blain kitchenware venkat

7/25/2019 Blain Kitchenware Venkat

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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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to be. The company is a closely controlled family owned entity with trusts together

owning more than


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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.

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=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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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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!@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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#[email protected]

.

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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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.

blain kitchenware venkat

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