Sectornomics: Technology

4 Internet stocks too rich to keep hoarding cash

Not long ago, a technology company paying a dividend was like admitting you had a hairless chest. Paying out cash to shareholders was the equivalent of admitting a company had nothing to invest in that would produce a bigger gain.

But technology companies have matured over the last decade—in some cases, hitting a kind of middle age. Big names like Microsoft, Intel, Cisco and even Apple have begun to look a little more like IBM—meaning they now pay dividends (Big Blue has done so for decades). But what about Internet companies, as more begin to "gray"?

The anti-dividend all-about-growth stance might be ripe for change.

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With income investments harder and harder to find, and Internet businesses proving to be steady cash producers once they get big enough, more of them can afford to pay dividends. And with growth slowing for several of the early Web's biggest names, like Yahoo and eBay, adding income to the investment mix can help them attract new investors.

"It has been a big success for Microsoft and Intel,'' said Josh Spencer, manager of T. Rowe Price's Global Technology Fund.

Top 5 dividend payers in tech

Apple (AAPL): $11 billion
Microsoft (MSFT): $9.5 billion
IBM (IBM): $4.3 billion
Cisco (CSCO): $3.8 billion
Qualcomm (QCOM): $2.7 billion

Source: FactSet, common dividends paid (excludes special dividends) for companies in the S&P 500 tech sector on a trailing four-quarter basis

We talked with three tech-stock watchers to identify the most likely big-name Internet stocks where "unthinkable" dividends could make sense: T. Rowe Price's Spencer, RBC Capital Markets Internet analyst Mark Mahaney, and Arvind Bhatia, who follows Web companies for Sterne Agee.

Spencer and Mahaney think some more mature Internet companies could be in a good position to add a dividend, especially those that have recently announced spin-offs.

Bhatia said the issue "indicates there's a maturing" in the Internet sector, but he was still skeptical that typical price-to-earnings ratios for Internet stocks (e.g. a 40 P/E) would attract an investor looking for a dividend.

The numbers are relatively easy to follow. To figure out whether a company can easily pay a 2 percent dividend—a little better than the market's average—divide its market value by 50. Then look at whether it has the cash flow to pay out that much, especially after accounting for spending plans or deal-making that may compete for the cash. That leads to a shortlist of the most obvious candidates.

1. eBay

A decade ago, eBay was an exemplar of the Web motto that dividends were for those who didn't have enough growth opportunities. But a decade is a long time.

Now eBay is a prime candidate to begin paying dividends, probably after it splits off its fast-growing Paypal unit from its slower-growth, but highly profitable, Marketplaces business. That deal is expected to close in the second half of this year. Paypal would probably reinvest its cash in growth, while Marketplaces may consider returning more money to shareholders, Mahaney said.

How much a dividend would cost the Marketplaces division would depend on how much it's worth after the spin-off is completed. Mahaney estimated in a recently published report that each company will be valued at $30 billion post-spin-off.

According to Spencer, "eBay has been distracted by the split." He added that after it's done, eBay core will do more to return cash to shareholders.

Top 5 dividend increases in tech

Mastercard (MA): 102 percent
Seagate Technology (STX): 42.8 percent
Altera (ALTR): 27.6 percent
Qualcomm (QCOM): 21.5 percent
Microsoft (MSFT): 17.2 percent

Source: FactSet, for companies in the S&P 500 tech sector on a trailing four-quarter basis; excludes companies not paying a dividend in one or more quarters in 2013

2. Google

Google is proof of the idea that paying a dividend doesn't need to be a sign of weakness; it can be a sign that a company is throwing off so much cash it can walk and chew gum at the same time.

Google already spent $9.8 billion on research and development last year and still had almost $12 billion in free cash flow, according to its Jan. 29 earnings announcement. It also has $64.4 billion in cash and short-term investments. There's plenty left over to finance Google's forays into mobile and social Web businesses. And if they did a bit less R&D for Google Glass—which came in for a bit of abuse when the company said it was scrapping the original product—and driverless cars, many investors wouldn't mind. Like Apple, Google is big and profitable enough to play the growth and income cards simultaneously.

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The reasons not to pay a dividend: A 2 percent yield would cost Google $7 billion a year, and a huge chunk of it would go back into the pockets of co-founders Larry Page and Sergey Brin, as well as executive chairman Eric Schmidt, who are the largest individual shareholders of the stock. They aren't exactly hurting for short-term cash, and have so far preferred to let their bets ride.

"Put Google on the list just because they have a lot," Mahaney said.

Some investors read a comment from Google CFO Patrick Pichette on its recent earnings call as a sign it was more focused on the message Wall Street always likes to hear—rewarding shareholders today rather than sticking to its long-term, high risk R&D-or-bust mentality.

"Share price does matter," Pichette told analysts. "It matters to our board. It matters to all of us. We're all shareholders in the company. And we do review this issue on a regular basis. We review it again responsibly with the Audit Committee, with the board. And I just have nothing to announce today."

For the record, Pichette specifically said he was "reiterating" the same message he has always provided.

3. Yahoo

A potential Yahoo dividend stands for the opposite idea as Google implementing one. Sometimes, when a company's hyper-growth days are behind it, a dividend is a good way to boost total returns.

It's not as if core Yahoo has much to lose by shifting investor-relations tactics. After accounting for Yahoo's stake in Alibaba (which the company plans to spin off later this year), and the value of its stake in Yahoo Japan (another spin-off candidate), the market is assigning a negative value to Yahoo's remaining businesses. Those range from its Tumblr microblogging service and BrightRoll video-advertising unit to its popular and profitable but growth-challenged core operations in search and display advertising. So a dividend on a post-spin Yahoo might not cost much, given the low basis.

The company will make about $1.2 billion in profit before interest, taxes and non-cash expenses this year, Mahaney said. That's about three times what Yahoo invests in plant and equipment each year. With Yahoo management recently emphasizing their focus on being good "stewards of capital," a dividend would fit. But Spencer thinks Yahoo might use its money for small acquisitions instead, moving into more emerging businesses with better prospects than Yahoo's shrinking core.

Yahoo has previously stated that it does not pay a dividend and has not elaborated.

Newest dividend payers in tech

Juniper Networks (JNPR): Q3 2014
Lam Research (LRCX): Q3 2014
NetApp (NTAP): Q3 2013
EMC (EMC): Q3 2013
SanDisk (SNDK): Q3 2013

Source: FactSet, quarter of initial dividend for companies in the S&P 500 tech sector on a trailing four-quarter basis

4. Priceline

The Web-travel giant could pay a dividend but has said it doesn't plan to do so soon, according to Mahaney. With $2.2 billion in operating cash flow in the first nine months of 2014, up 24 percent from a year before, and $6.2 billion in cash on its balance sheet, Priceline clearly has the money. A 2 percent yield would cost Priceline a little more than $1 billion a year. And there's no pressure to plow cash back into Priceline's business: It spent only $90.7 million on investments in new plants and equipment between last January and September.

Two things might hold Priceline back. First, it gets most of its profits from Europe and might hold off on major commitments until the Continent's economy strengthens. The more significant reason to delay on any dividend may be that Priceline has shown a recent taste for bigger acquisitions, including its $1.8 billion deal to buy flight-search site Kayak in 2013 and last year's $2.6 billion purchase of dining-reservation site OpenTable.

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If Priceline holds off on a dividend, that could add juice to speculation that the company may be interested in deals for companies like HomeAway, which owns a network of online exchanges for vacation-home rentals. HomeAway has a market cap of $2.5 billion.

What's clear is that Priceline, like other Web leaders, has reached a point where it's both fast-growing and fairly predictable, Mahaney said. "Secular growth companies provide very consistent growth," he said.