Introduction

Kohler Company was faced with a very tough decision of whether or not to settle

outside of court or go to court to settle with the dissenting shareholders. We will take

you through the history of the company and why they recapitalized. Also, we will touch

on some of the risks of going to trial to have the courts set a price. We have also broken

down the numbers and found many different prices found by using the dividend growth

model and the multiples approach. We will also show how different outcomes will affect

Kohler’s retained earnings and cash standing. In the end, we believe we have chosen the

best possible price to make everyone in the case happy without much sacrifice from

either side and without having to go to court.

History & Privacy Issue

By creating a hog trough John Michael Kohler established one of the most

profound plumbing companies in the world. In addition to the continual development

and production of plumbing supplies Kohler also hit many other markets since its

formation in 1873. The company’s private dedication to excellence has allowed them

expand and seek control of these other industries. Some of these include furniture,

engines, generators, rental services, and most recently the elegant golfing resort

destinations which gives travelers a sense of privacy. Privacy happens to be one of

Kohler’s most important values of which their success can be partially credited to it. In a

publicly held firm, the company’s ownership is held and controlled by outsiders who had

in some way bought into the firm as an investment, but in Kohler’s case being private

means something totally different.

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Since the company’s development and upcoming ownership has generally stayed

within the family and maintained a completely private state of control. This means both

family members and employees are distributed the ownership of the firm though shares.

Forbes claims that Kohler’s success can be credited towards going and staying private

because this implements a strategic long-term plan that will keep the tenure of the

business within the family who is valued immensely. As a proposed way of getting the

firm to a more private state after some shares had been sold to outsiders as an investment,

Herbert V. Kohler, Jr. sought after recapitalization. This made it nearly impossible for

any Kohler “family” member to sell shares to the public. After the proposals were

implemented the shares were now held by a sort of ironclad trust that makes a public

offering or outside sale very unlikely.

One of Kohler’s first big moves that indicated to its family members that privacy

was of utmost importance took place in 1912 when the villages of Riverside, WI were

developed. Houses were built and sold to workers for cost and included recreational

areas, open spaces, and eventually The American Club, this created a sort of utopian

Kohler Village gave it’s family members a sense of belonging and strong tie with the

company. In the 1970s the buildings were eventually tore down as an investment of

Kohler to put up office buildings and a very famous golf course known as Whistling

Straits. Along with theses establishments Kohler further expressed its company’s

continual search of success by creating an opportunity for synergy; they showcased their

own furniture, fixtures, whirlpool bathtubs, and power generators.

Another plus of being private is the opportunity to be more patient during the

business decision making process. This is due to no added stress from Wall Street and
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public brokers who have no idea what Kohler is all about like its family members do.

Kohler did no want to deal with Wall Street making critical decisions for them. It was

stated that Wall Street could have possibly vetoed the idea of expansion into the resort

destination business because at first it may have sounded paradoxical, going from

plumbing to vacationing, but as we have read this happens to be one of the firm’s most

recent and biggest successes. An example of the firm’s success that can be accredited to

privacy was during expansion into China and other foreign markets around the world.

Natalie Black, the wife of Herbert V. Kohler, states that “If not for our being private, we

probably never would have tried to enter China” (mikehenning.com). Kohler established

a name for their firm in the foreign market in 1991 when they first started manufacturing

in China. The competitors that existed in the market when Kohler made their move could

only find success in forming joint ventures with local partners. This left the expansion

seeking Kohler at an immediate disadvantage and made the situation more risky, but due

to their private disclosure, they were able to turn the risk into reward and institute a

profitable and fast growing extension to their firm.

Another important part of Kohler’s prominent history was in 1978 when they

offered a reverse stock split to facilitate their public disclosure henceforth leaving them

more private. The initiative for this decision was because somewhere along the line of

business a few outstanding shares that were held by the family were sold to outsiders.

Herbert Kohler noticed that the number of shareholders was increasing over time, nearing

400, so he decided to go on with the proposed 1-for-20 reverse stock split to keep the

SEC and their regulations out of his firm. The effect of this split forced the non-family

shareholders to sell out at $412.50 per share substantially reducing the number of
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outsiders. This was very beneficial because Kohler keeps its always sought after private

control without a corporation take over, steers them clear of regulatory statutes, and also

keeps important business data about the industry out of competitors’ possession. After

the successful reverse stock split only a small percentage of stock still remained with

outsiders, but was closely monitored for the next 20years to maintain the private state of

firm control.

It is hard to find negatives for being so private because Kohler has been so

successful at it. A few possible reasons for big companies such as Kohler to have public

shares is because they offer a new source of capital, a cash flow for acquisitions, liquidity

for estate planning and a means to reward employees with options. Kohler could make

the counter to these public offers by saying we may not have these public options, but

who is going to take us over anyway… we’re Kohler.

Why recapitalize:

In 1998, Herbert Kohler proposed to buy back all the shares from outsiders and

further restrict the selling of shares to outsiders. There were many reasons for this

recapitalization plan:

ƒ Herbert Kohler did not like the high speculative prices that the shares were selling

for. People started to think that Kohler would go public and it would increase the

share prices. Therefore, they paid higher prices for the Kohler stock with the

expectations that the stock price would go higher. He thought that it might entice

the family members to sell their shares to outsiders.

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ƒ Kohler preferred the company’s private status. It was a family owned business

and Kohler wanted to keep it within the family.

ƒ Kohler could not control prices of shares that were traded publicly. The high

prices also speculated that the company might go public and this caused concern

among the family owners.

ƒ With recapitalization, it would be easier for Kohler to make investments for the

long-term growth of the company that are hard to justify to the public. If there are

more outside shareholders, then such investments would have to be explained to

outside shareholders. Example of this is the updating of cast iron technology

when competitors were looking for alternative materials. If Kohler were a public

company at that time, it would have a hard time explaining this move to the

outside shareholders and the board of directors might not have approved it.

ƒ With fewer shareholders, Kohler would not have to disclose the financial

statements. In Kohler’s viewpoint, these disclosures gave up too much

information to the competitors and could hurt the growth of the company.

ƒ If number of shareholders reached 500, then Kohler would be subject to strict

regulatory requirements by Securities and Exchange Commission. In that case,

Kohler would have to disclose the financial statements and also file certain

disclosures with the SEC. This would not only increase the cost of meeting those

filing requirements but it would also put burden on the company to disclose

everything on time and with complete accuracy in order to avoid any penalties.

ƒ With fewer outside shareholders, there would be less pressure to declare

dividends each year. Therefore, Kohler could use the earnings to invest into long-
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term plans triggered towards growth of the company. Kohler family members

would be inclined more towards long-term growth as compared to outside

investors who look for short-term monetary gains.

Recapitalization Plan:

Kohler had been looking to revamp its ownership structure. Several plans were

proposed that were dropped by the company management. In 1998 the company’s

general counsel and Natalie Black (wife of Herbert Kohler) came up with a new plan to

restructure the ownership of Kohler (Harvard Case). The plan was targeted to keep

Kohler Company private in future. The plan carved four different classes of stock:

ƒ Common Voting Stock

ƒ Restricted Voting Stock

ƒ Series A Non-voting common stock

ƒ Series B Non-voting common stock

The restricted voting stock was restricted for the company executives. This was to

make sure that no outsider would be able to vote on issues concerning the company and

that the decisions of the company lay with the family members. One outstanding common

share at that time could be exchanged for:

ƒ 1 share of voting common stock

ƒ 244 shares of Series A non-voting common stock

ƒ 5 shares of Series B non-voting stock

Each share of the old restricted stock was converted into 250 shares of new Restricted

Stock. Shares could only be transferred to related parties of Kohler descendents. In this

case, the shares are transferred to a non-permitted transferee; Kohler could buy back the
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shares at the fair market value (Harvard Case). This plan paved the way for Kohler to

buy back shares from outsiders. Outsiders who were not related to Kohler family had two

options:

ƒ Accept cash at the fair market value appraised by an independent appraiser

selected by Kohler

ƒ “Dissent” and take the matter to court where the fair market value of shares would

be determined.

This plan completely rested with the thinking of Herbert Kohler, who wanted to buy

back shares from outsiders to keep a check on the speculative prices and also to avoid

giving out company information to competitors through financial disclosures. Kohler’s

board of directors approved the plan with 88% votes at a special shareholders’ meeting in

May 1998. This plan ensured that Kohler would remain a privately owned firm, and

therefore received the support from Kohler family members.

Why Shareholders are Filing Suit Against Kohler

The dispute between privately owned Kohler Co. and its shareholders occurred

after the company’s recapitalization a few years ago. Over 100 shareholders that

apprehended 811 shares or roughly 12% of Kohler’s stock felt that the company was

being unfair to its owners after the capital adjustment. The purpose of recapitalization

was to buy out all the outside shareholders and restrict future sales of stock to outsiders

because Kohler values their private status to which they credit their success. By making

these modifications the current share price was then set at $54,500, which seemed right

by Kohler’s board of directors and the majority of shareholders (88%). The other 12%,

both outside and family shareholders felt that the value of their stock exceeded the
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recapitalized share price by an estimated five times. They projected the share’s worth at

an outrageous $273,000. After determining this value they decided to exercise their right

to defy the current share price is unfair and requested a lawsuit to determine the

appropriate valuation. The question that arose from the case is whether or not the

$54,500 was fair value or if the $273,000 was a reasonable request by the 12%. Then if

neither were proper, then there must be a precise meaning of fair value decided legally.

Trial Riskiness

The negotiated share price had yet to be determined so a trial by court seemed to

be the remedy unless Kohler decided to formulate a fair settlement price. With the

possibility of this court case in the near future there are some risks Kohler could face.

Some of these consist of who is involved and what is at stake for them, the issues that a

trial by court brings, the dilemma of bad press, and the chance of the IRS stepping in.

After reviewing the risks associated with the court case Kohler should seek a settlement

in order to avoid the tribulations.

Throughout their years in business, Kohler has established a name for their

private business and along the way they have picked up strong relationships with family,

shareholders, and charities. By creating these bonds, Kohler institutes a sense of asset

protection for their firm. If Kohler decides not to settle outside of court then these groups

of people could be affected and become disgruntled. The family, which is the actual

Kohler family and its employees have strong ties with the company and could end up

being dissatisfied with the court decision and could cause problems within the business

and workforce. The shareholders, the 88% that didn’t file suit, will be affected in a
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couple ways. They could benefit from the case because of the possibility of a higher

share price, but if they are true and ethical towards the company they will back them the

whole way and hope for a settlement deal. One of Kohler’s major fall backs is their

relationship and commitment to charitable foundations. Their main charity is called the

Kohler Foundation and was setup to support educational and cultural programs so if the

case was to go through then this program’s image and standing could be publicly

affected.

A court case can be a very expensive process and depending on the outcome

could be very detrimental to a firm. In order to enter a case, there are court costs which

must be paid in order for the case to be heard. Also, the cost of lawyers is extremely high

and could become even more pricy if the litigation process drags on. For Kohler, they

must look at the case from the standpoint that if the verdict were to favor the 12% of

shareholders could the firm afford it? In addition to this, since this is a minority situation,

then all shareholders will get the new price.

After interviewing Mr. Huddleston he said a company’s image is one of the main

things that will be affected when going into a court case such as this one. The press that

Kohler will receive will in no way be beneficial to their current public status. They

currently value the private ownership they maintain and do not want the public to view

them in any way as unfair and immoral to customers or shareholders which can derive

from bad press associated with a lawsuit. Therefore, finding a settling price seems to be

the best option for Kohler from a press standpoint because keeping the company name

out of jeopardy is key for future success. The thought of bad press could also cause an

ethical dilemma with Kohler’s family, shareholders, and charity programs. The idea of
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casting a shadow over the company name could have these members wanting their

name out of association with Kohler.

Last of all, Kohler takes the risk of their firm becoming even more public after the

decision and then letting Wall Street and/or IRS step in. If Kohler’s total number of

shareholders exceeds 500 then the company must go public and in turn be on the New

York Stock Exchange and abide to their rules and regulations. Even though the Feds

(Federal Reserve Board) tends to favor the wealthy elites such as Kohler, in a case like

this we feel they will oppose them since they have been private for so long. By staying

out of court and keeping themselves private Kohler can continue to be successful and

avoid the public buyers, sellers, and traders in Wall Street.

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Huddleston Interview – Thursday March 9th

1) In a large corporate case such as the one Kohler is being faced with what are the

risks involved with going to court as opposed to settling?

Mr. Huddleston first claimed that it all depends on the strength of the case when

determining what to do basically saying that if the $54,500 is the right price then

proceeded with it and win. On top of that he claimed that the biggest risk is the cost of

litigation, also other things such as taking away time of management in the business

process and the firm’s image. He claims that with a big private corporation like this one

they would rather have no press and settle outside of court because litigation effects

image dramatically and that it must be taken into consideration.

2) Once a price is established either in or out of court is it mandatory that everyone,

not just the 12% that filed the suit, get the new price?

Mr. Huddleston described this as a minority risk case and after a decision is made either

in or out of court then it will apply to all shareholders since just a few of them are

wanting the higher price. He stated that a way to avoid this would be to figure out what it

would take to buy out the 12% and get rid of them so you don’t run the risk of the rest of

the stockholders.

3) If this case is taken to court how will a price decision be made?

He said that the judge will hear all evidence from both sides and ultimately set a price

that he feels right; it could be the $54,500, the $273,000, or any medium between the two

after properly weighing both arguments. He also claims that the IRS shouldn’t have

much say in a case such as this one as the Harvard Business case suggested.
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Kohler’s Offer Price

Kohler’s initial offer price of $55,400 per share may have been too low. This

price is based on the presumption that Kohler will remain a private company with the

same growth strategy and basic ownership and control structure. This price raises some

eyebrows within the company for many reasons. First, just a month before the

recapitalization, a Kohler family member traded shares and received $103,600 per share

(Harvard Business Report). According to our calculations, the book value per share in

1998 was $103,629. The book value per share represents the amount of money each

shareholder would get per share if the company went under and had to liquidate. So the

question here is why would a Kohler family member trade at $103,600 just one month

before an independent valuation firm set the final buyout price at $55,400? The answer is

speculation, which we will touch on later in the paper.

Implication for Shareholders

The implication of the price $55,400 for the group of shareholders that disagree

with this price is that they feel they are getting ripped off. The case states that they feel

they are getting as little as 1/5th of the actual value of the company’s stock price.

The 88% of shareholders who agreed with the recapitalization most likely

exchanged their shares for the new shares issued by Kohler. As the “stock issues”

spreadsheet shows, the majority of the authorized stock had been already issued as of

December 31, 1998.

Shares Issued Info

• 73.46% of authorized common stock had been issued as of 12/31/98.

• 13.59% of authorized restricted stock issued as of 12/31/98

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• 12% of shares being dissented

• 14.54% of shares bought back by Kohler at a price of $55,400 as of

12/31/98

Implication for Kohler

The implication for Kohler offering the share price of $55,400 is the chance of

dissent, which as we know actually occurred. The case states that in the state of

Wisconsin, the value of shares held by dissenters is always equal to the “fair” value. The

problem with this is that there are multiple meanings of the words “fair value” for

everyone involved in this case. Obviously, if someone thinks the company is going

public soon, then that should be incorporated into the “fair” value. For Kohler, they

know they are not going public, so adding on an extra amount of money to the value of

the stock does not represent the company’s “fair” value whatsoever.

The effects of dissent could be devastating by means of going to court. We have

already outlined the effects and negatives of going to trial earlier in the paper. These

effects should be remembered as implications for Kohler by offering the buyout price of

$55,400.

Dissenter’s Claimed Price of $273,000

First and foremost, we strongly believe that this price is an overwhelmingly

overpriced value of Kohler’s stock. We stand on the side of Kohler with regards to the

dissenter’s wishes of receiving $273,000 per share as the buyout price. The group of

people dissenting against Kohler’s proposed price of $55,400 per share could share the

same financial numbers and percentages as we do in column one in the spreadsheet

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attached titled “Dividend Discount Model Analysis”. This could be true. However, we

believe that the main reason the group of dissenters wants a higher price is for the shear

belief that the company is going to go public soon and they want their share prices to be

as high as possible so they are bought out when the company goes public. If the share

price is high when the company goes public, then they would reap a huge profit on the

value of the shares that they hold. The less the share price, the less they earn when the

company buys back from private shareholders to make an IPO offer on the free public

market.

Implications for Kohler

Kohler had been a private company the entire life of the company and there was

no plan by upper management to ever go public; not in the near future, and not in the far

future. Paying the dissenting group of shareholders this amount would be crazy for the

company because the value of Kohler is not that high. Kohler believes, as do we, that the

group of dissenters was speculating the announcement that Kohler would go public in the

near future which would give them reason to suggest such a high “fair” value price of

Kohler. If Kohler had to pay out this price, they would have to fork out $221.4 million

dollars (811 dissenting shares multiplied by $273,000). This would take over twenty

percent of Kohler’s year 2000 retained earnings to pay for the dissenters’ shares during

recapitalization. This would be a huge loss for Kohler if they went to court and the courts

decided to award the group of dissenting shareholders the amount of $273,000.

Obviously, we want to stay out of court for the shear reason of the possibility of the

courts awarding this price to the dissenting shareholders. The results would not be pretty

for Kohler.
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Implications for Kohler Foundation

Implications of this stock price for the Kohler Foundation are huge as well. The

case states that the Kohler Foundation is required by law to annually pledge a minimum

of 5% of its assets to charitable causes (Harvard Business Report). It can easily be seen

that the lower the value of the stock, the less the Kohler Foundation is forced to give

away to charitable organizations. On the other hand, if the value of the stock is very

high, then they are forced to give away even more money. They are rooting for the price

to stay low because the higher the price, the more money they must give away to

charitable organizations. We are not implying that giving to charitable organizations is

bad; as a matter of fact it is a good business tactic to gain marketability and brand name

awareness. However, if an organization is forced to give away a certain percentage of its

assets, it is always good for them to give away a percentage of a lower number rather

than a higher number. This keeps the cash in the organization, which in this case, is the

Kohler Foundation.

Implications for the Estate of Frederic Kohler

There are also implications for this share price for the estate of Frederic Kohler.

The higher the share price, the more taxes that Kohler must pay on the estate of Frederic

Kohler, who owns 975 shares (findarticles.com). What this means is that taxes paid are

directly proportional to share price. Obviously, if the share price is lower, then Kohler

will pay less in taxes because the value of the estate will be much lower. If the share
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price is determined to be $273,000 like the dissenters are claiming, then Kohler will be

paying a gigantic amount of taxes on the estate of Frederic Kohler.

Implications for SoGen

SoGen, a primary holder of outside shares and a big player in the dissenting

group, had recently bought 63 of its 80 shares of Kohler in March 1998 at a price of

$103,600 per share (Harvard Business Report). If the value of Kohler stock is kept at

$55,400, SoGen would take a huge loss on their investment. SoGen desires to either keep

their equity in Kohler stock or to receive a higher price than what they invested at

(findarticles.com). Obviously, SoGen has a huge stake in this case. A lot of their money

is at stake as well as their investment strategy with Kohler. They have a huge interest in

how this all unfolds and we can see why they are disagreeing with the price offered of

$55,400 per share.

Implications for Other Shareholders

Another implication of this price is the question of what happens to the 88% of

shareholders who originally agreed to the $55,400 price per share if this case goes to

court and the court awards a price of $273,000? Obviously, the people who only

received $55,400 would then feel that they got ripped off by Kohler and that the price

that they received was five times undervalued. This would generate huge problems for

Kohler and the people who originally agreed upon the $55,400 price per share would be

outraged.

Obviously, there are many implications to this price of $273,000. For the

dissenting shareholders, if they get this price then they can gain large profits if their
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speculation is true about the company going public. For the company, they would take a

huge hit on their retained earnings to pay out this price per share to the dissenting

shareholders. For the Kohler Foundation that owns Kohler stock, we know by the case

that they give away 5% of their assets every year to charitable causes; because of this,

they would want the value of the stock to be lower so that they do not have to give away

more money. For SoGen, they have a huge interest due to the price they paid just a

month before the recapitalization. Obviously, there are a lot of people, groups, and

organizations who have a huge stake in this case. A lot of people will be affected by any

decision. We believe that the basic foundation to this price of $273,000 is based on the

speculation that the company will go public. Due to the information available, we can

deduct that Kohler is not going public anytime soon, therefore, the price of $273,000 is

way overvalued to the actual “fair” value of Kohler.

Risk of Court Determined Value

There is huge risk at stake if this case goes to court. With the exception of the

group of dissenters, all parties involved most likely wish to stay out of court due to the

risk factor of the courts determining a price. There is a lot of money at stake for Kohler,

Kohler Foundation, and the Estate of Frederic Kohler. This is one reason why we will

offer a settlement outside of court later in the paper. The effect to each of these parties

could be monumental in the history of their existence. The courts could choose a price

that would be devastating for some of these groups. This risk is just not worth going to

court. It also could be risky for the dissenting group such as SoGen because the court

could even value the company at even less than $55,400.

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Our Proposed Settlement Offer Price Outside of Court

There is a wide range of prices that we came across when trying to figure out a

settlement price. We know that we are proposing to settle outside of court, it is just that

there are many different factors regarding coming up with a stock price. For example,

Kohler does not have a Beta factor, so in some of our price proposals we used different

betas using different techniques to coming up with those beta figures. Three options that

can be pursued with regards to coming up with a stock price are:

• Book value per share method.

• Multiples approach to valuing a company’s stock

• Dividend discount model.

Book Value per Share

As stated earlier in the paper, the book value per share is simply the amount of

money that each shareholder would get if the company were to liquidate. SoGen has

recently bought shares at $103,600 per share in 1998, or roughly the amount of the book

value per share of Kohler stock in 1997 (spreadsheet attached). We do not think this is a

coincidence that just prior to the recapitalization announcement in April of 1998 that

shares of Kohler stock were being traded for almost exactly the same amount of the 1997

book value per share. Therefore one of the options Kohler could pursue in this case is to

offer a settlement price of the book value per share at the time of the recapitalization to

the dissenters to settle the case outside of court. However, we realize that the book value

per share only shows what the company is worth if it liquidates and goes out of business.
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Book value per share does not look into the future of the company. We are not talking

about looking into the future as speculating, but rather looking into the future by looking

at projected income statements and projected statements of cash flows. We believe that

the “fair” value of the stock offered as settlement should take into account the prospect of

future profits, and therefore, using the book value per share approach is not the most

effective way to offer a settlement price outside of the courts.

Multiples Approach Settlement Price

Another approach to finding a stocks value is using the multiples approach. The

case gives basic stock and financial data for companies comparable to Kohler is some

way or form. Using these numbers, average price-book ratios, price-earnings ratios, and

price-cash flow ratios can be found. These averages are shown in the spreadsheet titled

“Multiples Approach.” When these averages are used with Kohler’s book value per

share, earnings per share, and cash flows per share, estimated prices can be obtained by

multiplying the two as shown in the “Multiples Approach” spreadsheet. An appraiser for

SoGen believes that Kohler’s stock price could be valued as high as $400,000 if Kohler

Co.’s financial were examined. Using the multiples approach as we have shown gives

high stock price estimates that could be used to argue higher prices.

The estimations shown are higher than the price we have chosen, but many

problems can be found with these estimates. Kohler Co. has business sectors in

household fixtures, cabinets, small engines, generators, and resorts. Kohler Co. is

diversified and should be considered a conglomerate. Comparing a conglomerate to

other businesses is difficult to do because it is unlikely that any other company would
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truly match there corporate structuring. The comparable companies’ ratios will show

some indication of what Kohler’s should be, but they are definitely not an exact match.

One approach to deal the problem of Kohler Co. being a conglomerate would be to break

down each business segment of Kohler Co., use a multiples approach with similar

companies, and then average all the segments. This would take an extensive amount of

research and time.

Another problem with the multiples approach is that the ratios could be adjusted

and refigured in many ways to justify almost any stock price desired. By weighting each

comparable company in different ways, different ratios would be found. Small changes

in ratios can lead to huge changes in stock pricing.

Multiples Approach Findings

• P/B Estimated Stock Price $155,255.43

• P/E Estimated Stock Price $469,379.92

• P/CF Estimated Stock Price $182,615.22

• Average of the three $269,083.52

Dividend Discount Model Settlement Price

We have two different ending prices that we are focusing on using the dividend

discount model. The only factor that is different in the two formulas to come up with the

two prices is the figure for beta. In the first price, you can see on the attached

spreadsheet titled “Dividend Discount Model Analysis” that we came up with a price

quite similar to the $273,000 that the dissenting group is asking for. Our price that we

came up with is $269,243 per share. This price was found by using the dividend discount
 21

model. We found our required rate of return by using the industry average beta

calculated from the case, the risk free rate in 1998, and the average market risk premium

over the last 75 years; both of which figures were found in our Investments textbook.

Then, we projected our future dividends from the case and found a projected share price

in 2002 and discounted all of those cash flows back to 1998. As we know, the net present

value of any asset is equal to the present value of all future cash flows. This is what we

did to come up with this price of $269,243 per share.

In our next price we came up with, which is the price we believe should be our

initial settlement offer; we just did one minor thing differently than in the previous

proposed price. This time, instead of taking the simple industry average beta, we made it

an industry weighted average beta based on sales in order to proportionally show the

companies size, strength, and market power. By using a different beta based on the

weighted average, this changed our required return by about half a percentage point and

made a huge difference in our valuated share price of Kohler. As you can see in the

attached spreadsheet, the price we came up with as option 2 is $120,125 per share.

Amazing how such a little change in the required return can change the value of the price

of one share of stock. However, we believe this is the correct way because of the

weighted average approach to the industry beta that we had to use for Kohler due to

Kohler not having a known beta because they are not a public company.
 22

Kohler Retained Earnings Implications

As of 2000, Kohler would have projected retained earnings in the amount of

$968.9 million dollars to use for reinvestment into the business and to pay off current

debt (Harvard Business Report). Since the recapitalization can be considered reinvesting

into the business, Kohler will not have a problem paying off the dissenting group of

shareholders at our suggested settlement price of $120,125 per share. There are 811

shares that are dissenting. If we settle these shares at a price of $120,125 per share the

total cost will be $97,421,375. Also as show in spreadsheet “Stock Issues” Kohler has

repurchased about 14.54% of its common stock during recapitalization, and they have

bought back about 86.41% of its restricted stock. The cost of these stocks being bought

back at a price of $55,400 totals about $66,834,887. This figure plus the settlement

figure brings the recapitalization figure to about $164,256,262. This plus legal and

appraisal fees would come out of our retained earnings. If our settlement price is

accepted Kohler Co. would use roughly twenty percent of its projected year 2000 retained

earnings.

The “Stock Issues” spread sheets shows different costs for different settlement

prices. Obviously higher stock prices would lead to a greater amount of retained earnings

being used for the Kohler Co. recapitalization.

Back-up Plan

A main reason as stated that Kohler Co. wants prevent a court valuing of its stock

is that if a court sets a value for they stock, then that price must be offered to all the share

holders. The price will even be awarded to all shareholders that had previously sold their

shares to Kohler as of December 31, 1998. Kohler might even have to pay interest on the
 23

amount over $55,400 to individuals who had previously sold their stock to Kohler in

1998. Having to offer every shareholder the court determined price would kill our

retained earnings depending on how high the court determined the share price. For this

reason, we are willing to use 25% of our projected 2000 retained earnings to stay out of

court. Settling out of court is a negotiating process. With talented negotiators we believe

we can keep our share price around $120,125, but we must have a limit on how high we

are willing to go. As the spreadsheet titled “RE Analysis” shows, 25% of our retained

earnings would justify a price as high as $216,264 per share. Obviously we would much

rather pay $120,125 per share, but we would pay as much as $216,264 per share to avoid

a court decision. Different court decisions could produce hard to predict negative effects

to our retained earnings. A lot more people might decide to sell their shares to Kohler if

a high share price is determined.

Competitor Analysis:

1- American Standard:
It manufactures air conditioning systems, bathroom and kitchen fittings,

and braking and control systems for trucks, buses and utility vehicles.

Sales of each division are as following:

Air conditioning systems 60%

Bathroom and kitchen fixtures 24%

Braking and control systems 16%

2- American Woodmark:
It manufactures kitchen cabinets and vanities.
 24

3- Masco:
It manufactures kitchen and bath products e.g. cabinets, appliances,

showers, tubs and other plumbing supplies. In addition to that it also

manufactures home improvement products such as water pumps and

insulation.

4- Briggs & Stratton:

It manufactures horsepower gasoline engines for outdoor equipment e.g.

lawnmowers, pumps and pressure washers for agricultural, industrial and

consumer uses.

5- Cummins Engine:
It manufactures diesel and gas engines. In addition to that, it also

manufactures engine components used in automotive, power generation,

industrial and filtration markets around the world.

6- Detroit Diesel:
It manufactures diesel and other alternate fuel engines for the automotive

and power generation markets. It also provides service for these engines.

Kohler competes with American standard, American Woodmark and Masco in the

plumbing fixtures and furniture market. American Standard and Masco are the big rivals

in this market. The following table presents the comparison of Kohler with its

competitors in terms of sales for 2004 and number of employees.

 25

Company Name Kohler American Masco American WoodMark

Standard

Company Type Private Public (ASD) Public (MAS) Public (AMWD)

Sales in 2004 (in 1,557 5,528 7,017 350

millions)

Employees in 2004 28,000 61,500 62,000 5,904

As we can see from the table above, the sales for Kohler are not that great as

compared with its competitors. One of the reasons is that Kohler offers high quality

products for higher prices and they don’t need to make high volume sales in order to

make profits. Also, the table above indicates sales for the whole company and not just the

furniture and fixtures segment of Kohler and its competitors. American Standard and

Masco are more diversified as compared to Kohler and offer more products. That is why

their sales are higher than that of Kohler. Kohler’s sales were higher than American

WoodMark. Also, the sales are kind of directly proportional to number of employees.

American Standard and Masco are much bigger in size as compared to Kohler and that is

why they enjoy higher sales.

1
The figures for sales and employees are taken from the following websites. The sales figures are in Euros. Also we converted the
2005 sales into 2004 sales using the sales growth rate for comparison purposes since sales for Kohler were given for 2004.
For American woodmark : http://www.hoovers.com/american-woodmark/--ID__12620--/freeuk-co-factsheet.xhtml
For Kohler: http://www.hoovers.com/kohler/--ID__40269--/freeuk-co-factsheet.xhtml
For American Standard: http://www.hoovers.com/american-standard/--ID__40026--/freeuk-co-factsheet.xhtml
For Masco: http://www.hoovers.com/masco/--ID__10962--/freeuk-co-factsheet.xhtml

$1 = .733 Euros on December 31, 2004 if we want to see the sales figures in dollars.
http://www.oanda.com/convert/fxhistory
 26

Kohler competes with Briggs and Stratton, Cummins Engine and Detroit Diesel in the

industry for manufacturing engines. Following table represents a brief comparison of

Kohler’s performance with its competitors.

2
Company name Kohler Briggs & Stratton Cummins Engine

Company Type Private Public (BGG) Public (CMI)

Sales in 2004 1,557 1,079 4,905

Employees in 28,000 7,732 28,104

2004

In the engines manufacturing industry, Kohler is competing with high profile

companies such as Cummins and Briggs & Stratton. Briggs and Stratton is the world’s

largest manufacturer of air cooled gas engines, whereas Cummins is the world leader in

the manufacturing of diesel engines. This tells us that competition is really tough and in

order to stay and compete with these big giants, Kohler has to keep producing quality

products and also come up with new innovations. If they stay private, then they won’t

have to disclose financial and other information to the public. This way they can try to

stay ahead of the game. Also, they won’t have to justify their investment decisions

triggered towards long run growth to the public.

Product Portfolio:

Kohler enjoys a well diversified product portfolio. Kohler manufactures cabinets,

bath tubs, tiles, engines, generators, furniture, and kitchen and bath accessories. Kohler

2
The figures for sales and employees are taken from the following websites. The sales figures are in Euros. Also we converted the
2005 sales into 2004 sales using the sales growth rate for comparison purposes since sales for Kohler were given for 2004.
For Cummins: http://www.hoovers.com/cummins/--ID__10423--/freeuk-co-factsheet.xhtml
For Briggs: http://www.hoovers.com/briggs-&-stratton/--ID__10231--/freeuk-co-factsheet.xhtml
 27

started business as a manufacturer of plumbing fixtures but then diversified its product

portfolio in order to grow and reduce the risk of a product failure. According to Harvard

Business Report, in 1997 Kohler had 5 divisions which were as following:

ƒ Kitchen & Bath Group

ƒ Power Systems Group

ƒ Interior Groups

ƒ Hospitality and Real Estate Group

ƒ Elim. & Corp. Var.

Kitchen and Bath Group made a net income of about $87 million followed by Power

Systems Group with net income of about $20.4 million. Elim. & Corp. Var. had a loss of

about $25 million. Kitchen & Bath Group and Power Systems Group in this case are the

cash cows that are providing most of the money for growth of other divisions. However,

they are not at the end of their life. Kohler keeps on innovating kitchen and bath products

and engines so that these divisions remain cash cows for several more years. Elim. &

Corp. Var. is the dog in this case and needs to get rid off since Kohler lost about 25

million dollars in this division in 1997. Interior Groups division is a rising star. It is not

yielding that much income but we are hoping that it will become a cash cow in future.

Hospitality and Real Estate Division is a question mark on the product portfolio.

We looked at Kohler’s website and found the following divisions in Kohler’s

3
family of businesses:

ƒ Golf/Resort Destinations

ƒ Kohler Engines, Generators and Rental Services

3
The divisions in Kohler’s family of business are taken from the Kohler website which is as following:
www.kohler.com
 28

ƒ Furniture

ƒ Kitchen and Bath

We can see that Kohler got rid of Elim. & Corp. Var. division since it was draining cash

from other divisions and was losing millions of dollars. As of now, Kohler only has 4

divisions. Kohler Kitchen & Bath and Kohler Engines, Generators and Rental Services

are still cash cows. The furniture division is picking up slowly and so is the Golf/Resort

Destinations division.

Rebuttal of Presenting Group

• The first thing that the presenting group does not talk about is the idea of having a

backup plan or negotiation strategy. This would be good if they reject our first

offer. What is the presenting group going to do if they get rejected? They should

have a backup plan in place like we do. It’s not just all about stock price, it’s

about how much Kohler wants to stay out of court and how much retained

earnings they are willing to use to avoid court.

• In the presenting group’s reverse split section on page 6, they make the claim that

reducing the number of shares each owner has will reduce dividend share. This is

not true. Dividends will be proportionate to the amount of stock value the owner

has.

• The presenting group claims that Kohler should meet with outside stockholders in

determining the value of the stock price. First of all, outside shareholders only

make up 4% of shares outstanding and they have no voting power or influence on

 29

the board of directors. It is not necessary to run all of our plans and strategies by

this small 4% of stockholders. They are not a factor.

• While we realize that going to court is not good for our public image, we have

shown in our paper that a counter PR campaign can actually make this publicity

positive for Kohler. The presenting group failed to see this opportunity.

• The presenting group uses the average growth rate from 1998-2002 for their

dividend discount model calculations. We have used a more historically accurate

rate averaged from 1993-2002.

• The presenting group has used an average of the industry betas. Just by taking the

average, size, market power, and market share cannot be represented in the beta.

Because of this, we have taken a weighted average beta weighted by sales to take

into account the size of the other companies in the industry.

• On the price cash flow ratios that the presenting group has calculated, the number

they call Net Cash Flow is actually the increase in cash and cash equivalents

number. They shouldn’t even be using net cash flow in the first place, they

should be using OCF. They used the wrong figure here.

• When calculating stock price and all ratios that use total shares outstanding, they

do not factor in the restricted shares. We used 7588 shares in all of our

calculations while they used 7445. 7588 is the right number to use because it is

the total number of shares outstanding, not just the total common stock.

• We believe that SoGen would not agree with their proposed price of $110,000.

This price is too low. SoGen has invested about $100,000 per share believing that
 30

these shares will greatly increase in price in the future. They are not willing to

drop a suit for such a low rate of return (10%). Bottom line, their price is too low.

• On page 19, the presenting group talks about how a price of $110,000 would

affect outside shareholders as though we would have to pay all shareholders the

$110,000 if we settle outside of court. Our interview with Huddleston shows that

if we settle outside of court, it has no bearing on the people who already agreed

with $55,400.

• The presenting group has no analysis of how the recapitalization will affect

Kohler’s cash status and retained earnings standing. We have shown in our paper

how retained earnings will be affected with different settlement prices. This is a

key factor to consider for Kohler and the other group didn’t touch it.

• On page 13-15, when finding all their ratios, the presenting group used the price

which was calculated in the dividend growth model that they calculated. This is

wrong because if you don’t get the right price form the dividend growth model,

then all the ratios will be wrong. Also, the main point of using all different ratios

is to come up with different prices.

Conclusion

Our analysis has shown that going to court has various negative such as, bad

press, unpredictable stock price, court cost, and revealing private information. For these

reasons we recommended settling out of court. The first challenge of settling out of court

is determining our initial share price offer. To figure this offer many methods were used

including the dividend discount model approach, book-value approach, and a multiples
 31

approach. We recognized that numbers could be adjusted in many ways to justify any

price imaginable. We also recognized that comparable companies are not exactly like

Kohler and using their averages might not be completely accurate. The initial offer price

we recommend from analysis is $120,120. We showed the effects of this price and other

prices on The Kohler Foundation, the estate of Frederic Kohler, SoGen, and the Kohler

Company. A detailed retained earnings analysis showed the effects of recapitalization on

Kohler’s retained earnings. From this retained earnings analysis we recommend that

Kohler be willing to use at most 25% of their projected year 2000 retained earnings.

Using 25% of retained earnings for the entire recapitalization would allow a settlement

price of $216,264 per share for the 811 shares. In the end we recommend Kohler do

everything possible to settle out of court. They have sufficient retained earnings to settle

at almost any price they want, but we believe that $120,125 is very justifiable and more

than fair.
 32

Grammatical Errors in Their Paper

• Page 2, last sentence first paragraph – after the words decision and company there
should be commas. Also, that same sentence is unparallel and has flow issues.
• Page 2, last sentence first paragraph effects should be affects
• Last sentence on page 2 is a run on.
• Page 3 3rd sentence has subject verb agreement problems
• Page 3, in the middle of the page, the sentence that starts “Not only…” does not
make sense, “and good employee relations” - what?
• Page 3, 2nd sentence 2nd paragraph, after the word business should be a comma
• Page 4, first sentence, they have quotations in wrong spot, and the first quote
never has an end quote.
• Also, on page 4, they have a colon in a spot where there should just be a comma
before a quotation, top 1/4th of page.
• In the middle of page 4, they use the word dependant when it should be dependent
with an E
• Page 5 2nd paragraph 3rd sentence they have “it” and should be is
• Top of page 6 after “we think that..” should have the word they in it
• Page 6, they use the term split instead of reverse split.
• Page 6 last sentence they use the terms “amount of stocks” , it should be number
of shares
• Bottom of page 6, reducing the amount of stock each owner has does not make
dividend per share decrease.
• Last paragraph page 7 and into page 8 is all repeated information. Very redundant
• Page 7 2nd part they use the term shareholder’s with an apostrophe and there
should be no apostrophe – 5th sentence 2nd part
• 2nd paragraph page 8 3rd sentence should have a comma after However and also
should have a comma after enough.
• Page 8 2nd bullet they use the term “made” , it should be “offered”
• All of page 9 is repeated information. Very redundant
• First paragraph page 10 is all repeated information for about the 3rd time
• Page 10, 2nd sentence should have comma after pros
• Page 11 2nd sentence first paragraph should have comma after For example
• Page 11 3rd sentence first paragraph should have comma after settled
• Page 12 (top), sentence that ends in “future cash flow” should have an s for plural
• Page 12, first paragraph last sentence should be market RISK premium – and so
on throughout the paper
• Page 12 first sentence under discount rate should have semi colon after the word
“this” – also should have “the” before arithmetic average
• Page 13, subject verb agreement is wrong in last full sentence on page
• Page 16 2nd sentence should not have a comma after is
 33

• Page 17, last sentence first paragraph does not make sense
• Page 19 2nd paragraph 2nd sentence they use the word “bided” which has no
meaning in this context
• Starting on page 19, their citations are the whole website when it should just be
short and simple. This is very picky, but it kind of decreases the “eye quality” of
their report
• Page 19 2nd sentence under foundations its should be “their”
• Page 20, they use $675,000 total when it should be per person in the state
• Page 22 under advantages for shareholders “trail” should be trial
• Continuous throughout the paper they use the term “holders” instead of
shareholders, this may be confusing to an outside reader.
 34

March 9, 2006

Mr. Stephen Huddleston

Clarke House
98 West Jefferson Street
P.O. Box 9
Franklin, IN 46131-0009

Mr. Huddleston,

On behalf of our senior seminar group, we would like to thank you for allowing us to conduct an in-person
interview on March 9th. Your knowledge on corporate law helped us immensely when preparing our
presentation about the Kohler Co. and their lawsuit situation. We greatly appreciate your time and
consideration.

Thank you,

Chad Hoffman
Zeeshan Malik
Brad Patterson
Nate Roberts
 35

WORKS CITED

http://www.masco.com/investors/pdfs/Masco10-K2004.pdf

http://www.mikehenning.com/2005.cfm

http://www.sec.gov/rules/proposed/s7398/singer2.htm

Harvard Business Case

http:// papers.ssrn.com/sol3/papers.cfm?abstract_id=721002

http://www.findarticles.com/p/articles/mi_qn4196/is_19980419/ai_n10430992