Dividend Policy at Linear Technology

HBS case no. 9-204-066

Case details
1) April 2003 - Paul Coghlan, CFO wants to prepare recommendation for dividend decision.
2) Linear Technology - a semiconductor manufacturing company focussing on analog chips
3) First dividend announced on Oct 13, 1992. Quarterly div was set at a low figure of $0.05 per share. LT
4) LT paid dividends each quarter since then. In spite of drop in earnings in 2002, LT continued with the i
5) LT also repurchased shares on many occasions (Ex 3).
6) LT still hd a large cash balance - $1.56 bn with sales of $440 mn in 2003.
7) Some shareholders feel that LT should declare a special dividend due to large cash balance.
8) Dividend payers tended to be larger, more consitently profitable firms, with slower growth in sales an
9) Over time the trend was to move away from dividends. In 1978, 2/3 rds of companies in NYSE, AMEX
Technology firms were driving the trend.
10) Some issues in dividend policy trends: a) Profitability and investment opportunities - As a company e
it usually considers dividend payment. Repurchases are more flexible as they are discretionary and no ex
b) Executive stock options: Managers have little incentive to pay dividend since they gain by exercising E
c) Taxes: Janus fund, no. 1 institutional shareholder, suggests that LT should save a third of the cash for "
dividends and repurchase.
d) Market valuations: Since the middle of 2000, the returns of dividend paying stocks outstripped non di
11) Dividend policy at Technology firms: a) Intel - paid dividend over 10 years, split stocks several times s
paid dividend of $0.02 per share on a quarterly basis. b) Maxim: It was similar to LT in size and fianncial p
dividend of $0.02 per share from fall 2002. c) Microsoft - paid first quarterly dividend of $0.04 per share
d) Cisco - in 2002, shareholders rejected a proposal to initiate dividend, Cisco preferred to use cash for in

Exhibits
1) Linear Stock Price History, 1986-2002
2) Selected Linear Financial data, 1992-2003
3) Linear Payout Policy, 1992-2003
4) Top 10 Institutional Shareholders, 2003
5) Dividend Policy for the S&P 500, Annual Data from 1993-2002
6) Cumulative Executive Compensation, 1993-2002
7) Tax Rates, 1960-2002
8) Municipal and Corporate Bond Yields
9) Market to Book Ratio of Dividend Payersand Nonpayers, 1960-2002 / Dividend Initiation Rates and Ini
10) Price Index of Dividend Payers and Nonpayers on the PhiladelphiaStock Exchange semiconductor Ind
11) Data on Companies in the Semiconductor Index (SOX), 2002
12) Selected Financial Data, 1998-2002

Case questions
1) Describe Linear Technologies payout policy.
2) What are Linear's financing needs? Should Linear return cash to its shareholders?
What are the tax consequences of keeping cash inside the firm?
3) If Linear were to pay out its entire cash balance as a special dividend, what would be the effect on valu
On earnings? On EPS? What if Linear repurchased shares instead? Assume a 3% rate of interest?
4) Why do firms pay dividends? Why has the rate of dividend initiations changed over time?
5) What should Paul Coghlan recommend to the Board?
 vidend decision.
on analog chips
w figure of $0.05 per share. LT was hopeful to sustain the payout ratio in future.
2002, LT continued with the increase in dividend to convey positive outlook.

large cash balance.

with slower growth in sales and assets and fewer future growth opportunities.
of companies in NYSE, AMEX ans NASDAQ paid dividends but only 21% in 1999.

pportunities - As a company establishes regular and predictable cash flows.

ey are discretionary and no expectation about repitition.
since they gain by exercising ESOPS if share price goes up.
d save a third of the cash for "rainy days" and spend the rest equally between

ying stocks outstripped non dividend payers.

ars, split stocks several times since 1992, had not increased dividend since 2000,
ilar to LT in size and fianncial performance, would start paying a quarterly
y dividend of $0.04 per share in March, 2003, historically they preferred repurchase.
co preferred to use cash for investment or share repurchase.

vidend Initiation Rates and Initiations

k Exchange semiconductor Index (SOX), 1998-2002

hat would be the effect on value? On the share price?

a 3% rate of interest?
anged over time?
Analysis

Ratio Analysis, 1992-2003

June Fiscal Year 1992 1993 1994 1995 1996

Sales 119.4 150.9 200.5 265 377.8
Net Income 25.0 36.4 56.8 84.7 134
Operating cash flow plus CAPX 28.8 42.4 62.5 103.9 164.7
Capital Expenditure 9.8 7.6 16.2 22.1 70.4
Market value of equity 661.3 1,030.0 1,597.6 2,428.1 2,239.8
Shares outstanding (split adjusted) 280.2 285.4 290.5 294.3 298.6
Dividends Paid 0 5.3 8.3 9.8 11.9
Stock repurchases 0.7 1.2 1.3 6.1 22.9
Earnings Per Share 0.09 0.13 0.20 0.29 0.45
Share Price, Fiscal Year Close $2.36 $3.61 $5.50 $8.25 $7.50

Dividend Policy
Dividend payout ratio 0.0% 14.5% 14.6% 11.6% 8.9%
Dividend yield 0.0% 0.5% 0.5% 0.4% 0.5%
Div per share (split adjusted) $0.00 $0.02 $0.03 $0.03 $0.04
Repurchase per share (split adjusted) $0.00 $0.00 $0.00 $0.02 $0.08

Profitability
Net income (% of Sales) 20.9% 24.1% 28.3% 32.0% 35.5%
Cash flow (% of Sales) 24.1% 28.1% 31.2% 39.2% 43.6%

Investment
CAPX (% of Sales) 8.2% 5.0% 8.1% 8.3% 18.6%
Pre-Investment cash flow (% of CAPX) 2.9 5.6 3.9 4.7 2.3

a
First thee quarters of FY2003.

Q 1) Describe Linear Technologies payout policy.

Pl see Ex. 3.
LT initiated a dividend in 1992. Since then it has raised the dividend by $0.01 per share once a year or whe
The above analysis shows dividend policy expressed in terms of 2003 shares outstanding. The dividend pa
With another $0.01 increase in dividend in 2003, the payout ratio would be 33.1%.
Repurchases have been larger and more variable than dividends. Over the past 5 years, repurchases pea
For 7 quarters between Q3 of FY 1999 and Q1 of FY 2001, LT made no repurchases.
Q 2) What are Linear's financing needs? Should Linear return cash to its shareholders? What are th
LT does not have any external financing need. It has a cash balance of $1.57 bn. LT could fund $0.06 div p
This is because of the variable cost structure of LT (Pg 2 of the case). Though sales dropped 47% in 2002

LT could return cash to its shareholders after meeting all other funding requirements.

Whether to hold cash inside the firm or pay out to the shareholders depends on the relationship between c
If the cash is held in the firm but invested outside say in T-bonds, the money earned will be taxed at the co
the tax will be at the personal tax rate.

Q 3) If Linear were to pay out its entire cash balance as a special dividend, what would be the effect
On earnings? On EPS? What if Linear repurchased shares instead? Assume a 3% rate of interest?
Let us look at the following table.
Policy Share price Earnings Shares
Retain $1,552 mn $31.43 $197.6 mn 316.2
Repurchase shares worth $1,552 mn $31.43 $165.7 mn 266.8
Pay special dividend of $1,552 mn $26.52 $165.7 mn 316.2
=31.43-1552/316.2

Q 4) Why do firms pay dividends? Why has the rate of dividend initiations changed over time?
Why pay dividends: Tax issue, signalling, clientele effect, agency issues

Time variation in dividend: In US, most listed firms paid dividends in 1960s, fewer than 21% firms paid dividend in 19
in 2002. The changes are due to taxation changes, firms' growth opportunities, external funding constraints etc.

Q 5) What should Paul Coghlan recommend to the Board?

Let us discuss in the class.

What happened?
LT incresaed dividend by $0.01 per share. Stock price rose by 8.7%. Repurchases were modest in the last quarter of
 1997 1998 1999 2000 2001 2002 2003a
379.3 484.8 506.7 705.9 972.6 512.3 440.8
134.4 180.9 194.3 287.9 427.5 197.6 170.6
151.0 267.0 280.4 442.3 559.6 257.2 189.9
21.9 24.4 39.1 80.3 127.9 17.9 9.8
3,930.9 4,633.2 10,338.3 20,151.3 14,102.2 9,936.6 9,644.0
303.8 307.3 307.5 315.2 318.9 316.2 312.4
15 18.3 22.1 28 41.2 54 47
11.6 56.5 108.7 0 69.8 221.6 165.7
0.44 0.59 0.63 0.91 1.34 0.63 0.55
$12.94 $15.08 $33.63 $63.94 $44.22 $31.43 $30.87

11.2% 10.1% 11.4% 9.7% 9.6% 27.3% 27.6%

0.4% 0.4% 0.2% 0.1% 0.3% 0.5% 0.5%
$0.05 $0.06 $0.07 $0.09 $0.13 $0.17 $0.15
$0.04 $0.18 $0.35 $0.00 $0.22 $0.70 $0.53

35.4% 37.3% 38.3% 40.8% 44.0% 38.6% 38.7%

39.8% 55.1% 55.3% 62.7% 57.5% 50.2% 43.1%

5.8% 5.0% 7.7% 11.4% 13.2% 3.5% 2.2%

6.9 10.9 7.2 5.5 4.4 14.4 19.4

share once a year or when it splits its shares. It has split its shares 4 times since 1992.
tanding. The dividend payout ratio has varied with profits from 14.5% in 1993 to 27.3% in 2002.

years, repurchases peaked at $125 mn in Q3 of FY 2003.

 reholders? What are the tax consequences of keeping cash inside the firm?
LT could fund $0.06 div per share or $75 mn outgo out of after tax net income.
es dropped 47% in 2002, profit and cash flow margins were not significantly affected.

e relationship between corporate and personal taxes.

ed will be taxed at the corporate tax rate but if the same is done by the shareholders,

hat would be the effect on value? On the share price?

a 3% rate of interest?

EPS (data from fiscal 2002) Earnings calculation

mn $0.63 PBIT 278.4
mn $0.62 Interest 45 =1500*3%
mn $0.52 PBT 233.4
Tax 67.7 29.0% =80.7/278.4
PAT 165.7

anged over time?

% firms paid dividend in 1999, Dividend initiations and increases picked up slightly
unding constraints etc.

dest in the last quarter of FY 2003.