Do you believe Blaine’s current capital
structure and payout policies are appropriate? Why or why not?
Should Dubinksi recommend a large share
repurchase to Blaine’s board? What are the primary advantages and disadvantages
of such a move?
Consider the following share repurchase
proposal: Blaine will use $209 million of cash from its balance sheet and $50
million in new debt-bearing interest at the rate of 6.75% to repurchase 14.0
million shares at a price of $18.50 per share. How would such buyback affect
Blaine? Consider the impact on, among other things, BKI’s earnings per share
and ROE, its interest coverage and debt ratios, the family’s ownership
interest, and the company’s cost of capital.
As a member of Blaine’s controlling family,
would you be in favor of this proposal? Would you be in favor of it as a
Blaine Kitchenware Inc. Blaine Kitchenware Inc. Take-Home Case Assignment BSAD 342 Prof. Vishwakarma Grady McQuillan Joe Mackay Mitch Chown Alessandro Galeone 2| P a g e Discussion questions Do you believe Blaine’s current capital structure and payout policies are appropriate? Why or why not? The current capital structure and payout policies for Blaine’s Kitchenware Inc in our opinion is not the most appropriate. The firm’s structure is invested primarily in equity, for the most part (other than twice in their history) not incurring any debt. Although the company originally seemed to pride itself in not incurring debt it’s evident that it has long-term affects on the value of the firm. Whether they considered that less debt would provide them with less risk or not, the fact is that they are not maximizing the value of their firm completely by staying away from debt financing. Although risk will increase when their debt increases, debt financing will lower the cost of capital primarily due to tax reduction. The firm will never reach their full potential by acting this conservative with their financing, and in return this affects their shareholders and payout policies. As stated in the case, “Despite the company’s profitability, returns to shareholders had been somewhat below average”. This is due directly to their net income and the amount of book equity. Subsequently, Blaine’s ROE in 2006 was extremely lower than that of its peers. This creates a big problem for the firm because their returns are lower than others and it reduces how outsiders will value the firm. Furthermore, their payout ratio has also been affected. From 2004 to 2006 there payout ratio has risen from 35% to 52.9%. This is due to the amount of cash spent on common dividends. The companies dividend per share has risen slightly over the past three years because of this, however, the company issued new shares with some of its acquisitions. The number of shares 3| P a g e then rose accordingly, which subsequently reduced the earning per share of the company. From 2004 to 2006 the earnings per share dropped from 1.29 to .91, a significant drop for the previously invested shareholders. The average shares outstanding grew over 17 thousand shares. There is a clear discrepancy in the company’s payout ratio, and as I’ve stated they are not maximizing the firm’s value by lowering the cost of capital. Blaine Kitchenware’s decision to be strictly conservative in their efforts for financing their firm forces the value of the shareholders to minimize. Their 100 percent equity approach may be the safest idea in their mind, however without the debt financing the company cannot take advantage of the tax shield and the reduction of overall taxes. Although riskier, debt financing leads to an optimal financial structure and because Blaine Kitchenware refuses to do so, we agree that their capital structure and pay out policy is not the most appropriate for the firm. Should Dubinski recommend a large share repurchase to Blaine’s board? What are the primary advantages and disadvantages of such a move? Dubinski should be recommending to Blaine’s board, a large repurchasing of shares for many solid reasons. The main reason being that Blaine’s Kitchenware’s Business is over liquid and under levered. In 1994 the Initial Public Offering happened which gave the founders family sixty two percent of the business. Since this initial public offering the share holders value has increasingly been diluted by the companies acquisitions of small independent manufactures because BKI stock had been used partly with cash for these purchases. These acquisitions have been good in terms of strong growth where BKI was weak in the beverage appliance segment, and growth in Blaine’s top line was attributed almost exclusively to these acquisitions. The consequences to these new acquisitions are that this has diluted the shareholders value, their earnings per share has fallen significantly due to these dilutive acquisitions, and return to shareholders were below average. 4| P a g e Blaine’s financial posture was very conservative as they have only twice borrowed beyond seasonal working capital needs. Although the company has very conservative roots it is important that they realize the need to acquire leverage and buy back stock. The shares outstanding have amplified, which has consecutively increased their payout ratio to an outstanding more than fifty percent of their net income being spent on dividends. It is very important that Blaine’s overturns the dilution of the shareholders percentage of ownership and put a stop to the trend in their payout ratio as it is unsustainable. The primary advantage to the repurchase of stock is that stock holders that remain will have a higher owner percentage (presumably the family member won’t sell their stock) and therefore the payout ratio can descend and earnings per share can ascend. The potential disadvantage to the repurchasing of stock is that Dubinksi’s timing could be off for the repurchase of stock as their stock price was not far off its all time high. Although this can be seen as a disadvantage, it really is not because this all time high stock price really is not that high compared to its competitors performances. So rather than this historically high company stock price being a disadvantage to repurchase of stock, it is not because looking at their history they are growing, so this is the time to repurchase the stock to encompass greater future earning. Even though Dubinski feels as if it is a bad thing to be obtaining heavy debt for only the third time, it really is not, it is evident that this interest expense is tax deductible and makes no sense not to take advantage of this tax deductible financing. When Dubinski looks at his grandfathers cream separator that was the best selling product for a decade, he should realize that this product would not do good in today’s market, just as the old way of not using leverage does not work in today’s financial world. It is clear that it is a time for a change and that Dubinski has to obtain leverage and buy back some outstanding stock to create the best value for Blaine Kitchenware Inc. 5| P a g e Consider the following share repurchase proposal: Blaine will use $209 million of cash from its balance sheet and $50 million in new debt-bearing interest at the rate of 6.75% to repurchase 14.0 million shares at a price of $18.50 per share. How would such a buyback affect Blaine? Consider the impact on, among other things, BKI’s earnings per share and ROE, its interest coverage and debt ratios, the family’s ownership interest Typically, investors view share buybacks as a positive development; for two reasons. I. The stock re-purchase often results in an increase in stock price and II. Investor’s percentage share of a company’s earning increases. Often indicative that a company feels as though they are undervalued. By reducing the number of shares available for purchase on the market; firms often witness an increase in the share prices of their stocks. To elaborate further, by reducing the number of stocks – the division of residual income at the years end (often in the form of dividends) is divided amongst a more concentrated group. The result being higher returns to stockholders (higher ROE). “Because you’re over-liquid and under-levered. Your shareholders are paying a price for that”. This statement reflects Blaine’s return to shareholders which is well below the average amongst its competitors - peer median of 25.9% return on equity, meanwhile Blaine falls at the group low of 11%. The fact that Blaine achieved an EBITDA among the strongest in its peer group reveals that the issue does not lie in profitability. The issue at hand is a dilution of common stock, which has come at the cost of Blaine’s acquisition strategy employed. Therefore, initiating a stock repurchase of 14 million shares at the price of $18.25/stock, meanwhile issuing $50 million in debt offers the following benefits: o Earnings per share of $1.19 – represents a 30.8% increase o Return on equity of 23.4% - represents a 112.7% increase 6| P a g e o Interest coverage – 18.9 ratio (1.5 or lower is when the ratio becomes a concern. This extremely high ratio reflects just how little the company has leveraged debt) o Debt ratio – 0.084 (Company can easily meet its debt interest obligations; further reinforces the lack of leveraging) o Family ownership interest – assuming the Blaine family members hold onto their stocks during the re-purchase; family ownership would increase *Note: see exhibit 1. for the above calculations As a member of Blaine’s controlling family, would you be in favor of this proposal? Would you be in favor of it as non-family shareholder? As a member of Blaine Kitchenware’s controlling family it is abundantly clear that the best option for my fellow family members as well as my personal interests would be to go into debt and buy back some outstanding shares. This option would, however, be very risky and unfavourable if the company of the family members were short on liquidity and needed some cash to cover their immediate expenses. By looking at Blaine’s past results and analyzing future trends it is clear that the company is in a very secure position, with a strong customer base, market share, financial data, and strong proven leaders at its helm. Due to this and the expectation that the company will continue its strong results it is desirable to hold a larger stake in the company, but also the effect of buying back some shares with debt could magnify the importance of these results in the company’s financial data where earnings per share and other key metrics would go through the roof. This could also backfire in the case of poor results but as that seems only a remote possibility compared to that of continued success it is deemed a desirable course of action. This action would raise the percentage share of each family member’s ownership interests in the company, but wouldn’t immediately raise the overall value of these shares. That is because the 7|