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All Contents © 2019The Kiplinger Washington Editors
By Dana Blankenhorn
| December 6, 2016
Technology stocks and dividends go together like ice cream and chopped liver, which is to say they don’t, although there are always exceptions.
This is because technology companies generally focus on growth. The saying in the industry is that if they’re paying you to own their stock then they don’t have anything better to do with the money. Growth is expensive, and it pays to invest ahead of it, whether that is in equipment or in people.
But, as with haggis ice cream, there are exceptions.
Telephony is one such exception. Companies like AT&T Inc. (T) and Verizon Communications Inc. (VZ) have long paid dividends approaching 5%. Their equipment suppliers like Harris Corporation (HRS) represent another exception. The growth rates tend to be low, and dividends are necessary to attract capital.
Hard disk drives are a third example. They are slowly being replaced by memory chips, which are faster, have no moving parts, and are growing cheaper by the day. So companies like Western Digital Corp.(WDC) pay handsome dividends to make up for a lack of capital gains.
Then there are exceptions within the exceptions, technology companies where the yield is truly extraordinary, because valuations have been beaten down. The careful dividend shoppers can find some great deals in this bargain bin.
Dividend yield: 8.9%
One key to successful dividend investing is to look for stocks that have been beaten down by events with heavy short-term repercussions, but with long-term income potential.
Traders who seek capital gains will abandon a stock that has just paid a heavy price for an income stream, but dividend investors are looking for income streams that can be made profitable.
CenturyLink Inc. (CTL) is an example of this.
The announcement on Halloween that it would pay $34 billion in cash and stock for Level 3 Communications Inc. (LVLT) scared off many investors, who sent shares plummeting from $31 per share to their present level below $25.
But remember, dividend seeker — the dividend yield on a stock rises as its price falls. If the company is otherwise healthy, you’re looking at a bargain.
At its opening price on Tuesday, CenturyLink was paying a yield of about 8.9% on a market cap of $13.3 billion.
The question for investors is whether the 54-cent-per-share quarterly dividend will be maintained, and without the Level 3 deal, the prospects for that looked poor.
But Level 3, whose cross-country fiber lines and co-location centers are vital to the internet core around the world, usually scores margins of 15% on $2 billion of revenue each quarter. Its cash flow is accelerating, with operating cash flow of nearly $2 billion in 2015. Its debt-to-assets ratio is now under 50%, a figure compatible with that of CenturyLink. The market cap of Level 3 has adjusted to the deal price, as CenturyLink is paying $20 billion for the equity and taking on $14 billion in debt.
CenturyLink already owns the former U.S. West, a regional Bell company covering most states west of the Mississippi, except California and Texas. It also owns the former Savvis, a large web hosting company. Its managers know how to squeeze dividends out of a balance sheet, and how to maintain cost controls.
The combination with Level 3 will help CTL stock’s base business, making the dividend independent of a shrinking phone company that, unlike the other former regional Bells, lacks a large presence in mobile phones, instead reselling service from Verizon.
The LVLT deal will consolidate the internet long-distance business, reducing competition and allowing the company to maintain pricing power. CenturyLink is paying over four times revenue for Level 3, but it gets growth from which it can now extract income.
Traders may not like it, but dividend investors should love it. This yield probably won’t last long, and the hope of management is that the Level 3 acquisition makes it sustainable.
The risk/reward tradeoff on CTL stock has tilted toward reward.
Raysonho @ Open Grid Scheduler / Grid Engine via Wikipedia
Dividend yield: 6.7%
If you only keep up with the news occasionally you may be scratching your head saying, Nokia Corp. (NOK)? Weren’t they sold to Microsoft Corporation (MSFT) years ago? Didn’t Microsoft have to write off the whole value of the deal, suffering the financial equivalent of second degree burns?
True, but that deal was for the Nokia handset business — the business of making phones. Nokia kept the equipment business, which makes things like the base stations phone companies use to move those signals along to their destinations.
That base station business was profitable in 2014 and 2015, allowing Nokia to pay an annual dividend that came to 29 cents per share in June. At Tuesday’s opening price of $4.27, that equates to a yield of 6.7% on a company with a market cap of $24.7 billion.
Unfortunately, that dividend is not sustained by earnings in 2016. NOK stock lost 22 cents per share during the first half of the year and another 2 cents per share in the third quarter. That’s why the stock price is so low right now, and the yield is so high.
The reason for the earnings shortfall is the acquisition of Alcatel-Lucent, announced in 2015 at $16.6 billion, and closing in January with the final shares acquired only this month aftera “squeeze out” in which remaining shareholders were made to accept the last offer.
The combined company has 40,000 people in research alone, aimed across the technology landscape from 5G telephony and software-defined infrastructure for clouds to sensors for the Internet of Things. This is a true tech company, operating on the bleeding edge rather than in a dying niche.
What Nokia doesn’t have right now are earnings, because international weakness meant few companies in Asia or Latin America were buying advanced LTE mobile networking equipment this year.
Telecom capital spending has a boom-bust cycle which, for now, has busted … but it’s not going to stay busted. Customers are going to demand more wireless bandwidth from their smartphones, which should bring demand for equipment back at some point. Nokia also wants to divest its mapping and location business, dubbed HERE, raising $2 billion.
Nokia bulls firmly believe sales will pick up in 2017 and that combining costs with Alcatel-Lucent will lower costs and help consolidate the market, delivering better pricing. Most analysts have the stock rated a buy so you may even score a capital gain next year.
Nokia does have risk attached to it, but if you’re going for the highest yield you should expect that. What it also has is the potential of reward beyond the dividend.
Robert Scoble via Flickr
Dividend yield: 6.4%
Seagate Technology Plc. (STX) is one of only two remaining makers of hard disk drives in the market, the other being Western Digital. The company’s market cap is $11.8 billion. The yield on the 63-cent-per-share dividend is a whopping 6.4%.
This was once an extraordinarily good business, from the days when every PC had a hard disk drive and businesses bought large servers for storage. But phones and tablets don’t use hard disks, with their spinning aluminum platters and read-write heads. They use chip-based memory, which is costly but faster and has no moving parts.
Even cloud data centers, which had been big buyers of disk arrays assembled by resellers such as EMC Corp., now part of Dell, are increasingly buying chip memory, because chips are faster, more reliable, and their cost is declining.
Seagate’s revenues, and profit margins, have been slowly declining for years. During the fiscal year ending in June it failed to generate enough earnings to sustain $2.43 per share in dividends, and this continued during the September quarter, where it had fully diluted earnings of just $301 million, 55 cents per share, but paid out 63 cents in dividends.
This has taken a toll on the stock price which is down significantly from the early 2015 high of over $60 per share. It now trades below $40. But dividend investors know that a falling stock price means a rising yield, if the dividend can be sustained. Seagate management seems dedicated to that.
To maintain its place in the market, Seagate has become a reseller of memory chips in the form of solid state drives, or SSDs. It markets its drives direct to consumers, both under its own name and that of LaCie, a French company it acquired in 2012.
Seagate continues to push the envelope in this area, recently announcing an SSD for the Xbox game machine with 512 GB of storage, half what spinning hard disks could store earlier this year. The market standard for hard drives is now up to 8 TB and portable hard drives are now available with 5 TB of capacity.
Seagate now makes a 10 TB drive for back-ups and network attached storage. Seagate also sells systems which combine chip and disk memory, under the name ClusterStor, with capacities to 300 TB.
Storage needs are said to be unlimited, and Seagate has shown that it can extract maximum value from the market, by selling directly to consumers and by selling chip-based memory alongside standard hard drives. But many analysts now question the company’s ability to sustain profits, with most calling it a hold.
Still, there are analysts willing to put a buy rating on the stock, like Needham & Co. They point to Christmas-season earnings that could top $3/share, and if you buy now management has already announced the 63 cent/share dividend will be paid out as-usual in January.
Of all the stocks in this gallery, Seagate is the most traditional. It’s a company in a declining sector of the market whose management is dedicated to maintaining a high dividend to attract capital. When you buy Seagate, you are betting management can succeed with this top priority, and that if this becomes a problem they can make a strategic acquisition that keeps the dividends flowing.
This article is from Dana Blankenhorn of InvestorPlace. As of this writing, he did not hold a position in any of the securities discussed.
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