Blaine Kitchenware Case Study Blaine Kitchenware has occupied the industry for over 80 years and continues to gain control in the market it occupies. As the CEO of the company, Mr. Dubinski is faced with the difficult decision of determining what is best for the family company. The following questions will address what decision is the optimal and why it is beneficial for BKI. Ans. 1) The main dilemma in the case is whether Blaine Kitchenware’s should choose to repurchase its own shares or not. If Blaine’s Kitchenware does repurchase its shares, they must consider whether to partially repurchase the market float or go for a complete buyback where Blaine’s family would become the owner of all the remaining shares. They also have to consider of the effect of the repurchase on various factors like the risks involved in raising a debt especially when they are large, very conservative and debt free. They should also consider things such their acquisition plans, their earnings per share and their dividend per share, ownership structure, capital structure and of course the reputation of the company in the market after the buyback. With this in mind we can consider a few situations and then decide what Blaine should do, keeping in mind the perspective of both the existing shareholders' as well as Blaine's family’s. Since no debt is being raised, if all the cash & cash securities plus the market securities are used for the buy-back, his family may like this option. Their management will have increased stakes, this will reduce their chance of being acquired and this will provide more dividends to their remaining shareholders. There is a big question facing Blaine and that is why would their existing shareholders want to sell their equity back to the company? Another scenario is to completely buyback the market float. Although this will involve the company raising a significant debt, this will also give them complete control to the promoters. It is probable that their family’s needs concerning the dividend amount and growth can be better met through this option and the policy can be set according to their expectations. The return on equity will increase which will aid the family in better realizing value for their stake. From the point of view of the shareholders, they are getting a premium on the current market price if they go ahead with the offer and since debt is being raised – the WACC will come down. I believe, this could possibly be the best option for Blaine’s Kitchenware to make. According to their current situation, their current capital structure and payout policies are appropriate. Blaine is currently over-liquid and under-levered and their shareholders are suffering from the effects. Since Blaine Kitchenware is a public company with large portion of its shares held by their family members, they have a financial surplus, which decreases the efficiency of its leverage. In other words, Blaine does not fully utilize its funds. Since they are totally equity financed, there is no tax shield. A surplus of cash lowers the return on equity and increases the cost of capital; also large amount of cash may offer incentives to acquirer to and also decrease the enterprise value of Blaine. Acquirers could pay way less than they originally expect to buy out the firm.
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Regarding their payout policies, the management’s goal is to maximize the shareholder’s value, rather than paying dividend. The management should use the available cash and invest in attractive investments. Although investors take dividend as an indicator for a company to succeed, they also expect dividend will be paid continuously at either stable or growing rate. In summary, in order for Blaine to keep its current payout policies, they must reduce numbers of outstanding shares throughout share repurchasing. Ans. 2) Such a large move for the company can greatly affect a lot of aspects, and different interests lie in different areas for shareholders and management. When stock repurchases occurs it lowers the amount of stocks within the company, and eventually within time the E.P.S. would increase in future. This company is facing an unbalanced capital structure and such a move of a share repurchase, with the help of both cash and short/long term borrowing. Raising debt can have its advantage within capital structure, replacing the equity within the firm can reduce WACC and that can lead to a tax advantage. Covering the advantages and disadvantages of the repurchase, we will recommend what Dubinski should do. Covering the advantages of share repurchase first, and focus on what advantages Blaine can gain from repurchasing the shares. A first advantage of a share repurchase can be the tax implications involved with it, and the benefit that arises from it. The more a company is leveraged by debt affects the capital structure, which in turn lowers the amount of taxed income. This is one beneficial form of stock repurchase. The second benefit arising from a stock repurchase is the increase in earnings per share. If earnings were to remain stable, and the number of shares decrease than the earnings per share will increase. When an efficient market reacts to information such as this, the price of the stock will increase because the price of the share increased. When investors are alerted about a new stock repurchase the price of the stock generally increases which is also beneficial for Blaine Kitchenware. Advantages in stock repurchase also occur to the outside market, where it alerts them on how healthy cash flows are within the firm. Float is also decreased in the firm, where outside shareholders have less share of the company. An increase in buying back the equity can be beneficial for any company that has the power to do so. Although there are several beneficial advantages to stock repurchasing, their also is a few disadvantages that come with it. Announcement of the share repurchase, and the actual repurchase have a big effect from the timing of the events. Although stock prices might increase initially, they might decrease once the actual stock repurchase is finalized. Disadvantages in stock repurchasing are largely involved with timing, and what the markets might think of the purchase. It can manipulate earnings and overstate them in a way that is not as good for the company. Manipulating earnings can overstate the actual company value. Stock repurchase can be incredibly beneficial, especially for a company like BKI that has the power to perform a buyback. If company has healthy cash-flows matched with a need to increase debt within the company, this can be beneficial for BKI. Increasing earnings per share, is important in repurchasing shares but also the tax advantages (even if they might be lower) they are still advantageous. If a firm has extra cash, with a healthy cash flow and a reduction of tax and possibly an increase in firm value. Dubinski should make a large share repurchase, and BKI should recover some its shares in hopes
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of gaining the advantages of tax, and a stronger EPS. The company has the assets (cash) and can take the restructuring of debt to take advantage of this share repurchase.
Ans. 3) Calculations EPS EPS= EBIT/CSO Repurchase of shares: 259 million in cash 50 million in new-debt bearing interest To repurchase 14,000,000
Interest = 6.75% (50,000,000) = 3,375,000
CSO = 59,052,000 - 14,000,000 CSO = 45,052,000 EBIT = 63,946,000 - 3,375,000 EBIT = 60,571,000 EPS = 60,571,000/ 45,052,000 EPS = 1.34 Change in EPS = 1.34 - 0.91 0.91 Change in EPS = 0.4725 = 47.25%
ROE ROE = Net Income CSO ROE = 53,630/45,052 ROE = 1.19
Interest Coverage Ratio Interest Coverage = EBIT/Interest Expense Interest Coverage = 63,946,000/3,375,000 Interest Coverage = 18.95 Debt Ratio 3|Page
Debt Ratio = Total Debt/Total Assets Debt Ratio = 103 890 000/592 253 000 Debt Ratio = 0.1753 Family's Ownership Interest 62% (59,052,000 CSO) = 36,612,000 shares After repurchase of 14,000,000 shares 36,612,000/45,052,000 = 81.27% With the calculations made we can see that not only can BKI afford to repurchase their shares, but they will benefit from it. After calculating EPS there would be a 47.25% increase in the earnings per share after recapitalization. Another positive number would be the 1.19 ROE, this number shows that after the shares are repurchased that there will be a positive return on equity. This number means they will turn a 119% return on their equity after the shares are repurchased. Interest Coverage and the debt ratio is another interesting number. With the 18.95:1 ratio for interest income, and a 0.1754 debt ratio, we see that BKI has a large amount of assets built up and will be easily able to afford the price of buying back these shares. This was one of the main concerns, where they did not want to borrow money and potentially have a large interest expense. As for the family's ownership interest, under the new proposal, they would now own 81.27% of the company, giving them even more power than they would have before. All of these calculations indicate that it would be greatly beneficial to BKI to repurchase their shares, where they can afford it and they will benefit from it in the long run. Ans. 4) When a company is owned and maintained by a family that maintains it in a strong family setting, it is important for them to maintain a certain percentage of ownership. Eliminating external owners is important in gaining a better advantage for the company, and in this instance the family Is looking to gain a larger ownership of the company. The proposal would have to examine a number of factors, and some main questions were asked on would it sap financial strength, or prevent the company from making future acquisitions. Before examining the perspective of the family, and the shareholder it is important to examine what an external financial party would insists on behalf of a structured financial argument. A company with a healthy cash flow, matched with a stable Net income can be a candidate for a stock repurchase. It is important to examine the current debt obligations within the company, which are far less weighted compared to Liabilities and Shareholder’s equity. The firm’s choice will ultimately lie on BKI’s financial perspective and needs on liquidity, capital structure, dividend policy, and ownership structure. As a member of the family I would be in favor for the stock repurchase for a number of reasons. Members of the family were welcoming the idea of the possible effects of the share repurchase, one main attraction of the repurchase would be the fact that 4|Page
ownership percentage would rise. This attraction is key to the family who maintain this more family company, and a larger ownership in the company would allow them to own more of it. Looking back on the history of the company, it is important to realize the intangible effect the company has, and how advantageous it would be for them to have a buyback. It would also give the board more flexibility in setting future dividends per share, and give them more control of the company. As a member of the family I would want the share repurchase because of the amount of control I would obtain, along with the knowledge of my company having healthy cash flows. Although I would approve of the share repurchase I would be skeptical about the debt factor within the repurchase, the interest rate could be detrimental to the company and the interest payments could incur more cost than benefit. It is also the third time since its inception, that the company seeked debt financing which proved to be a large decision for the company. As a member of the family I would approve of the repurchase, and there are no new trends that indicate that the company will see future bad financial performance. As a shareholder of the company you could be reluctant to receive a payment from the buyback at market price, or you can be a shareholder who retains their shares. It is beneficial in both cases; both shareholders who continue to own shares will see a rise in EPS in shares after the repurchase which will benefit the shareholders. The shareholders could see a significant rise for a short time, however it is important to realize the amount of control they will lose when the family gains more control. Although stock price might increase for a short period of time, the ownership percentage can decrease which is detrimental to shareholders. Shareholders should accept the proposal cause it can increase the company’s value, and stocks which can increase the value of selling the stocks which is beneficial for shareholders. A stock repurchase for any company is based on timing, and certain financial and non financial factors need to be met in order for the purchase to realize any benefit. BKI has a strong and healthy cash flow, matched with an optimal need for debt restructuring that could benefit the company. The benefits that are realized from this repurchase can be very beneficial for BKI, and because of the financial position it is in, along with a family favoring of the repurchase BKI should perform the repurchase. In all, the short and long term benefits arising from the stock repurchase greatly outweigh the costs of not performing any capital restructuring.
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