Blaine case

6 June 2016

There is a banker pointed out that BKI is currently highly over-liquid and under-levered. He suggested to borrow money and to buy back own shares. In detail, the proposal is involves that borrowing another $50 million and paying a 13.8% premium to buy back 14million (23.7%*59m) of the outstanding shares. After reviewed company’s current debt, equity and leverage levels situation, I believe that it is necessary to repurchase of 14 million shares of stock at $18.50 per share. As the banker mentioned that BKI is currently suffered with highly over-liquid and under-levered. The current capital structure and payout policies for Blaine’s Kitchenware Inc. are not the most applicable for the firm long-term growth.

From the BKI’s income statement in 2006, the cash and securities reach to $230,886,000, which means that BKI did not make full use of its fund. In other words, BKI is lack of effective investments. On the other sider, BKI is totally debt free. In frank, it is not a bad thing. It means that the company works well and has enough capital to operate its business. However, if the company always stays in the free debt position, it may not be the best strategy for the company’s development. In general, I believe that there are many advantages to accept the proposal. Pro sides: (In thousands)

BKI can creative more value. In 2006 the equity of the company was $488363 and the Net income was $53596.78, so the ROE is 11%. If using repurchases shares strategy, the equity would drop to $229363 and the net income would turn into $41915.13. As the same amount of Equity, the later one creates more value. In shortly, ROE would increase by 7.3% from the prior 11% to 18.3% ($41915.13/$229363). It is a good advance to make full use of the cash and cash equivalents.

An interest coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy interest expenses. After borrowing $50M from the bank, the interest expense could be $3375 (6.75%*$50000) and the EBIT is the same that keeps $63946. So the interest coverage ratio is 18.5. Another advantage of the share repurchase could be tax shield. A reasonable debt level could be a good way to help BKI to maximize its value. In general, the more leveraged by debt the lower the amount of the tax income will be. $50 million loan will create $0.34 per share (50*0.4/59.052) tax benefit. If the loan was $259 Million it will reach to $1.75 per share (0.4*$259/59.052). The share repurchase could increase the EPS in the future, which will be benefit to the shareholders. EPS would increase from 0.91 to 0.93($41915/$45057). Generally, a higher EPS serves as a good indicator of a company’s profitability.

From the perspective of the Board of Directors, I will be totally in favor of this proposal. The biggest advantage is that repurchasing the stock will increase their ownership percentage. Here are some supports. The family members owned 62% of the outstanding shares following the IPO so they have 36612 shares (62%*59052) of the company. After repurchasing their ownership, percentage will increase to 81.3% (36612/45057). So shares repurchase will be a good advance.

The larger ownership they have the more they will own from the company. As for a non-family shareholder, I will be in favor of share repurchase as well. There are some reasons. First of all, after repurchasing, the EPS will increase from 0.91 to 0.93. On the other hand, the stock price will increase in a short time after share repurchase. Although the increasing tendency will fade off, it still has a lot of potential benefits. What’s more, share repurchase is a good way to increase the value of the company, which will benefit to shareholder as well. Every coin has two sides.

There are some disadvantages coming with it as well. Although using leverage could create more value for the company, in a great extent, it will increase the risk of the company. Although stock prices could increase when the company began to repurchase, they might fall down once the repurchase is finalized. Considering to those disadvantages, probably some members of Board will question that paying a large special dividend of $4.39 per share may have the same effect with repurchase shares. I do not believe that we can pay large special dividend could instead of shares repurchase.

There are several reasons. Firstly, the goal of the share repurchase is maximum the shareholder’s value rather than paying dividend. On the other hand, the BKI is currently highly over-liquid and under-levered, paying dividend definitely cannot solve this problem. What’ s more, although investors like the dividend, it is just period solution to attack people and it may not be able to keep the company growing in a long run.


Based on the analysis above, we can got the more leveraged by debt the lower the amount of the tax income will be. $50 million loan will create $0.34 per share tax benefit. If the loan was $259 Million it will reach to $1.75 per share. On the other hand, the EPS will increase from 0.91 to 0.93. In the same industry, a higher EPS is a good signal for investors. What’s more, the ROE will increase from 11% to 18%. As for the static trade-off model which is an idea that a company chooses how much debt finance and how much equity finance to use by balancing the costs and benefits. So static trade off model is a good way to know if the debt finance is positive to the company’s development. According to the analysis above, we know that the $50M loan will not lead Blanie to the financial distress zone. On the contrary, with the decreasing WACC and the good tax benefit which will bring a better value to the company. Draw a conclusion, I believe the shares repurchase is a great solution for Blaine to overcome the highly over-liquid and under-levered situation.

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