Monday, June 25, 2012

Tech Sector Dividends

Here's a Barron's article on why tech sector dividend payouts tend to be relatively low as a percent of their free cash flow.

The article points out that, according to Moody's Investor Service, the tech sector only pays out roughly 21 percent of its excess cash flow (operating cash flow minus capex).

Other industries pay out more like 43%.

What's a couple of reasons for this?

1) The amount of cash overseas that if paid out would result in repatriation taxes.

Apple (AAPL), Microsoft (MSFT), Cisco (CSCO), and Google (GOOG) alone have more than $ 200 billion in cash and investments but much of it sits outside the United States. Also, since a substantial amount of their future earnings will not be generated inside the U.S., expect the amount of liquid funds that accumulates overseas to continue growing.

2) The inherent uncertainty of the tech industry.

Tech businesses are always susceptible losing their leadership position in the markets they serve. The competitive landscape shifts as a disruptive technology or company comes along that threatens the status quo.

Examples of those left behind by a shifting landscape:

-Digital Equipment Corporation
-Wang Labs
-Eastman Kodak

...among many others. Tech businesses often need to hold more cash so they're ready for unforeseen changes that may occur. The financial flexibility to anticipate and influence the direction of change is key. Fear of not having enough funds to invest internally (or to buy competing smaller companies with key technologies) must at least partly explain what are by just about any standard extremely healthy balance sheets. Tech businesses (at least those who want to be competing from a position of strength) need to have enough funds to not only maintain but ideally enhance their market positions. 

Disruptions occur and they're unlikely to be linear. So how much capital will be needed to maintain a strong competitive position is quite a lot less predictable or knowable. Having some insurance cash laying around seems wise when you are competing in extremely dynamic industries.

Being ready when the technology world inevitably shifts from time to time doesn't just come down to the amount of liquid cash and investments available. Yet, financial flexibility is a nice thing to have when something unexpected comes along (Research in Motion: RIMM probably wishes they had more financial flexibility right now). It's easy to argue some of these large cap tech companies have taken the amount of cash and liquid investments they have on hand a bit too far but it's not hard to understand why.

The economic moat of some tech businesses is often less robust than it seems at any point in time and threats to their viability come along faster and more unpredictably. Despite all this, with their ample free cash flow and the enormous liquidity on their balance sheets these days, it is thought that payouts from the tech sector will rise nicely this year.

Well, at least according to this Barron's article they will. Moody's Investor Service expects that dividends from the tech sector should rise 14.3 percent in 2012.

Adam

Long positions in AAPL, MSFT, CSCO, GOOG

Related post:
Technology Stocks

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