According to their current situation we do not think Blaine Kitchenware’s current capital structure and payout policies are appropriate. Blaine is currently over-liquid and under-levered and their shareholders are suffering from the effects. Since Blaine Kitchenware is a public company with large portion of its shares held by their family members, they have a financial surplus, which decreases the efficiency of its leverage. In other words, Blaine does not fully utilize its funds. Since they are totally equity financed, there is no tax shield. A surplus of cash lowers the return on equity and increases the cost of capital; also large amount of cash may offer incentives to acquirer to and also decrease the enterprise value of Blaine. Acquirers could pay way less than they originally expect to buy out the firm.
Regarding their payout policies, the management’s goal is to maximize the shareholder’s value, rather than paying dividend. The management should use the available cash and invest in attractive investments. Although investors take dividend as an indicator for a company to succeed, they also expect dividend will be paid continuously at either stable or growing rate. In summary, in order for Blaine to keep its current payout policies, they must reduce numbers of outstanding shares throughout share repurchasing.
If Blaine’s Kitchenware decides to repurchase its shares, they must consider whether to partially repurchase the market float or go for a complete buyback where Blaine’s family would become the owner of all the remaining shares. They also have to consider of the effect of the repurchase on various factors like the risks involved in raising a debt especially when they are large, very conservative and debt free. They should also consider things such their acquisition plans, their earnings per share and their dividend per share, ownership structure, capital structure and of course the reputation of the company in the market after the buyback.
Should Dubinski recommend a large share repurchase to Blaine’s board? What are the primary advantages and disadvantages of such a move?
Dubinski can recommend a large share repurchase to the board using cash and cash equivalents and raising some debt.
1. Debt has a lower cost of capital
2. Increase leverage. Invest in its business without increasing shareholders’ equity
3. Deliver better return on equity
4. Increase control for family members. Reverse downward trend from IPO.
5. More flexibility in setting future dividends per share
1. The company’s asset base will decrease. It would have to borrow money if it wants to acquire another company or expand its production
2. Increasing long term debt may cause financial distress. Larger portion of its EBIT is used to pay for interest expenses.
3. Loss of control for smaller shareholders as family ownership rises to 81%
4. Volume is reduced- reducing liquidity of the stock is reduced in the secondary markets
Such a large move for the company can greatly affect a lot of aspects, and different interests lie in different areas for shareholders and management. When stock repurchases occurs it lowers the amount of stocks within the company, and eventually within time the E.P.S. would increase in future. This company is facing an unbalanced capital structure and such a move of a share repurchase, with the help of both cash and short/long term borrowing. Raising debt can have its advantage within capital structure, replacing the equity within the firm can reduce WACC and that can lead to a tax advantage.
Stock repurchase can be incredibly beneficial, especially for a company like BKI that has the power to perform a buyback. If company has healthy cash-flows matched with a need to increase debt within the company, this can be beneficial for BKI. Increasing earnings per share, is important in repurchasing shares but also the tax advantages (even if they might be lower) they are still advantageous. If a firm has extra cash, with healthy cash flow and a reduction of tax and possibly an increase in firm value. Dubinski should make a large share re-purchase , and BKI should recover some its shares in hopes of gaining the advantages of tax, and a stronger EPS. The company has the assets (cash) and can take the restructuring of debt to take advantage of this share repurchase.
Consider the following share repurchase proposal: Blaine 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 14.0 million shares at a price of $18.50 per share. How would such a buyback affect Blaine? Consider the impact on, among other things, BKI’s earnings per share and ROE, its interest coverage and debt ratios, the family’s ownership interest, and the company’s cost of capital.
Repurchase of shares Interest = 6.75%(50,000,000)
259 million in cash = 3,375,000
50 million in new-debt bearing interest
To repurchase 14,000,000
CSO = 59,052,000 – 14,000,000
CSO = 45,052,000
EBIT = 63,946,000 – 3,375,000
EBIT = 60,571,000
EPS = 60,571,000/ 45,052,000
EPS = 1.34
Change in EPS = 1.34 – 0.91
Change in EPS = 0.4725 = 47.25%
ROE = 53,630/45,052
ROE = 1.19
Interest Coverage = EBIT/Interest Expense
Interest Coverage = 63,946,000/3,375,000
Interest Coverage = 18.95
Debt Ratio = Total Debt/Total Assets
Debt Ratio = 103 890 000/592 253 000
Debt Ratio = 0.1753
Family’s Ownership Interest
= 36,612,000 shares
After repurchase of 14,000,000 shares
With the calculations made we can see that not only can BKI afford to repurchase their shares, but they will benefit from it. After calculating EPS there would be a 47.25% increase in the earnings per share after recapitalization. Another positive number would be the 1.19 ROE, this number shows that after the shares are repurchased that there will be a positive return on equity. This number means they will turn a 119% return on their equity after the shares are repurchased. Interest Coverage and the debt ratio is another interesting number. With the 18.95:1 ratio for interest income, and a 0.1754 debt ratio, we see that BKI has a large amount of assets built up and will be easily able to afford the price of buying back these shares. This was one of the main concerns, where they did not want to borrow money and potentially have a large interest expense. As for the family’s ownership interest, under the new proposal, they would now own 81.27% of the company, giving them even more power then they would have before. All of these calculations indicate that it would be greatly beneficial to BKI to repurchase their shares, where they can afford it and they will benefit from it in the long run.
As a member of Blaine’s controlling family, would you be in favor of this proposal? Would you be in favor of it as non-family shareholder?
When a company is owned and maintained by a family that maintains it in a strong family setting, it is important for them to maintain a certain percentage of ownership. Eliminating external owners is important in gaining a better advantage for the company, and in this instance the family is looking to gain a larger ownership of the company. The proposal would have to examine a number of factors, and some main questions were asked on would it sap financial strength, or prevent the company from making future acquisitions. Before examining the perspective of the family, and the shareholder it is important to examine what an external financial party would insists on behalf of a structured financial argument. A company with a healthy cash flow, matched with a stable Net income can be a candidate for a stock repurchase. It is important to examine the current debt obligations within the company, which are far less weighted compared to Liabilities and Shareholders’ equity. The firm’s choice will ultimately lie on BKI’s financial perspective and needs on liquidity, capital structure, dividend policy, and ownership structure.
As a member of the family I would be in favor for the stock repurchase for a number of reasons. Members of the family were welcoming the idea of the possible effects of the share repurchase, one main attraction of the repurchase would be the fact that ownership percentage would rise. This attraction is key to the family who maintain this a more family company, and a larger ownership in the company would allow them to own more of it. Looking back on the history of the company, it is important to realize the intangible effect the company has, and how advantageous it would be for them to have a buyback. It would also give the board more flexibility in setting future dividends per share, and give them more control of the company. As a member of the family I would want the share repurchase because of the amount of control I would obtain, along with the knowledge of my company having healthy cash flows. Although I would approve of the share repurchase I would be skeptical about the debt factor within the repurchase, the interest rate could be detrimental to the company and the interest payments could incur more cost than benefit. It is also the third time since its inception, that the company seeked debt financing which proved to be a large decision for the company. As a member of the family I would approve of the repurchase, and there is no new trends that indicate that the company will see future bad financial performance.
As a shareholder of the company you could be reluctant to receive a payment from the buyback at market price, or you can be a shareholder who retains their shares. It is beneficial in both cases, both shareholders who continue to own shares will see a rise in EPS in shares after the repurchase which will benefit the shareholders. The shareholders could see a significant rise for a short time, however it is important to realize the amount of control they will lose when the family gains more control. Although stock price might increase for a short period of time, the ownership percentage can decrease which is detrimental to shareholders. Shareholders should accept the proposal cause it can increase the company’s value, and stocks which can increase the value of selling the stocks which is beneficial for shareholders.
A stock repurchase for any company is based on timing, and certain financial and non financial factors need to be met in order for the purchase to realize any benefit. BKI has a strong and healthy cash flow, matched with an optimal need for debt restructuring that could benefit the company. The benefits that are realized from this repurchase can be very beneficial for BKI, and because of the financial position it is in, along with a family favoring of the repurchase BKI should perform the repurchase. In all the short and long term benefits arising from the stock repurchase greatly outweigh the costs of not performing any capital restructuring.
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