Blaine Kitchenware Case Soln

8/13/2019 Blaine Kitchenware Case Soln

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Blaine

Kitchenware

Inc.

Take-Home Case

Assignment

BSAD 342

Prof. Vishwakarma

Grady McQuillan

Joe Mackay

Mitch ChownAlessandro Galeone


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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 companyspayout ratio, and as Ive stated they arenot

maximizing the firmsvalue by lowering the cost of capital. Blaine Kitchenwares 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 Blaines board? What are theprimary advantages and di sadvantages of such a move?

Dubinski should be recommending to Blaines board, a large repurchasing of shares for many solid

reasons. The main reason being that Blaines Kitchenwares 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 Blaines 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.


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Blaines 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 Blaines 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 wont 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 Dubinksis 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 todays

market, just as the old way of not using leverage does not work in todays 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.


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Consider the fol lowing share repurchase proposal: Bl aine wil l use $209 mi ll ion of cashfr om i ts balance sheet and $50 mi ll ion in new debt-beari ng interest at the rate of 6.75% to

repurchase 14.0 mil li on shares at a price of $18.50 per share. How would such a buyback

affect Blaine? Consider the impact on, among other things, BKIs earnings per share and

ROE, its interest coverage and debt ratios, the familys 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. Investors percentage share of

a companys 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 stocksthe 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 youre over-liquid and under-levered. Your shareholders are paying a price for

that. This statement reflects Blaines 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 Blaines 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 $1.19represents a 30.8% increaseo Return on equity of 23.4% - represents a 112.7% increase


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o Interest coverage18.9 ratio (1.5 or lower is when the ratio becomes a concern. Thisextremely high ratio reflects just how little the company has leveraged debt)

o Debt ratio0.084 (Company can easily meet its debt interest obligations; furtherreinforces the lack of leveraging)

o Family ownership interestassuming the Blaine family members hold onto theirstocks during the re-purchase; family ownership would increase

*Note: see exhibit 1. for the above calculations

As a member of Blaines controlling family, would you be in favorof thi s proposal? Wouldyou be in favor of i t as non-famil y shareholder?

As a member of Blaine Kitchenwares 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 Blaines 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 companys 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 members ownership interests in

the company, but wouldnt immediately raise the overall value of these shares. That is because the


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increase in percentage ownership would be offset by the decrease in owners equity (value transferred to

liabilities).

The way in which this proposal would increase the value of the firm and of its shares is in the tax

shield associated with interest payments and having debt. Due to this tax shield that is created by the tax

deductible nature of interest payments (and not dividend payments) the cash flow from Blaines assets

(CFFA) would increase as a result of replacing some of these dividend payments with interest payments,

and due to the increase in the cash flows the overall value and share price of the company would also be

greater. Therefore, it is due to the tax shield effect of being a leveraged firm that as a member of Blaines

controlling family I would want to go ahead and buy back these shares with new debt and unlock this

hidden value within the company.


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Exhibit 1. Effects of Share Re-purchase: Calculations

EPS 53,630/45,052 = $1.19

% Change in EPS (1.19-0.91)/0.91 = 30.8%

ROE 53,630/(488,363-259,000) = 23.4%

% Change in ROE (23.4-11)/11 = 112.7%

Interest Coverage 63,946,000/(0.0675 x 50,000,000) = 18.9

Debt Ratio 50,000/592,253 = 0.084

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Blaine Kitchenware Case Soln