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7/25/2019 Blain Kitchenware Venkat
1/19
BLAINE KITCHENWARE CAPITALSTRUCTURE
Executive Summary:
Blaine Kitchenware, a medium sized producer of residential kitchenware and
appliances is trying to unleash the value inherent in its strong operational cash
ows and balance sheet to enhance value for majority shareholders. The company
though publicly traded is majorly owned by !" #ubinski family members. "ver thepast couple of years, the company has accumulated signi$cant amount of cash
through operations. %hile the company don&t foresee a signi$cant amount of capital
e'penditure as it has outsourced majority of manufacturing operations, it is
interested in pursuing inorganic growth activity through ac(uisition of other players
in the kitchenware space. )rom a growth perspective the company is trying to
e'pand its presence in beverage making appliances and overseas markets. %hile
the growth plans are on track, the company seems to not have found enough
lucrative opportunities, as it has been signi$cantly increasing the dividend payout
ratio.
The company&s *+- illion cash e(uivalents, zero debt and steady operational
cash ows makes it an ideal candidate for takeover candidate by private e(uity
$rm. !" #ubinski is worried about maintaining status (uo and let someone
takeover Blaine. /e is contemplating to emulate the same strategy in0house to
unleash value through recapitalization of Blaine&s balance sheet, but he is
concerned about the conservative nature of family members who are inherently
averse to debt. #ubinski is in dilemma as to what is the optimal amount of debt to
be taken, whether to go for a repurchase1special dividends. /e is also worried about
the further conse(uences of this transaction on family&s ownership, share price,
!23, dividend payout, cost of capital and growth capital for future.
4 detailed analysis of the company&s current e'ternal, internal environment and
$nancial condition has led to the conclusion that repurchase of the shares withe'isting cash, marketable securities and additional debt will enhance value for the
shareholders, increases the ownership of family and decreases the attractiveness of
Blaine to e'ternal investors.
Compay aa!y"i":
Blaine Kitchenware is a medium player in kitchen appliance industry with 56 of
market share. 7n recent years, the company made some very important steps to
reduce its production costs by shifting business model towards outsourcing along
with using e'ico manufacturing opportunities. These changes allowed the
company to sustain price pressure and utilize 84)T4 advantages. /owever, Blaine
hasn&t achieved the level of economies of scale as its competitors and hence the
company has shunned away from cost leadership generic strategy and focused on
high0end product lines, niche segments using focused di9erentiation strategy. The
company&s revenue mi' is concentrated with more than :;6 coming from mid0tier
products, similarly ecent ac(uisitions have
helped the company to grow, diversify these revenue streams and were aimed at
di9erent niche markets where the biggest gain in the future margins were believed
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BLAINE KITCHENWARE CAPITALSTRUCTURE
to be. The company is a closely controlled family owned entity with trusts together
owning more than
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BLAINE KITCHENWARE CAPITALSTRUCTURE
loyalty, there is a big threat of new entrants. Dlobalization also made it
possible for other kitchen appliance producers from 4sia to penetrate western
markets with their products who compete $ercely on price.
T(reat o& "u)"titute" ' *e#ium: 3mall kitchen appliances are satisfy
needs for cooked meals for its end0users. 7n developed countries like the =3,where competition in a food and restaurant industries so high that prices for
dining out are always under the pressure. 7n addition, government and
society (uality control along with wide availability make restaurant industry
more a9ordable and acceptable even for very strict customers. )ul$lling the
same basic needs with no switching costs, that industry is imposing
undeniable threat to the small kitchen appliances.
Riva!ry amo$ competitor" ' Hi$(: The industry has seen a lot of
consolidation processes in recent years. Big national chains, mass
merchandizers, feeling pressure from cheap 4sian import, started to use price
wars techni(ues to secure market share. !ven in fast recovering and growingeconomy, there is an inade(uate slow growth in new unit consumption. 4s
stated earlier, kitchen appliance has become more like a commodity,
homogenous product and switching cost are very low.
Based on the analysis, we can conclude that small kitchen appliances industry is not
attractive. @ery high level of competition, high bargain power of buyers, and
substantial threat of new entrants along with possible threats of substitutes from
restaurant industry can negatively inuence the future of company. Eow suppliers
power helps the industry players be more e'ible in their production and $'ed0cost
decisions. )urthermore, slow growth and consolidation trend are forcing companiesto cut price and erode margins.
3ince the industry leader, 4uto Tech 4ppliances, whose revenue is larger by more
than four times than that of the second player, FGE orporation, the >ule of Three
and )our is not applicable to the kitchenware industry that highlighted instability of
the industry and room for growth to all the players.
7ndustry1ompa
ny
/igh edium Eow
/igh
ediumEow B!aie
=sing D!1cKinsey matri' above, we can conclude that Blaine Kitchenware is
located in an unattractive industry and its strength as a business is medium with its
di9erentiation strategy. There is enough room for growth as the industry is not
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stable and the company only has 56 growth market share, but the company and
industry&s growth is dependent on broad economic and housing growth.
#espite the cyclical nature of the business, a regression analysis of company&s
3ales, !B7T#4 and #ividends against time gave a high positive correlation indicating
that the Business risk is relatively low0moderate as the industry has been instableand the company has been able to constantly e'pand its operations. The low
correlation amongst !B7T#4, !23 can be attributed to the integration costs during
the time period. This low0moderate business risk pro$le of the company suggests
that there is room for taking some $nancial risk, still keeping the overall risk pro$le
medium.
+H0+< >evenue !B7T#4 !23 #23orrelation +,-.- +,/0- .HI+ +,--/
1iacia! Aa!y"i":
)rom +I0+ of
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BLAINE KITCHENWARE CAPITALSTRUCTURE
The company&s asset base has grown at -.56 from +H0
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+H +; +eturns J6
>"4 >"!
The company&s ineMciency in churning out ma'imum output of its assets is visible
in the poor return on asset and e(uity numbers J>"4 of -6, compared to peers
5+6, >"! of 556, compared to peers +"!
might drop down signi$cantly in the years to come.
LT**u!tip!e" B!aie
Ea"yLivi$ Avera$e *i *ax
!@1>evenue+.5
5.-5.; 5. 5.-
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BLAINE KITCHENWARE CAPITALSTRUCTURE
!@1!B7T55.H
5:.55.H C.H 5:.5
!@1!B7T#4-.-
5;.+-.5 " Capita! Structure a# Payout Po!icie" Aa!y"i":
Blaine&s current capital structure is very conservative with no debt and large
amounts of cash and marketable securities. 4 rational capital structure should
consider the tradeo9 among the following major featuresN J5 corporate ownership
and controlO J+ cost eMciency of capital by utilizing leverageO and JI pro$tability
and real economic value added based on company&s long0term strategic plan.
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/owever, at the end of +
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accumulating this cash and destroying value the aggressive upward revision in the
payout policy is a good move by the management. /owever, from a long term
perspective shareholders tend to e'pect the same payout ratio to continue in
future. The reduced or discrete dividend payout is generally viewed as a negative
signal for a company&s performance. 7t was possible that the management of BK7
didn&t want the market to discover its embarrassed situation in the capability to
create value for shareholders in long term. 3o the company would have been better
o9 if it would have declared special dividend1bought back shares rather than
horrendously increasing payout ratios in a short frame of time.
Basically, management of BK7 should redesign its capital structure and payout
policy based on its long0term strategy, which should focus on business innovation
and continuous cash ow creation capability, not just simply better $nancial and
dividend payout ratio in short0term.
Stoc2 Buy)ac2 Strate$y Aa!y"i"
The major targets for BK7&s management are defense against hostile takeover and
ma'imize return for shareholders. To achieve the targets, it seems that optimizing
the capital structure of BK7 through stock buyback is a plausible strategy at this
special time. BK7, despite being public company, was controlled by family members
descendent from the $rm&s founders. )rom this aspect, buybacks would increase in
management1family ownership, control over cash usage and decision authority. The
family stakeholders of BK7 would applaud this strategy. 3imilarly, the market
generally regards stock buyback as a positive signal, if the company maintains a
stable operation. BK7&s stock buyback would bring positive signal e9ect, such asenhancing the con$dence of investors and stakeholders, and would become a driver
forces for BK7&s management back to optimal track to make its business plan and
market strategy in long0run.
%hether is repurchasing stock really good strategy for BK7 at this momentP #ubinski
should consider the following downsides of stock buyback strategy. Blaine&s stock
price was not far o9 its all0time high, yet its performance clearly lagged that of its
peers. 2er this reality, we assume that the stock price of BK7 in +< was
overvalued. 7f so, it could lead the proportional loss of shareholders& value. "n the
other hand, it is possible release misleading signal to market and drive the stockprice higher, deviating from its real value. Thus, #ubinski should consider whether it
is a good timing to pursue stock buyback and whether buyback truly represents the
best possible $nancial leverage strategy for BK7 compared other possible strategy
like special dividend and etc.
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7t would de$nitely be a big problem with BK7 that if repurchasing the number of
shares is not complemented on behalf of creating more value for shareholders and
increasing cash ow generation capability but rather making $nancial data look
better, as the higher debt ratio means re(uiring higher ability to generate cash ow
to reduce the #1! ratio e9ectively. Therefore, #ubinski should consider this
transformation in conjunction with all of BK7&s strategy planning, which should
include organization structure optimization Je.g. incentive policy, leadership,
culture, and target of BK7, ownership structure adjustment, redesigning $nancial
budgeting process, marketing strategy Je.g. pricing, positioning, and ac(uisition
plan, and supply chain management Je.g. sourcing strategy, back integration or
forward integration, and operation eMciency etc. 7n a nutshell, pursuing stock
buyback to optimize BK7&s $nancial ratios should not become the core of this
transformation, BK7 should plan it from strategic perspective and focus on !@4.
Stoc2 Buy)ac2 Impact o BKI:
B!aie %i!! u"e 63+- mi!!io o& ca"( &rom it" )a!ace "(eet a# 6=+ mi!!io
i e% #e)t )eari$ itere"t at t(e rate o& 4,.=? to repurc(a"e 0fN ;.56 and >m0>fN ;.;6
ost of #ebt
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BLAINE KITCHENWARE CAPITALSTRUCTURE
.
WACC -,3.? /,=
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)irst of all, share buyback reduces the number of shares outstanding, thus then
increasing the control and ownership of BK7. oreover, as BK7 should input cash to
repurchase its outstanding shares, it leads to reduction of the assets on the balance
sheet, and then, as a result, the >"4 goes up. 7n terms of >"!, it is obvious that
repurchasing stock is e(ual to reducing the outstanding shares in stock market, so
there is less outstanding e(uity of BK7 and it conversely results in increased >"!.
Besides, it will also improve the 21! ratio, as the stock price of BK7 might increase
after its buyback announcement and retiring its stock.
The share buyback signi$cantly increases the family ownership to :5.I6, increases
>"! drastically and marginally increases >"4 and !23. The buyback marginally
increases the e(uity cost of capital but with reduction in cash and additional debt it
reduces the weighted average cost of capital of Blaine. The buyback also increased
the enterprise value of the company to *:
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Ta' shield bene$t Q *+;- illionR I.:6 Q *C-.: illion J4ssuming that the
company holds on to this debt inde$nitely and keeps very minimal cash re(uired for
operations
Ta' bene$t13hare Q *C-.: illion 1 ;-.; illion shares Q *5.I;1share. 3o the share
price immediately jumps to *5C.
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BLAINE KITCHENWARE CAPITALSTRUCTUREH::.H ++-.H
!(uity Jkt-;-.< :II.;
4ssuming the share price at*5H.551share
!B7T#4CI.- CI.-
7nterest e'pense0 I.H
Itere"t Covera$e 5%it(EBIT@A7 N* 30,-
EBIT@AItere"t expe"e
EPS+,-0 +,.0
RE 00,+? 0/,?
RA -,0? 00,4?
@E 5*2t7'
3"! drastically, marginally increases >"4 and
decreases !23. The dividend marginally increases the e(uity cost of capital but with
reduction in cash and additional debt it reduces the weighted average cost of
capital of Blaine. 7t also increased the enterprise value of the company to *:
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BLAINE KITCHENWARE CAPITALSTRUCTURE
reluctance to debt. %ith no change in ownership and the risk of takeover still intact,
the family hasn&t bene$ted much as they would be more interested in control rather
than improvements in returns. 4s a member of family 7 would be very skeptical to
the special dividend issue.
The special dividend keeps the ownership and hence the inuence of e'ternalshareholders as a group intact, thought it decreases !23, it increases >"!, 21! and
retains the attractiveness of BK7 as a potential attractive candidate with not
signi$cant amount of debt, but with reduced share price, hence o9ering lot of near
term upside potential. The special dividend retains a signi$cant amount of cash to
shareholders. 3o even though it reduces share price, the bene$ts clearly outweigh
the shortcomings. 4s an e'ternal shareholder, 7 would be very enthusiastic about
this proposal and push forward this proposal alternative to the share buyback
program.
ptima! capita! "tructure a# "(are purc(a"e:
4s the company increases its debt levels, its credit risk increases and hence the
interest coverage ratio decreases and credit rating decreases. This is evident in the
(uotes received from the banker. 4s per the (uotes received from banker, a
detailed analysis is performed to calculate interest rates, debt borrowing, share
repurchase program and cost of capital for the si' alternatives. %e have assumed
that *+- illion from e'isting *+I5 illion cash and cash e(uivalents will be usedfor buyback and *++ million still remains as cash on balance sheet. %e have also
assumed that the buyback will happen at a price of H6 premium to the market price
after the ta' shield e9ect of using e'tra cash and new debt is factored in the price.
*etric !# 0 3 < = 4
7nterestoverage
8 5;.;
55.; -.+ C. ;.+ H.+
>isk free >ate ;.+6 ;.+6 ;.+6 ;.+6 ;.+6 ;.+6 ;.+6
3pread 6 .
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3hare 2rice 5
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0 +. H.
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redit >ating 2robability444 .5644 .+:64 .;I6BBB +.I6BB 5+.+6B +
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the remaining cash ows from operations Jafter interest payments for pursuing
growth opportunities or retire debt periodically and reissue debt for growth capital.