Summary of Facts
September of 2005 Ashley Swenson is faced with preparing a recommendation on the restructuring of the dividend payout policy for Gainesboro Machine Tools Corporation. In the past few years the company has experienced a decrease in sales due to increased competition. With the recent development of the Artificial Workforce, the company is looking at making a positive turnaround. With the soon to come global expansion and the forecasted growth in sales brought by new innovations of the Artificial Workforce, the direction of the dividend policy needs to be determined. When forming the recommendation something to be considered is the thought of rebranding the company to more accurately depict its move into the high tech CAD/CAM industry. Also, the current effects of Hurricane Katrina on the Oil and Gas refinement industry has caused some uncertainty in the near future sales of the Artificial Workforce product line to that industry. Problem
First and foremost the dividend payout policy needs to be addressed. The major options to be considered are: a zero payout policy, a 40% dividend payout policy, or a residual payout policy. The company is also considering taking advantage of the recent stock price decline with a repurchase. Lastly, with the new innovations of the Artificial Workforce, the company is considering a rebrand to reposition themselves in the eyes of the public as a high tech CAD/CAM company. Analysis
In a special letter to shareholders the directors declared their intention to continue their annual dividend, however there are three major options facing the company concerning dividend policy. Zero-dividend payout:
A zero-dividend payout would suggest that the Gainesboro is pursuing a “growth” strategy, a more common approach for technology companies. This would be a significant departure from Gainesboros’ position as a value company that sees itself as a stalwart in the industry. Changing this public perception of the company comes with benefits as well as some drawbacks. The pros of rescinding their commitment to a dividend would be: saving the money for other uses such as R&D or further expansion of its new Artificial Workforce line, and sparking interest from investors who are looking for a stock that is poised for strong growth. According to This departure from past dividend policy would fuel the trend seen in exhibit 4, which highlights the change in makeup of shareholders in Gainesboro. From 1994 to 2004 there has been an investor shift towards investors who are looking for short term, trading-oriented growth. This has been coupled with a retreat in the share of investors looking for long-term investments. A zero-dividend policy would be in direct conflict with the recent message in a letter issued by the board of directors. This would certainly send share prices lower as the current stock has the anticipated future dividends incorporated into its current price. Rescinding the current dividend policy has the potential to alienate a significant portion of the current shareholders. Exhibit 4 provides a clear breakdown of Gainesboro’s shareholders. Nearly 40% of shareholders (13% institutional, 26% individual) have a preference for long-term investment in Gainesboro and prefer a wealth preserving investment rather than a wealth accumulating investment. 40% Dividend:
Committing to paying a 40% dividend will maintain Gainesboro’s public image as a long standing company in the industry. However paying the dividend will also have several, if not more drawbacks than benefits. Paying the dividend will hurt free cash flow in both the short and long term. Using the projections that Ms. Swenson has provided in exhibit 8, we can estimate that paying a 40% dividend will result in a negative cash flow of $95 million from 2005-2011. Over this same time period, a zero dividend policy would yield a positive free cash flow of $120 million. The dividend would also require that Gainesboro increase it’s...
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