News surfaced this afternoon that Analog Devices (ADI) was planning to make a bid to acquire Linear Technology. LLTC’s stock jumped nearly 30% on the takeover news, which was made official shortly later.
Linear Technology is the second company in our dividend portfolios to be acquired this year (Valspar was the other holding and was acquired by Sherwin-Williams in March 2016).
Technology is not one of the best sectors for dividend income because of its fast pace of change and demanding reinvestment requirements for companies to stay relevant and grow. Linear Technology, however, was a clear exception.
My full thesis on Linear Technology can be read by clicking here. The company has been in business for 35 years and manufactures analog semiconductor chips. These chips are essential components used in practically every electronics product to monitor, amplify, condition, transform, or regulate signals found in the real world such as temperature, pressure, light, weight, and sound. Analog chips are also needed to provide voltage regulation and manage power usage.
While semiconductor technology rapidly advances every year, Linear Technology’s offerings focused on serving slower-changing markets and applications with long lives. Chips built for cars or industrial equipment must last for many years and take a long time to be designed in to a product.
The process technologies and assets used to make these chips also have long life spans, allowing Linear Technology to earn a high and stable return on invested capital. The company’s long-lasting customer relationships, patented technologies, end market diversity, and focus on enduring product applications with high returns created enduring competitive advantages.
Turning to the dividend, Linear Technology has increased its dividend every year since it started paying one in the early 1990s. The company was set to join the dividend aristocrats list by 2019 and had proven itself to be one of the most reliable dividend growers in the market.
While certain semiconductor end markets such as automotive are enjoying strong growth, the industry looks increasingly mature. Growth from personal computers and smartphones has largely tapered off. As a result, there has been a wave of consolidation in recent years as companies look to save costs, become more productive, and find growth via acquisitions.
Linear Technology’s portfolio of mission-critical semiconductor chips, leading positions in growth areas like automotive, healthy balance sheet, and outstanding operating margins near 50% made it an attractive target.
Here’s what both companies said about the deal:
“The combination of Analog Devices and Linear Technology brings together two of the strongest business and technology franchises in the semiconductor industry,” said Vincent Roche, President and Chief Executive Officer of Analog Devices. “Our shared focus on engineering excellence and our highly complementary portfolios of industry-leading products will enable us to solve our customers’ biggest and most complex challenges at the intersection of the physical and digital worlds. We are creating an unparalleled innovation and support partner for our industrial, automotive, and communications infrastructure customers, and I am very excited about what this acquisition means for our customers, our employees, and our industry.”
Bob Swanson, Executive Chairman and Co-founder of Linear Technology, added, “For 35 years, Linear Technology has had great success by growing its business organically. However, this combination of Linear Technology and Analog Devices has the potential to create a combination where one plus one truly exceeds two. As a result, the Linear Technology Board concluded that this is a compelling transaction that delivers substantial value to our shareholders, and the opportunity for additional upside through stock in the combined company. Analog Devices is a highly respected company. By combining our complementary areas of technology strength, we have an excellent opportunity to reinforce our leadership across the analog and power semiconductor markets, enhancing shareholder value. Together, Linear Technology and Analog Devices will advance the technology and deliver innovative analog solutions to our customers worldwide. We are committed to working with the ADI team to ensure a smooth transition.”
While many investors are quick to cheer a takeover of one of their stocks, acquisitions are bittersweet to me. I agree with many of the thoughts on the topic laid out by Dividend Growth Investor.
With my investment philosophy, I purchase a dividend stock with the intention of holding it forever. I try to buy time-tested companies that I believe will be larger in size in the next decade and beyond as they execute their business models.
If I get this right – even with just a few holdings – the power of compounding and dividend reinvestment can result in outstanding long-term returns.
When a holding of mine is acquired, another company gets to enjoy the long-term compounding of the business. On the other hand, I am forced to take profits, pay a potentially large tax bill, and engage in trading activity that eats into my investment returns.
Finding blue-chip dividend stocks with bright futures is difficult, and acquisitions force me to try and find an equally attractive new investment.
Assuming the price paid for an acquisition is significantly above my cost basis, I do get to “pull forward” several years of gains in the stock immediately. This provides me with greater purchasing power to accumulate more shares of another quality dividend growth stock.
However, such a small win can miss the big picture.
After its surge in price, LLTC’s stock trades at approximately 29 times forward earnings estimates. While it will take Linear Technology at least a couple of years to grow into the multiple paid by Analog Devices, the company is likely to be worth far more in the next 5-10 years. Analog Devices will now realize this value – not me.
Simply put, it’s very difficult to put a value on a business that can potentially double or triple in size over the next 10-20 years. Oftentimes a premium paid of 20-40% is short-sighted and misses out on the compounding that could be enjoyed by long-term investors if the company’s positive thesis plays out.
I decided to sell out of Linear Technology today. The stock sits somewhat above Analog Devices’ bid of $60 per share (part cash and part stock), and there does not appear to be any compelling reason to wait around.
Proceeds from the sale will sit in cash as I continue to hunt for a new high quality dividend stock trading at a reasonable price.