(When) asked if the company planned to start paying a dividend or initiate a stock buyback program, "At this time,

we have no plans to do either. We don't think it's our job to manage our shareholders. It's our job as the management team to manage the company, to manage it through when the stock price is going up and to manage it when the stock price is going down. Steven Jobs (Hillis, Apple Plans no Dividend or buyback)

Dividends are real money. That's the hallmark of a blue chip stock. If a company doesn't pay a dividend, it's a speculation. Geraldine Weiss (Sullivan, Dividend Stocks Pay Off)

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AppliedBusinessFinance UNCCharlotte MBAD6154

GAINESBORO MACHINE TOOLS

PAYOUT POLICY FOR A NEW IDENTITY

Clay Fowler Jabbar Jamison

AGENDA
Gainesboro Their dilemma Payout policy Dividends Relevant theories Repurchases Signaling Payout policy in the 21st century Recommendation Forecasts and supporting evidence Suggested Readings
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Gainesboro Case Analysis

/Gainesboro_and_their_dilemma

GAINESBORO
Conventional industry: Machine tools manufacturing Historically strong earnings and regular dividends 25% of revenue New industry: CAD/CAM software industry Expensive restructuring Enormous growth potential, domestic and international

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/Gainesboro_and_their_dilemma /Income_statements
GAINESBORO MACHINE TOOLS CORP. Consolidated Income Statements (in thousands of dollars, except per-share data)

Shares Outstanding

18,600,000

For the Years Ended December 31, 2002 2003 2004

Projected 2005

Net sales Cost of sales Gross profit

858,263 540,747 317,516

815,979 501,458 314,522

756,638 498,879 257,759

870,000 549,750 320,250

Research & development Selling, general, & administrative Restructuring costs Operating profit (loss)

77,678 229,971 65,448 (55,581)

70,545 223,634 0 20,343

75,417 231,008 89,411 (138,077)

77,250 211,500 0 31,500

Other income (expense) Income (loss) before taxes Income taxes (benefit)

(4,500) (60,081) 1,241

1,065 21,408 8,415

(3,458) (141,534) (750)

(4,200) 27,300 9,282

Net income (loss)

($61,322)

$12,993

($140,784)

$18,018

Earnings (loss) per share Dividends per share

($3.25) $0.77

$0.69 $0.25

($7.57) $0.25

$0.98 $0.39

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Gainesboro Case Analysis

/Gainesboro_and_their_dilemma

DILEMMA
Two expensive realignments $61.3 million loss in 2002 $140 million loss in 2004 Still paid $.25 / share dividend Share price down 24% from one year ago Avg$29.15 in 2004, currently

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Gainesboro Case Analysis

/Payout_policy

PAYOUT POLICY
How can a company increase its value through its choice of distribution policy, defined as the level of distribution, the form of distribution, and the stability of distributions? Optimal distribution policy

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Gainesboro Case Analysis

/Payout_policy/Dividends_and_dividend_theory

DIVIDENDS AND DIVIDEND THEORY

Dividend Irrelevance Theory Distribution method is irrelevant to firm value Investor creates their own distribution

Applied Business Finance UNC Charlotte MBAD 6154

Gainesboro Case Analysis

/Payout_policy/Dividends_and_dividend_theory

DIVIDENDS AND DIVIDEND THEORY

Bird-in-hand theory Suggests dividends preferred over capital gains Reliability trumps potential

Applied Business Finance UNC Charlotte MBAD 6154

Gainesboro Case Analysis

/Payout_policy/Dividends_and_dividend_theory

DIVIDENDS AND DIVIDEND THEORY

Tax preference theory Capital gains preferred over dividends Capital gains taxes are avoidable and deferrable Tax liability begets dividend avoidance

Applied Business Finance UNC Charlotte MBAD 6154

Gainesboro Case Analysis

/Payout_policy/Dividends_and_dividend_theory

DIVIDENDS AND DIVIDEND THEORY

Clientele effect Different strokes One clientele is as good as another

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/Payout_policy/Stock_repurchases

STOCK REPURCHASES
Buybacks via open market or tender transaction Boosts EPS Adjusts capital structure Flexibility / Timing effects Signals confidence in future earnings

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/Payout_policy/Signaling

SIGNALING
Information implicitly revealed Market uses and consumes information content Emperical studies show Potential consequences

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/Payout_policy/_in_the_21st_century

PAYOUT POLICY IN THE 21ST CENTURY

66.% in 1978 to 20.8% in 1999 Lower propensity to pay Changing company characteristics

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/Payout_policy/Recommendation/Alternatives

THE ALTERNATIVES
Alternative options Various dividend payout ratios (exhibit 8a) 40% Residual dividends (18%) Revenue-mix adjusted dividend (~10%) 0%

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/Payout_policy/Recommendation

RECOMMENDATION
Zero-dividend high-growth stock with residual repurchases New industry offers considerable growth opportunities Prior income-seeking clientele have divested

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/Payout_policy/Recommendation/Optimal
Exhibit 4 - Revised GAINESBORO MACHINE TOOLS CORP. Stockholder Comparative Data, 1994 and 2004 (thousands of shares)

1994 Shares Founders' families Employees and families Institutional investors Growth-oriented Value-oriented Individual investors Long-term; retirement Short-term; trading-oriented Other; unknown Total 6,803 919 735 18,385 37% 5% 4% 100% 2,390 1,471 13% 8% 2,390 3,677 Percentage 13% 20% Shares

2004 Percentage 13% 17% 6% 13% 26% 13% 12% 100%

Percentage Change in Clientele

2,421 3,155 1,138 2,421 4,806 2,421 2,239 18,600

0% -15% -53% 63% -30% 160% 201%

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/Payout_policy/Recommendation

RECOMMENDATION
Zero-dividend high-growth stock with residual repurchases New industry offers considerable growth opportunities Prior income-seeking clientele have divested Industry peers comparison

Applied Business Finance UNC Charlotte MBAD 6154

Gainesboro Case Analysis

Annual growth rate of cash flow (%) Next 3-5 Sales ($mm) Last 5 years years Gainesboro Machine Tools Corp. CAD/CAM companies (software and hardware) Autodesk, Inc. Ansys, Inc. Cadence Design Intergraph Corp. Mentor Graphics Moldflow Corp. Parametric Technology Corp. Synopsys, Inc. Electrical-industrial equipment manufacturers Cooper Industries, Inc. Emerson Electric Company Hubbell Inc. Thomas & Betts Corp. Machine tool manufacturers Actuant Corp. Lincoln Eletric Holdings, Inc. Milacron, Inc. Snap-On Inc. 504 (1.5) 15.0 Current payout ratio (%) 0.0 Current Insider dividend Debt/ equity owner- ship P/E ratio yield (%) (%)1 (%) (x) 0.0 28.0 30.0 nmf

1,234 135 1,198 551 711 49 660 1,092

4.5 16.5 (1.5) (8.0) 4.5 nmf (6.5) 6.5

10.5 13.0 6.0 12.0 2.0 11.5 6.0 6.0

6.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0

0.0 0.0 24.7 0.2 65.5 0.0 0.0 0.0

3.2 4.4 3.5 3.1 5.9 15.4 5.4 5.6

25.3 23.3 21.4 25.7 21.9 36.2 33.4 26.5

4,463 15,615 1,993 1,516

1.5 2.5 5.0 (10.0)

3.0 3.5 6.0 5.0

39.0 54.0 52.0 0.0

2.4 2.6 3.0 0.0

30.6 43.3 21.1 60.2

1.0 0.8 2.9 2.4

16.4 20.5 17.6 17.7

976 1,334 774 2,407

(21.5) 2.5 (15.5) 5.0

12.5 10.0 (2.5) 3.5

0.0 32.0 0.0 71.0

0.0 2.2 0.0 3.1

180.8 28.4 468.1 18.3

5.9 5.2 4.6 3.0

19.1 15.0 nmf 22.9

Applied Business Finance UNC Charlotte MBAD 6154

Gainesboro Case Analysis

/Payout_policy/Recommendation

RECOMMENDATION
Zero-dividend high-growth stock with residual repurchases New industry offers considerable growth opportunities Prior income-seeking clientele have divested Industry peers comparison Repurchases: Flexibility and signaling effects Pursue re-branding initiatives
Applied Business Finance UNC Charlotte MBAD 6154

Gainesboro Case Analysis

CLASS COMMENTARY

Applied Business Finance UNC Charlotte MBAD 6154

Gainesboro Case Analysis