IMBA Course – Corporate Finance 2

Valuation of Kohler

INSTRUCTOR
PROFESSOR LIU QIAO

PROJECT TEAM
冯梅 孙媛 黄旭哲 王美玲

10928183 10928335 10928497 10828517

Ariel Flora Leo Marie

18 December, 2009
1|Page

...................................................................... IV............................................ Executive Summary ................... 7 DCF approach ................... 2.... VII.. VIII............................................................... 1.............................................................................. 4 Methodology of Analysis .............................................................................................................................................................................Table of Contents I....................................... 13 Trial and Settlement .... 12 Dividend based valuation ............................................................................................................................. 7 Multiples Approach ................... 9 Reconciliation ................................................................. 3........................................................... 15 Recommendations and Conclusions ....................... 16 2|Page ..... 3 Background and Problem Framing .............................................. III...................................................................................... 14 Tax Controversy ............................... 6 Valuation ........................................... II................... VI..................................................................................................... V.................................... 11 Lack of Liquidity Discounting .............................................. IX.............................................................

we will use two methods—DCF model and multiples to evaluate the enterprise value and equity value of Kohler Co. The two methods are expected to generate a similar result. A settlement would be in the best interest of both parties. it would be detrimental to their reputation as the share price that they are valuing it at appears to be grossly undervalued. This is supposing that the plaintiffs actually win.000. Kohler Co. Kohler should settle at $273.. Executive Summary In our report. the case becomes slightly more complicated once the IRS (Internal Revenue Services) comes into the picture.680. This being higher than the price that shareholders are asking. Kohler should be even more inclined to settle. the settlement price being higher as well.I. Ultimately.96 per share for the shareholders.680.400. given the parameters of the case. Therefore the maximum settlement price that Kohler will be willing to offer the shareholders will be $120. Depending on the result of the trial. if not. it is unwise and unfavourable for Kohler to bring the case to court as being a time-honoured brand. while the dissenting shareholders estimate that the share price is $270. 3|Page . Adding the potential lawsuit and the tax implications. it seems favourable that Kohler should settle at $315. However. What is the fair value? What is the market—based value? According to the decision tree. Based on the information provided. taking all into account. The reason behind the big gap is something we should take an investigation in. the maximum share price that would be demanded to pay would be $120.786. which implies the book value of the company.400 as stipulated by the company. we will find the reason why there is difference between our own valuation and their estimation. Should Kohler decide to move the case to the court.000. As we can read in this case. the IRS would be very likely to demand that there would be tax levied upon the share price. estimate that the share price is $55. then the result would be based on the $55. we can also see some rationale about why we prefer settlement rather than bring the issue on trial.

In 1972. Kohler Co. In 1900 the manufacturing opearations moved four miles west into the countryside to the village of Riverside. In 1984. Outside shareholders owned 4% of Kohler Co. 4|Page . The two charitable trusts owned 17. diversification and international expansion in the following years. During the excellent leadership of Walter Kohler.II.S.’s diversification and international expansion brought its revenue growth.. Kohler.9% of the common stock. the name was changed into Kohler Village. The peak time was coming for both its fame in business and their charitable enterprises. Kohler. Kohler Co. the company went on to develop world class golf courses. About 20 other Kohler family members owned 13. The Austrian immigrant John Michael Kohler hit on the idea of enamelling a cast iron horse trough/hog scalder. the Frank Lloyd Wright Foundation designed a new master plan and Kohler decided to develop The American Club as a luxury inn. became Chairman and CEO. the company expanded beyond its Wisconsin roots. the company began a series of acquisitions aimed at expanding its product line and gaining entry into new markets.445 outstanding common shares in April 1998. stock. Herbert Kohler directly owned only 12. In 1977. He guided Kohler Co. was a manufacturer of plumbing fixtures in Sheboygan. became the leading manufacturer in plumbing fixtures and electric generators. In 1905. The Estate of Frederic C Kohler owned 13. adding legs to it. among which there are two largest—SoGen International and Franklin Mutual Discovery Fund. After the inn proved successful.1%. in 1912. The Kohler Foundation owned 12. directly owned 13. and selling it as a bathtub.’s development.4% of the common stock and beneficially owned an additional 6% through trusts established by his father. had 7. South Carolina.7% of the stock. Walter J. Background and Problem Framing Founded in 1883. Kohler Co. Ownership and control Kohler Co. Jr. In the late 1950s. His sister.7% of the shares. building a new plant in Spartanburg. the president and CEO of Kohler Co. started the conversion of Riverside into American Club. Herbert V. or 300 shares.1% and beneficially owned 6% through similar trusts. to house immigrant factory workers and help their social integration into the U. Ruth.

In Kohler’s opinion. the case was to be heard by the Wisconsin circuit court. which can balance the interests of the company. and the charitable foundations that owned shares in Kohler Co. In order to ensure Kohler’s private status. Outside shareholders.Herbert V. Kohler Co.? 5|Page . Herbert Kohler proposed a recapitalization of Kohler Co. share or settle with the dissenting shareholders at a much higher price.000. exercised their dissenters’ rights to have the “fair value” of the Kohler Co.400 per share. private ownership and privacy of results help focus on big ideas and excellent long-term performance.. which is five times as the price offered by the company. Kohler Ruth De Young Kohler Estate of Frederic Kohler John Michael Kohler Kohler Foundation Kohler Trust for the Arts and Education Kohler Trust for Preservation other Kohler Family Members Kohler Employee Plan Outside Shareholders Discrepancy According to its Chairman and CEO. the family. In May 1998. The conflict in Herbert Kohler’s heart is whether he should let the court determine the value of Kohler Co. The final buyout price was set at $55. The group claimed that Kohler Co. over 100 owners of 811 shares exercised their right to challenge the company’s valuation of their shares and brought suit against the company.’s private status resulted in its success. stock. Challenge Now. shares were worth $273. joined by some family shareholders. with the purpose of buying out all the outsider shareholders and restricting future sales of stock to outsiders.

we will attempt to resolve the discrepancy by adjusting the DCF taking into account different assumptions so support the conclusions from the two parties. Lack of marketability discount and Dividend based valuation We take into consideration other methods of valuing Kohler based on lack of marketability/liquidity and also Gordon’s Constant Growth Model. Trial and settlement Next we will use basic decision theory to make suggestions for Kohler to resolve the dispute with the shareholders pending the possibility of court case. 5. 3. Kohler and the disgruntled shareholders.III. this will take into consideration the controversy with the IRS and possible tax implications. DCF Using discounted cash flow method to come up with our own valuation of Kohler taking into account a few basic assumptions based on the information available. Methodology of Analysis We will proceed to analyze the case in the following steps 1. Multiples Using the comparable firms in the industry taking into consideration that Kohler’s scope of industry spans a few fields with different weighting 2. 4. 6|Page . Reconciliation Due to the nature of the controversy in the case.

And this could be evidence shows that the stock price that dissenter claimed is much higher than what we estimated. For this case. generators. 7|Page . And comparing a conglomerate to other businesses is difficult to do because it is unlikely that any other company would truly match their corporate structuring. is diversified and should be considered as a conglomerate. etc. so it is hard to find the true market fair value on stock market. which should be the true “fair” value of Kohler private company. small engines. So actually Kohler Co. because Kohler is not a public company. Valuation 1. and resorts. We will use those data to settle down the stock price of Kohler by average multiples. it provides some basic financial and stock market data for companies comparable with Kohler in the same industry. The following illusion shows the calculation process. But as Kohler Co. In the case. has cross business sectors in household fixtures. Multiples Approach Multiples approach is widely used when IBs do valuation for M&A and IPO. cabinets.IV.

we come out with another adjusted multiple approach to estimate the value of Kohler Co.So considering about this issue. as shown in the below exhibit: So base on this adjusted multiple approach method. This would be another strong evidence to show the dissenter that the stock price couldn’t be so high as 273.000$ and persuade them to accept the settlement price outside of the court. which is far below the claimed price of 273. 8|Page .831 Power S ystems Group 26. We firstly identify the revenue ratio among its majority business sectors.948$ per share. we estimate the stock price of Kohler Co.485.33% 1.000$ per share. and Power Systems Group as following exhibit: Exhibit Majority Business Sectors of Kohler (in $ thousands) Kitchen & Bath Group Weight Ratio Net Sales 73. such as Kitchen&Bath Group.260 And then base on the different ratio weight to calculate the weighted average multiples.67% 540. to reach about 158. Coming out another set of data.

335 1.78 1.373 46% 54% 9|Page .34% BBB 7.467.70% BB 9.2.17 44% 5.34% 8.10% B 9.038 786.64% 5.10% AA 7.68% ( [ [ ⁄ ] ⁄ ] ) WACC Bu Bl Tax rate Rf MRP Cost of Debt WACC 0.00% 7.34% based on moody rating 1998 (A rating) Corporate Bonds (10-year maturity) Rating Rate AAA 7. DCF approach a) b) c) d) Unleveraged the β from the list of comparables.18% A 7. use the average Find Leveraged β for Kohler Use MRP of 5% as a standard Cost of debt 7.07% (Average proj) (10yr bonds apr 98) Debt Equity Total D/D+E E/D+E 681.

724 71.481 465.207 294.308 87.101 91.357 94.027.687 61.337 74.023.161 924.512 258.806 982.387.124 225.071 531.876 81.838 261.384 495.560 261.669 355.537 114.950 119.713 225.324 87.241.899 70.261 410.450.839 55.182 316.841 1.419 56.767 1.355 43.786 17.00% 2.934 299.621 272.007 539.664 447.967 498.132 516.Assume Perpetual Growth at 6% from historical value of firm Invested Capital Operating Cash Inventory Accounts receivable Accounts payable Operating Working Capital Tangible Assets Operating Invested Capital Non-Operating Assets Total invested capital 63.826 Perpetual Growth Terminal Value NPV Debt Equity Value Share Price 6.165 109.234.939 109.661 -449 110.416 476.064 1.334 294.326.647 301.272 681.993 95.602 304.976 281.270 1.695 1.038 $1.081 49.621 106.518 97.929 251.523 47.579 $1.283.593 29.32 $134.903 1.093.704.021 554.251.949 50.846 61.85 10 | P a g e .065 376.877 Tax on EBIT NOPLAT Dep Inc in work Cap Cap Ex FCF 54.031 1.835 946.927 239.962 351.550 393.067 97.771 448.

193 Perpetual Growth Terminal Value NPV Debt Equity Value Share Price 4.324 47.54 $55.83% $2.857 Shareholders Perspective Shareholders claim $270.400 per share.876 61.26 683 4.68% $1.739.337 61.478.038 $2.058.337 61.876 61.910 681.949 51.83% FCF 49.949 50.335 681. Reconciliation Kohler’s Perspective Based on Kohler’s own valuation they came up with a value of $55.558 11 | P a g e . this can be derived as follows Assumption : pessimistic estimation of perpetual growth 4.297.224 Perpetual Growth Terminal Value NPV Debt Equity Value Share Price 6.117.33 468 1.324 47.15 $271.038 $419.100.000 per share Assumption : Optimistic estimation of perpetual growth 6.871.68% FCF 49.3.

12 | P a g e .14 This is closer to Kohler’s valuation and one that we find more acceptable than the shareholder’s claim.V. one of which is the lack of marketability discount that is applied to stocks and equity that is not freely traded on the open market. Lack of Liquidity Discounting There are many concepts that we can tap from this case.85 25% $101. Figuresx point to a 15% . When we use a median discount of 25% to the current valuation by DCF we get the following: Share Price Lack of Liquidity Discounted Stock $134.35% discount applied to the stock due to lack of marketability.

I believe that our assumption that lack of liquidity results in the stock following constant growth model is flawed.688 1998a 5.48% 6.848 2002 9. g : annual growth in div Market Expected Returns Bu Bl Rf MRP Expected Returns 0.546 (10yr bonds apr 98) 1999 5. 13 | P a g e .325.78 1.64% 5% 11.395 $152.505 $20.48% 1997 Dividends Paid 5.17 5.10 This value is generally under both valuations of Kohler as well as the shareholders.00% -3% 45% 13% 10% 188.403 2000 7.741 10.46 -3% Expected returns Perpetual Growth Terminal Value NPV Share Price 11.817 2001 8. Dividend based valuation Since the stock in not traded we can assume that the Price doesn’t fluctuate as much and in valueing the stock take into consideration only the constant growth model: Gordon’s contant growth model P0 = Div1 / ( r – g ) r: expected rate from inv.VI.

taking into consideration the probabilities and the discrepancy between the share prices. Hence.0 trial no claim by plaintiffs 70% $55. then the total amount that he would have to pay would be $55. should the plaintiffs lose the court case.400.900. the likely chance of this is 70%. However.0 no trial $120.680.VII.400 $38.0 claim by plaintiffs 30% $273.680 per share. he stands to lose a total of $273. given the probability that of 30% that Kohler would win the case. it is clear that should Kohler decide to bring the case to trial. which is the price that was stipulated by the company. the maximum share price that Kohler should be looking to settle would be $120. which though high.900.780.000 $120.780.000 should the plaintiffs win. the probability weighted amount is $81. is not a guarantee.0 Max price Kohler willing to settle for As shown in the decision tree. 14 | P a g e . Trial and Settlement Decision tree based on trial and settlement $81. On the other hand.680. However. Weighted we get $38.

for the above analysis we only look at amounts in excess of $27 million for the taxable estate. This being higher than the price that shareholders are asking.96 per share for the shareholders.010.141.984.33 $256.228.929.00 Win 30% $316.73 Price Per share Lose Trial 70% $347. Kohler should settle at $273.VIII.320.17 $315.103. the IRS too has their eye on Kohler. Tax Controversy $44.017.472. the base taxable amount would be $27 million. Hence regardless if Kohler goes to court or not.96 Price per share Settlement IRS 50% No IRS 50% $128.00 However. Being a large company. Depending on the result of the trial. the case is not as simple as bringing the plaintiffs to court.400.786. it seems favourable that Kohler should settle at $315. 15 | P a g e .00 $384.000.195.786.

It is highly recommended to Kohler to revalue the stock price at a “fair” market value and repropose this amount to the shareholders. Kohler is assuming that the growth rate of the stock price would be at 4. Given the state of things. by weightage of similar industries. the total amount that Kohler would have to probably pay is estimated at $256 Million on top of the $27 Million that is required by IRS.IX. the shareholders are feeling that they have been hoodwinked by Kohler and are disgruntled enough to bring Kohler to court to fight for their deserved rights. the next best alternative would be to go to court. although the tax payable to IRS is higher. whereas the shareholders are being optimistic and assuming that there would be a growth of 6. Due to the difficulty in estimating the true value of Kohler. the shareholders are also keen in extracting the maximum amount of money that they are able to from the company.83%. 16 | P a g e . it is definitely in the best interest of Kohler to bring the case to court given the large differences between the amounts of money involved. Both of which are unrealistic. Realizing that Kohler wants to keep the shares within the family. At trial. but it is the trauma and the additional legal and administrative fees that will hurt the company more than a simple decision of settling or not. Failing which. Given that.68% which is pessimistic. Given all the different scenarios and evaluations. Recommendations and Conclusions It appears to be that both Kohler and the shareholders are undervaluing and overvaluing the stock price respectively.000 per stock price. the estimated true value of the stock should be closer to $159. The closed door valuation of the stock price too does not inspire much interest as far as the shareholders are concerned.

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