By David Sterman
In the past few years, I've continually marveled at the stunning piles of cash parked on the balance sheets of many high-tech firms. These companies had been holding lots of cash to stay strong in case industry conditions waned. But even with the sharp economic blows of 2008 and 2009, their cash piles just kept growing. They've been saving for a rainy day that's likely to never arrive.
I've also been noting how these companies could boost shares by committing much of that cash to stock buybacks. Yet software giant CA Technologies. (NYSE: CA) may have upended that theory. In late January, the company announced plans to super-size its dividend, from $0.20 a year to $1 a year. The dividend yield suddenly shot up from 1% to more than 4%.
CA can surely afford the higher dividend. The $500 million a year it now plans to spend on dividends still keeps the payout ratio, in relation to free cash flow, at around 32% (according to analyst at Evercore Partners), while the company's $1.25 billion net cash position remains intact. Whatever cash flow doesn't go toward the dividend will be used for stock buybacks and acquisitions, according to management. You have to applaud any company that takes proactive steps to utilize a strong balance sheet and reward shareholders in the process.
Shares of CA popped nearly 10% on the news, which means just one thing: Other cash-rich software firms know that any similar move to either initiate or hike a dividend will be warmly greeted by investors.
So who's next? The table below gives a clear sense of net cash in relation to a company's market value (all figures are based on the most recently-issued quarterly results).
Frankly, as CA learned, any company with a dividend yield of just 1% isn't going to get much respect. You need a yield above 3% or 4% to really get interest. Intel (Nasdaq: INTC), with its 3% yield, also understands that.
Before you quickly scramble to see what these companies could do with their mounds of cash, I'll save you the trouble.
First of all, disk drive maker Western Digital (NYSE: WDC) may not be the bargain you may expect after its shares have run up more than 50% in the last three months. The company has $400 million remaining on a current buyback plan, and has never offered up a dividend. The hard disk industry is so volatile that Western Digital may never do so. Still, $3.7 billion in net cash earning almost zero interest begs for investors' attention.
What other companies may look to start or hike a dividend? Well, let's use CA's 30% to 35% payout ratio as a benchmark that other firms may consider. This could help a firm like security software vendor Symantec (Nasdaq: SYMC) offer up a 4% to 5% dividend yield. Also, software firm BMC Software (NYSE: BMC) could easily support a 3% yield.
Maturity equals payouts
For companies that have ample new growth opportunities ahead of them, dividends don't make sense yet. For a firm like IAC Interactive (Nasdaq: IACI), which owns leading web sites such as Match.com, there are ample acquisition opportunities to be reviewed in the quarters ahead. So IAC would like to retain its cash for now.
Yet firms in the semiconductor industry would be much more hard-pressed to find tangible growth opportunities through the M&A route. Chip makers such as LSI Logic (NYSE: LSI) and Altera (Nasdaq: ALTR) have settled into middle-age: Sales for LSI haven't budged above 10% since 2007, and Altera also appears to be stuck in the $2 billion annual revenue range. Yet each company has tossed off considerable free cash flow, even as the top-line remains anemic.
Evercore's Kirk Materne has the solution for companies like this:
"The fact that more companies are delivering only moderate revenue growth (+5-10%) and are getting little credit for their strong cash flow could force more software management teams to evaluate dividends as a more effective way to return cash to shareholders as well a way to attract a new set of investors to the story, especially with interest rates expected to remain at low levels for the foreseeable future."
Risks to Consider: These companies may finally look to put a robust dividend in place only a year or two before interest rates finally start to rise up form multi-decade lows. If rates rise high enough, then the dividend appeal for these tech firms would greatly diminish as they will never be truly high-yield plays.
It's been more than a decade since the dot-com era ended, and companies are only now realizing that the days of go-go growth in high-tech are over. CA's move to radically hike its dividend is a likely harbinger of major changes underway in the tech sector. In an era when companies will be pressed to return excess cash to shareholders, it pays to see which firms can handle a dividend hike, and to what extent. The companies that are likely to follow though on this will be the ones you'll want to own ahead of time.
Disclosure: David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of INTC in one or more if its “real money” portfolios.