More technology companies are paying dividends and increasing dividend payments. But Moody’s does not expect those increases to affect company ratings because by and large, the percentage of discretionary cash flow (cash flow from operations less capital expenditures) paid in the form of dividends has remained flat, at about 20%, over the last five years as companies’ cash flow has also grown.
While companies in most mature industries pay dividends of about 40% of discretionary cash flow, we believe most technology companies will keep dividends in the 20% to 25% range because of constraints on liquidity, operational requirements, and company-specific strategic considerations.
For example, we believe Xerox Corp. (XRX) (Baa2, positive) will deploy the bulk of its discretionary cash flow to share buybacks beginning in the second half of this year, while Dell (DELL) (A2, stable) and Hewlett-Packard (HPQ) (A2, stable) will opt to preserve cash for acquisitions. Meanwhile, International Business Machines (IBM) (Aa3, stable) will likely increase dividends commensurate with profit and cash flow expansion.
Where cash is held and generated also affects the ability of technology companies to increase dividend payments. Many generate more money overseas than in the U.S., and they could be on the hook for hefty tax payments if they use cash made abroad to pay U.S.-based common dividends. Although Oracle (ORCL) (A2, stable) has recently increased its dividend and Cisco Systems (CSCO) (A1, stable) expects to initiate one, the extent of their overseas cash holdings is a constraint to their shareholder largesse.
In addition, companies need to maintain some dry powder as an insurance policy against the surprises endemic to the technology sector. Look no further than Intel Corp. (INTC) (A1, stable), the market leader in cutting-edge microprocessor technology, which recently encountered a design flaw that will cost it $700 million.
To show how overseas cash holdings and company-specific needs can limit dividend payments, we will use Analog Devices Inc. (ADI) (A3, stable) as a case study. The company maintains nearly three quarters of its $2.7 billion cash overseas. We believe materially expanding the company’s dividend payments will be constrained by the geographic mix of its cash flow generation and capital expenditures. Raising dividends toward 40% of cash flow would be difficult for a company like Analog Devices, because its domestic liquidity profile would weaken and its financial and operational flexibility would diminish.