Rising Taxes? Could be Time for a Few Special Dividend Candidates
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Special dividends are distributions to shareholders that are made on a non-recurring basis, which are different than traditional quarterly dividends that shareholders are accustomed to. The most notable special dividend in recent memory came from Microsoft in 2004 when it paid $3 per share, or $32 billion to shareholders in one transaction. Other recent notables include Garmin, the satellite navigation maker and Limited Brands, the company behind apparel stores like Victoria’s Secret and Bath and Body Works, which both distributed one time dividends in 2010.
There are a few reasons why companies decide to pay special dividends; One reason could be that management believes it should reward shareholders immediately compared to smaller payments allocated quarter to quarter. Another reason could be simply the company doesn’t know what to do with the cash. This statement might seem a little odd, but if you think about why investors buy shares in a company, that is, they believe that management can earn a better return on capital than they can, then the cash should go back to shareholders if management fails to earn that greater return. The last reason, and is very relevant for the broader market today, is that taxes on individuals for receiving dividends is expected to increase, making any distributions beyond the current calendar year less enticing.
The idea of rising dividend taxes could become an issue for investors if the current budget proposed by President Obama becomes reality. Regardless of the political belief if this tax is justified or appropriate, companies will likely begin to think about how it would affect their shareholders, especially if the management of the company owns a significant portion of the shares. If this becomes reality, investors should look for companies that have a hefty amount of cash with little debt, generate significant free cash flow and currently don’t pay a quarterly dividend. Running the criteria through a stock screen, I found the following candidates which match these criteria; Dell (NASDAQ: DELL), SanDisk (NASDAQ: SNDK), Juniper Networks (NYSE: JNPR), & EMC (NYSE: EMC)
Note - Keen readers will notice that the previously four mentioned companies are all tech stocks. This is logical given the significant amount of cash generated by the industry and its historical reluctance to issue dividends.
Let’s take a deeper look at the companies I just mentioned:
Shareholders of Dell will probably raise an eyebrow at my argument that the company will pay a onetime dividend soon because a few shareholders have so strongly believed that the company should pay a dividend that they took the unusual step of making it part of the annual shareholders vote. Each time it has been proposed the company has voted against it. Michael Dell and company have argued that shareholders would be better off with share buybacks, versus stock dividends. But with the potential for rising taxes on dividends, and share performance languishing by about 20% versus the broader index over the past five years, shareholders might be getting a little impatient.
How much can the company provide? One of the negatives of distributing large amounts of cash, particularly in the tech industry, is that the company might not have enough funds to adjust to the rapid changes in the industry. This isn’t necessarily the case with Dell. The company has about $10 billion in net cash and generates about $4 billion in annualized free cash flow. With 1.76 billion shares outstanding, the company could easily pay a $1.50 per share in a special dividend. This transaction would cost roughly $2.6 billion or half their annual free cash flow and immediately yield investors about 9%.
SanDisk is a manufacturer of flash based memory storage solutions sold in consumer and enterprise products. Memory manufactures are typically given a pass on paying dividends because their business is highly cyclical meaning that cash on hand is often a necessity to whether downturns. But this argument can be somewhat debunked by the idea that Seagate, SanDisk’s main competitor in the memory space, currently offers a quarterly dividend with a respectable yield of almost 4%. With almost 1/5 of their market cap in cash net of debt, the company should consider offering $2 per share to at least match the yield of Seagate. Heck it would still be four times the size of their other distant competitor Sony.
Juniper Networks is a provider networking infrastructure products to service providers, enterprises and governmental agencies. The company has seen its share price drop over 40% over the past fifty two weeks as sales have come under pressure given the slowdown in governmental spending and cyclical nature of service provider spending. Cisco Systems, Juniper’s most direct competitor, has slowly been regaining footing from a series of operational missteps at the company. Shares have risen almost 17% over the past fifty two weeks. This dichotomy of performance could be a topic of discussion at Juniper’s shareholders meeting held sometime in May or June. The company could help ease shareholder dissent by offering a onetime dividend before the meeting. The company sure has the cash hoard and free cash flow to do so; Juniper generates $727 million in annual free cash, and has almost $3.3 billion of net cash on its balance sheet. With 530 million shares outstanding, the company could pay out half of their free cash and about $300 million on their current cash to distribute a dividend that would yield 5%. This would still provide the company with almost $3 billion in cash or almost $6 per share in cash alone and help ease shareholder concerns.
EMC Corporation is a provider of storage and software to enterprises. Out of the four stocks I mentioned, EMC is the only company that generates more free cash flow than their existing net cash which would make you think that the company should refill their corporate coffers before distributing cash to shareholders. But given that the company has only earned a return of 12% on their invested capital over the past five years (to put it in perspective, Microsoft has earned almost 35%,) shareholders might want to press the corporation to start returning funds back to them beyond their stock repurchase plan to increase that return. Similar to the other stocks mentioned, it would only cost the company $2.5 billion, or 50% of their annual free cash flow to provide shareholders with an incremental 4% yield.
What stocks do you think are ripe for one time dividends? Share your comments below!
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