,80

Blaine Kitchenware nc. case study

Basic case
Blaine Kitchenware was a mid-sized producer of small appliances primarily used in
residential kitchens. By 2006, the company's products consisted of a wide range of
small kitchen appliances. For the period 2003 to 2006, the industry posted modest
annual unit sales growth of 2%. n 2006, 65% of its revenue was generated from
shipments to U.S. wholesalers and retailers. BK's market research consistently showed
that the Blaine brand was well-known and well-regarded by consumers. During the year
ended December 31, 2006, Blaine earned net income of $53.6 million on revenue of
$342 million. Approximately 85% of Blaine's revenue and 80% of its operating income
came from the sale of mid-tier products.
Blaine's 2006 EBTDA margin of nearly 22% was among the strongest within the peer
group. Blaine's operating margins had decreased slightly over the last three years.
Margins declined due to integration costs and inventory write-downs associated with
recent acquisitions. Growth in Blaine's top line was attributable almost exclusively to
acquisitions. Despite the company's profitability, returns to shareholders had been
somewhat below average. Blaine's return on equity (ROE) was significantly below that
of its publicly traded peers. Moreover, its earnings per share had fallen significantly
since 2004, partly due to dilutive acquisitions. Stock price appreciation, during 2004-
2006, compounded annual return for BK's shareholders, including dividends and stock
price appreciation were approximately 11% per year which was below the 16% annul
compounded returned by shareholders of Blaine's peer group during the same period.
At the end of 2006, the company held $231 million in cash and securities, Blaine's
balance sheet was the strongest in the industry.
Now a private equity firm intends to purchase all of Blaine's outstanding shares at a
price higher than $16.25 per share for acquisition, the banker suggested BK itself could
do the same thingborrow money to buy back its own shares.
Relevant information for decision
Capital structure
Corporate capital structure is the ratio between all funding sources, and capital structure
is actually the ratio of debt capital. Because the cost of debt capital was significantly
lower than the cost of equity capital. The debt has greatly reduced the role of integrated
enterprise cost of capital. Therefore, it can increase earnings per share and its stock
value by improving the proportion of corporate debt appropriately, which assumes a
crucial role of financial leverage.
The capital structure of Blaine is prudent and conservative. The main source of funding
for business comes from equity capital. Such capital structure makes the risk of its
financing is low as well as the cost of its financing is high. Thus, the returns to
shareholders do not have a high level.
Debt ratio =debt asset /total asset 100'
Equity capital ratio =equity capital /total capital 100%
2004 2005 2006
Debt ratio 16.0% 16.7% 17.5%
Equity capital ratio 84.0% 83.3% 82.5%
For Blaine, the debt ratio is extremely low, only 16.7% average, and accordingly the
equity capital ratio is relatively high, reached 83.3% average. We can easily find that
improving the proportion of corporate debt can increase the earning per share and
finally increase the stock value. So the Blaine should consider borrow money to enlarge
the debt ratio.
Financial leverage effect
Enterprises financial leverage of funds has a magnifying affect, when the business uses
the liabilities, the effects of financial leverage will show. However, debt is not always
excellent, and we should firstly analyze whether the profitability of raising the funds for
capital is greater than the interest rate. f it is so'the use of debt will substantially
increase their earning per share.
Maintaining a proper balance is a premise to adjust surplus fund transfers and increase
return on investment owners. Due to the low debt ratio and high equity capital ratio of
Blaine, it positions in under-levered. The shareholders are paying a price for that.
Debt management can bring huge profit for Blaine'although the enterprises maybe
face great risks due to large debt. Either too much or too little does not mean that it is a
good balance. f the debt is too small, it cannot be effectively achieved balance the
benefits to the enterprise.
The financial position
During the year ended December 31, 2006 Blaine earned net income of $53.6 million on
revenue of $342 million.
2004 2005 2006
Net income $ 53,112 $ 52435 $ 53,630
Dividends $ 18,589 $ 22871 $ 28,345
Average shares outstanding 41,309 48970 59,052
Earnings per share $ 1.29 $1.07 $ 0.91
Dividend per share $ 0.45 $0.47 $ 0.48
Payout ratio 35.0% 43.6% 52.9%
Revenue growth 3.2% 5.5% 11.1%
Gross margin 30.0% 28.5 % 27.0%
EBT margin 21.4% 19.7% 18.7%
EBTDA margin 23.8% 22.4% 21.6%
Effective tax rate 32.0% 31.7 % 30.8%
Net income margin 18.2 % 17.0% 15.7%
Total current assets $ 376,351 $ 364,449 $339,678
Total current liabilities $ 62,935 $ 70,705 $76,581
Total liabilities $79,840 $92,290 $103,890
From the above figures, we can observe that net income margin and earnings per share
have declined in the past three year. The majority of liabilities are current liabilities and
the current assets are over liquid.
Operating conditions
Facing its competitors, Blaine holds prices firm and its organic revenue growth had
suffered in recent years. Finally, some of its core products lost market share. Growth in
Blaine's top line was attributable almost exclusively to acquisitions.
Blaine's stock price was not far off its all-time high, yet its performance clearly lagged
that of its peers.
Approximately 85% of Blaine's revenue and 80% of its operating income came from the
sale of mid-tier products. Blaine had introduced some technology, targeting higher-end
consumers and intended to compete at higher price points.
Blaine began by taking advantage of NAFTA, engaging suppliers and performing some
manufacturing in Mexico. By 2003, BK also had established relationships with several
Asian manufacturers.
BK had undertaken a strategy focused on rounding out and complementing its product
offerings by acquiring small independent manufacturers or the kitchen appliance
product lines of large.
Business owners and management staff
The attitude of the owners to the control enterprise may affect the capital structure. f
business owners do not want to be acquired by other companies'perhaps BK would
repurchase stock and maximize the use of debt financing.
Family members on the board may not welcome some of the possible effects of a large
share repurchase. Assuming that family members held on to their shares, their
percentage ownership of Blaine would rise, reversing a downward trend dating from
BK's PO. t also would give the board more flexibility in setting future dividends per
share.
Both Dubinski and the board knew that the recent trend in BK's payout ratio was
unsustainable and that this concerned some family members. The board's attitude to
risk is a factor affecting capital structure.
Alternative solutions (advantage/disadvantage)
The stability in operating is very essential to the capital structure if a company's sales
and earnings are stable and growing trend, it can use debt to raise more funds.
bank debt-- credit agreement
Advantage:
Borrowing money from bank is low-risk and low cost.
Disadvantage:
Good business reputation and debt service in time.
equity investment
Advantage:
Percentage ownership would rise, increase the control to company.
Disadvantage:
The cost of equity capital is much higher than the cost of debt capital, investors expect
higher returns; because the risk of equity investment is significantly higher than debt
investment.
corporate bonds
Advantage:
Easy to adjust the capital structure, protect the right of shareholder
Disadvantage:
The relatively high cost of capital may bring financial risks.
Plan of action
There are two principles of debt. One is expected rate of return must be higher than
lending rate. The other is that it must have enough cash for debt service in the worst
case.
Blaine should consider the actual situation, raise and use money from the timing and
reasonable amount, and predict and arrange the proportion of long and short term
funds. Blaine may be consider borrow money from bank and issue bonds.
To sum up, the most key point to liabilities is the relationship between the EBT margin
and the loan interest rate.