.

1. Investors enjoy the income that comes along with dividends, so the investor will be more prone to buying into a company’s stock that has dividends. Investors often see a dividend payment as a way of management believing that future earnings for the company will be on the bright side.

e.           We feel that Paul should recommend they do not increase the amount of dividends.  The market is still recovering from the dot-com bubble and dividend payments are very inflexible, so if they were to do this they should look into repurchases and special dividends.  Instead of paying out dividends this quarter Linear Technology should think about investing this capital in ether new business opportunities or repurchasing stock. By repurchasing stock instead of paying out higher dividends, investors individual shares will rise in prices and they will also benefit from paying lower capital gains taxes. Thus saving them for paying the much higher income taxes they would be forced to pay on the money paid to them from the dividends. All of this will benefit Linear Technology the most in the long run because with a buyback the EPS will increase, thus generating more demand for the stock. Leading to an increase in demand, which will simultaneously increase the share price.