Harvard Case
Harvard Business Review
Proposed solutions: Strength Analysis
Linear Technology Corporation grew strong for it time, by being one of the few companies with their designed and manufacturing parts being used in use cellular telephones, digital cameras, complex medical devices, and navigation systems. With the world being more focusing on technology, and with every consumer wanting the new and latest tech on market there is no surprised that Linear’s customers accounted for 5% of their business. Later with Linear getting involve with other industries, they would increase their customer base with 27% in computers, 6% automotive and 34% within few other industry. Proving that you need to expand if you want to grow. Linear put themselves on the map when they started to focus on analog segment which were used to regulate power that is need in common product today like cell phones and digital cameras. With Linear getting into the analog industry, competition will be key, but hiring the top engineers to help them grow and be one step ahead of their competitors. With everything that Linear done to strengthen their company, they were ranked the seventh-largest company when up against Maxim, Analog Devices, and National Semiconductor.
Proposed solutions: Potential risks involved in this credit derivative deal
Raising the dividend yield for Linear Technology Corporation in 2003 would involve a lot of risk. From an investor's point of view; it signals that company growth is slowing down. From management’s point of view; it would be a more effective strategy to either reinvest income into growth or to save the money (considering the uncertain business environment at the time).
The major risk involved for investors is that when a company increases its dividend yield it is usually a signal to the market that a company’s growth rate is slowing. Linear Technology does not want to signal to investors that their growth rate is slowing. Investors invest with the intention of profiting from their investment. When a company increases its dividend yield it is choosing to pay its free cash flow back to investors rather than reinvesting the free cash flow back into the company. This can be perceived as a negative sign to investors because it shows them that the company does not think that they would make more money by reinvesting in their own growth. Richard Shaffer, publisher of the Technologic Computer Letter, wrote that “When a high tech company starts paying a dividend, that indicates the company believes that shareholders can make higher returns going elsewhere. If I were an Intel shareholder, I’d rather they put my 40 cents a year back into innovation.” If the company were to reinvest the free cash flow into their growth rather than paying it out to investors in the form of a dividend, then they could grow that investment which could potentially yield more profit for an investor. An investor looking for big gains usually stays away from dividend stocks.
The major risk involved for management is that the business environment was not particularly promising. Linear’s “sales, gross profit and net income peaked in FY 2001 when technology spending worldwide was at an all-time high. Business slowed down considerably in FY 2002, and Linear finished the year with net income of $198 million relative to $427 million from the previous year.” Although net income had began rising again in 2003, it was still far from it’s all time high set in 2001. In addition, “the technology industry was still emerging from a recessionary environment and it was unclear how strong business would be for the remainder of the year.“ To make matters worse, the United States had just declared war with Iraq and wars can have detrimental effects on a nation's economy as a whole. Considering the risky business environment that Linear Technology corporation faced, it seemed to be in their best interests to either reinvest their free cash flow or save it for any unforeseen setbacks that they may face (rainy day fund).
Critique / Evaluate on the proposed “talk points” to clients
Profitability and investment opportunities
Many people argued that Linear Technology was too young and unpredictable to initiate a dividend policy. More established companies that have more consistent cash flows are usually the companies that initiate dividend policies. Some experts recommended that Linear Technology initiate a stock repurchase program rather than a dividend policy. I highly agree with this analysis. David Readerman, growth stock strategist at Thomas Weisel Partners explained, “Executives will be cautious about signaling to the market that their growth rate is slowing, which is what a dividend is usually seen as doing.” By initiating a repurchase program Linear Tech would be able to increase the stock price (by buying the stock), without signaling to investors that their growth may be slowing. This would be an ideal solution for Linear Technology.
Executive stock options
Many technology companies often offer extra stock compensation to managers and employees. They choose to do this because managers often invest in options rather than straightforward stock purchases. With much of their pay in options, managers have no reason to initiate dividends. This is because as a stock price rises, the value of an option rises directly; however, a dividend payment would have absolutely no effect on the price of an option. In order to keep top managers satisfied, it would make more sense for Linear Technology to reinvest their free cash flow rather than pay ot to shareholders through a dividend. Also, as a practical matter, “many tech companies use their available cash to buy back shares to offset the dilution caused when employees exercise their options. If companies instead pay out their cash in the form of dividends, then their shares outstanding will continue to rise, which means that their earnings per share will suffer—even as a dividend soaks up ever more cash.” Considering this, it seems more logical for Linear Technologies to reinvest cash rather than payout a dividend.
Taxes
“In January 2003, President George W. Bush proposed a radical change to the taxation of investment income.” His plan would eliminate taxes on dividends that get distributed from a company's earnings because they had already been taxed when the earnings were reported. Later that year, the House of Representatives proposed a similar bill, that lowered the tax rate on dividends on capital gains down to 15% from 38.6%. Blaine Rollins, the lead portfolio manager of the Janus fund said that “if the proposal went through, he would encourage companies to use both mechanisms. For companies with strong excess cash flow such as Linear, I would suggest saving a third of the cash for a ‘rainy day’ and sharing the other two-thirds with investors, split equally between dividends and buybacks.” Rollins conclusion seems logical; however given the uncertainty in the economic environment, I would not count on laws getting passed. I would look at the situation as is, and see that raising the dividend was still not a good idea. If the laws passed, then Linear Technology could always just raise the dividend for the next year. For now though, Linear Technology should reinvest their cash flow instead of raising their dividend.
Market valuations
“Since the middle of 2000, the returns of dividend payers had outstripped those of nonpayers by a wide margin. The semiconductor industry was no exception. These returns, and the wake of the recent corporate scandals at Enron and Worldcom, had ignited interest in dividend-based investing.” Because of this many investors wanted certainty. Rollins said “Without a tax change, I would have said ‘No’ [to Linear raising its dividend]. With a change, I am comfortable with their consistent increase. I see it as having a bird in the hand versus two in the bush. Linear’s dividend lowers its equity risk premium in today’s market, which is something we like.” Rollins makes an excellent point here. Although raising the dividend signals to investors that the growth of the company is slowing, it also signals to investors that the company is established enough to raise its dividend consistently through economic hardship. As an a manager, this is good reason to increase your dividend.
