Group 7: Blaine

Kitchenware Inc.
Maitreyee Shukla
Nikesh Solanki
Vasvi Gakkhar
Sakshi Madan
Chintan Shah
Sourabh Arora
Kumudini Mahajan

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INTRODUCTION TO THE CASE

Vasvi Gakkhar

Blain Kitchenware

Mid-sized producer of small Kitchen appliances.

Well Known Brand
Family promoted, Victor Dubinski CEO.
Captures 10% of $2.3bn US market.
Competitive advantage such as smart
technology

Financial Policy
Conservative financial posture
2 times in 85years company had debt
On both occasions debt was repaid as quickly as
possible
Blaines balance sheet was the strongest in the
industry

Main Problem

Lacked organic growth

ROE 11% , below industry average
Downward trend in its operating margin
Decreasing net margin
Dividend payout ratio over 50%

Main Issues

BKI is over liquid and under-levered

PE firms purchase all outstanding shares
Takeover of BKI
Whether to buy-back shares
or to pay dividends???

Problem
Consider the following share repurchase proposal:
Blain 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
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 familys ownership interest, and the
companys cost of capital.

Concept of Buyback
A company reacquiring/repurchasing its own
shares
A means for the company to invest in itself
Leads to decrease in the number of shares
outstanding in the market
Improvement in liquidity of shares &
enhancement of the shareholders wealth are the
main motives

Concept of Buyback
Profit earned by companies can be used in two
ways:
1)Rewards to shareholders in form of dividends
2)Stockholders equity

Concept of Buyback
Leftover retained earnings: when a part or
whole of the retained earnings cannot be invested
to produce acceptable returns.
These are used in share repurchases.

Why companies opt for

buyback?

Unused cash
Tax gains
To increase stake of promoters
Exit option

Unused cash
Huge cash reserves
Not enough profitable projects
Market price of share is undervalued

Tax gains
Taxes on dividends are high
Capital gains taxes are generally lower

To increase stake of
promoters
As a result of buyback, the number of shares
available in the market decreases.
Thus, promoters stake increases.

Exit option
If a company wants to move out of the country
OR
If the company wants to shut down business

Methods of Buyback
Tender Offer:
Shareholders are presented with a tender offer where
they have the option to submit a portion of or all of their
shares within a certain time period and at usually a price
higher than the current market value.

Open Market:
Companies can to buy shares on the open market, just
like an individual investor would, at the market price.

 Book-Building Process:
The book building process is a mechanism of price
discovery which helps determine market price of
securities.

Advantages of Buyback
of Shares

Increase confidence in management

Enhances shareholders value
Higher Share Price
Reduce takeover chances
Increase ROE
Psychological Effect
Excellent Tool For Financial Reengineering

Disadvantages of Buyback
of Shares
Sending Negative Signals
Backfire for a company competing in a highgrowth industry
When company pays too much for its own shares

No Buyback

Partial Buyback of 14 million

share by raising $ 50 million
debt at 6.75%

Complete Buyback

Approach 1 : No Buyback
Total Shareholders Equity : 59.052 million
Net Income : $ 53.63 million
Earnings Per Share : $ 0.908
Market Price of Share : $16.25
Price-Earning Ratio: 17.89 (Assumption)
Earning Yield : 5.6 %
ROE : 10.9 % (Against Industry Means)

Implications
No debts
Prone to acquisitions
This approach will maintain the companys status
as under leveraged and highly liquid.
This approach fails to create value for the
shareholders.
Need for Capital Restructure immense.

Approach 2 : Partial
Buyback

Marketable Securities = 164.309 Million

Total Cash and Cash Equivalents + Marketable
Securities = $230.866 Million
Proposal to buy 14 million shares using Cash &
Equivalents and raising $ 50 million debt

Forecasted Earning
Statement

Operating Results:
Revenue
Less: Cost of Goods
Sold

2004

2005

2006

2007

2,91,940

3,07,964

3,42,251 3,52,518

2,04,265

2,20,234

2,49,794 2,55,575

Gross Profit
Less: Selling, General &
Administrative

87,676

87,731

92,458

96,943

25,293

27,049

28,512

29,964

Operating Income

62,383

60,682

63,946

66,979

EBIT

62,383

60,682

63,946

Plus: Other Income (expense)

15,719

16,057

13,506

Earnings Before Tax

Less:
Taxes
Net
Income

78,101

76,738

77,451

24,989

24,303

23,821

53,112

52,435

53,630

66,979

Forecasted Net Income

Forecasted EBIT : $ 66.979 Million
Loss due to use up of cash & cash equivalents and
market securities = $209 Million @ 4.92%
= $ 10.282 Million
Revised EBIT : $ 56.697 Million
Debt Interest : $ 3.375 Million
Tax @ Rate 40% : $ 21.328 Million
Net Income : $ 31.992 Million

EPS & Ratios

EPS : $ 0.710
ROE : 11.46 %
Interest Coverage Ratio : 16.79
D/E Ratio : 0.178

Approach 3: Blaine
repurchases its entire
As we know;
market
float.

62% : Owned by Family

38% : Market float
For Partial Payback: Company will use Cash
and Cash Equivalents (10% will be used for
daily operations)and Market Securities
For total buyback: Debt to be taken
Shares has to be taken back at a premium
rate of 13.8% on market price ($16.25 to
$18.5)

 Market: 38% of 59.052 million shares is 22.439

million shares
Shares left after complete buyback: 62% of
59.052 million shares is 36.612 million shares
owned by family.

Calculation for the amount of debt to

be raised:
1. No. of shares to be bought back = 22.439 million
shares.
2. Total Price = 22.439*$18.5 = $415.121 million
3. (Less) Cash and Cash Equivalents and market
securities = $224.309 million
4. Total debt reqd for total buyback = $190.812
million @ a rate of 6.35% [Exhibit 4]

Interest to be paid
6.35 % of 190.812 million dollars
= $ 12.116 million

Contd
EBIT = $ 66.979 million
(Less) Loss due to use up of cash & cash
equivalents and market securities = 60.557 +
164.309
= $224.866 Million
Interest @ 4.92% = $11.06 Million [Exhibit 4 Avg
of yields on US Treasury Securities]

So, Revised Data

Revised EBIT = $ 55.919 million
Less interest (@ 6.35%)= $ 12.116 million
[calculated earlier]
Earnings before tax= $ 43.803 million
Tax (@ 40%)= $ 17.52 million [Note]
Net income= $ 26.283 million

EPS for Scenario 3

EPS = Net income/total no. of shares remaining
= 26.283 / 36.612
= $ 0.717

Expected Market Price

Expected Market price = EPS* P/E ratio
= 0.717 * 17.89
= $ 12.84
Decrease in value per share for the shareholders
= 16.25-12.84
= $ 3.4
Does not lead to creation of more shareholder value
(shareholders who retain shares)

ROE
Net income = $ 26.283 million
Shareholders' equity = $ 263.477 million
ROE = ($ 26.283 million / $ 263.477 million) * 100
= 9.97 %

Debt Ratio
Debt to equity: Debt/Equity
= 0.724

Interest Coverage
= EBIT/Interest Expense
= 4.589

WACC
WACC Weighted Average cost of
Capital raised (i.e. Relative cost of debt
and equity raised)

The Higher the WACC the less likely it is

, that the company is creating value.

WACC : An Investment Tool

Investors use WACC as a tool to decide whether to
invest.
WACC represents the minimum rate of return at
which a company produces value for its investors

Cost Of Capital
WACC = [Rd*(D/V)*(1-Tc)] + [Re*(E/V)]
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D =market value of the firm's debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc =corporate tax rate

Re = Ri + B(EMRP)
Ri = Risk Free rate of return = 5.02%
B = market Risk = .56
EMRP = Equity market risk premium = (6.725.02) = 1.7%

Therefore Re = 5.02 + [.56*1.7] = 5.972

Rd= 0
Re = 5.972
Debt = (230,866)
Debt/ Value = -.31
Therefore Equity/Value = 1- (D/V) = 1.31
Therefore WACC = Re*(E/V)]
= 5.972 * (1.31)
= 7.82

Interest Shield
A reduction in tax liability coming from the ability
to deduct interest payments from one taxable
income.

For example, a mortgage provides an

interest tax shield for a property buyer
because interest on mortgages is
generally deductible
An interest tax shield may encourage a
company to finance a project through
debt because dividends paid back on
stocks issues are never deductible.

Example of a Interest Tax

Shield

Suppose two firms L and U are identical in all respect

except that firm L is levered and firm U is unlevered.
U is an all equity financed firm while firm L employ
equity and 5000 debt at 10% rate of interest
Both firms have an EBIT of Rs2500, pay corporate tax
at 50% and distributed 100% earnings as dividends to
shareholders

 You may notice total income after corporate tax is Rs 1250

for the unlevered firm U and Rs 1500 for the livered firm L
Thus levered firm L investors are ahead of unlevered firm U
by Rs250
You may also noticed that tax liability of levered firm is less
then unlevered firm by Rs250
For firm L tax savings has occurred on account of payment of
interest to debt holders

CONCLUSION

Scenario 1 BKI should not go for any

buyback.
Company is over-liquid and under-levered
Family owned business: conservative debt policy
Failed to create value for stakeholders
Both minority shareholders and promoters will
suffer

Scenario 2 A partial buy-back using only

cash and cash equivalents/ Market securities
Uses $209 million of cash from its balance sheet
and $50 million in new debt
Management will have an increased stake
Low market as compared to the peers, stockholders
to sell the stock and invest in alternates

Scenario 3 When Blaine repurchases its

entire market float
Company raising a significant debt
Complete control to the promoters
Return on Equity will improve
Shareholders will get a premium on current market
price
Dividend policy can be made

Thank you.