Linear Technologies Case
Linear Technologies Case
1. Linear’s historical payout policy has been to pay a quarterly dividend of $0.05/share and use any additional funds to repurchase shares to increase shareholder value. This kept their payout ratio to around 15% until about 2002 where this dividend payout moved the ratio to around 25% to 30%. Currently Linear is sitting on a large amount of cash ($1.5b) that they are investing in very low return securities. They currently don’t have any investment opportunities available so they are considering using this money to payout a one time dividend.
2. The current value of the firm can be calculated by multiplying the share price in Exhibit 3 by the number of shares: V = 30.87 x 312.4m = $9,643m
If Linear paid out a one time dividend we would expect the value of the firm to go down by exactly the value of the dividend payment or $1.5b. As the value has gone down by that amount, we would take the new value of $8,143m and divide it by outstanding shares of 312.4m to determine a new share price of $26.07. We’d also expect earnings to decline by the interest income that Linear is making on its cash or 3% of $1.5b or $45m. Based on the current shares outstanding this reduces earnings/share by $0.144 for the foreseeable future.
If Linear repurchased shares you would expect the value of the firm to decrease by the same amount as the dividend payout but the share price should remain unchanged because now by repurchasing shares you have reduced shares by the value of the cash. You would expect the same decrease in earnings and earnings/share as a dividend payout as the firm is no longer able to receive income from it’s additional cash.
3. The tax implications of keeping it inside the firm is that the firm will continue to get taxed on it’s interest income at a corporate tax rate that is (probably) higher than the capital gains or dividend tax rate that investors will have. If the firm pays it out as a dividend their investors are required to pay a tax immediately. As the $1.5b is a substantial amount, this could create a very large amount of taxes that investors will need to pay based on this decision. On the other hand, if the firm repurchases shares this will increase the value of current shares outstanding which will trigger a capital gains tax. However, as capital gains taxes do not need to be paid until the investor sells the shares, this would delay or allow an investor to slowly determine when to sell shares, allowing them to sell them in years they have other losses to offset their overall tax burden.
4. Linear’s decision is related to information asymmetry because outsiders don’t have the information that Linear’s management team does. If Linear pays out the cash (via repurchase or dividend) they are signaling to the market that they do not have any profitable investment activities and could signal that there overall growth is slowing (as typically, high growth, tech firms do not pay out large dividends). This isn’t necessarily true, it could just mean that Linear doesn’t need the cash in the short term for any upcoming projects. If Linear did happen to come across an attractive investment opportunity after this distribution they could always raise capital later on through share issuance or debt offering. In addition, by holding a large portion of cash on its balance sheet, it is signaling that they are not using the cash for internal projects and investors may worry that they will not use the money in the most optimal way.
5. Linear should return a small portion of cash to shareholders via a stock repurchase (less than $500m), because they do not want to set the precedent that every time they have large amounts of cash that they will be willing to pay it out to shareholders. In addition, as they have had some market pressures they should keep an additional amount of cash on hand to help raise investment income so they can continue to pay out their quarterly dividends. If they distribute their entire cash reserve they could be cash constrained when it comes to their quarterly dividends especially as their dividend payout ratio is almost 30%. They do not want to signal to the market that they do not have other opportunities to use their cash on hand; especially in a downturn because it could create fear in its investor base that the company has begun to hit a downturn and doesn’t have profitable investment activities in the foreseeable future.