BLAINE KITCHENWARE INC:

CAPITAL STRUCTURE
CASE STUDY

By:
Abhinav Goel – A023
Shreya Gupta – A025
Nooruddin H – A026
Anuj Kant – A029
Apaar Miglani – A036
Udit Narindra – A040
Introduction
• Recent development is consolidation in a fragmented
industry
• Acquisitions of BKI were done through cash and company
stock
• Margins dropped in the last three years despite launch of
high-end products
• Integration costs and inventory write downs for their recent
acquisitions
• Imports and private labels caused the industry to lower
prices to maintain sales growth, but Blaine did not follow
• Growth in top line thus was attributable to recent
acquisitions
Introduction (Contd.)
• ROE levels were disturbingly low at 11%
• partly due to dilutive acquisitions
• Very conservative w.r.t to outside borrowings
• Dividend payout and Capex were small enough to be funded by the
operating cash flows
• Current levels of dividend payout are unsustainable
• leading to lower cash for reinvestment
• Shareholders not satisfied with marginal increase in dividend
• Stock price at all-time high; share repurchase plan is a
tough decision
• Killing of war chest for acquisition
• Future need for debt becomes more real
• Growth without acquisition seemed difficult; organic growth
expectation of only 3%
Q1

Are Blaine’s current capital

structure and layout policies
appropriate?
Q1
• Appropriate is a very subjective term; however, the
company is over-liquid and under-leveraged
• Changing times, where topline growth, ROE and size
matters more
• Leverage is an important tool to increase ROI and ROE,
which needs to be used by Blaine
• Funding everything by high-cost low-risk equity
• makes the investments less attractive
• but more secure
• A portion of Capex and acquisitions should be funded with
debt
• maximise return on equity
Q1
• Debt has a lower cost of capital
• further enhanced by the tax shield it receives on the interest payment
• has higher risk, as interest receives highest priority in Cash flows
• Industry average net-debt-to-equity ratio is about 17% while
Blaine is at about (24%)
• Only equity funding it is further destroying ROE for its
shareholders
• little incentive to stay with a company that has lowest ROE
• further risk of diluting it
• Cash management is also an important issue when having
huge cash and marketable securities
• End up investing in less-profitable projects
• Cost efficiency receives lower priority
• Idle Cash reduces value of the company
Q2

Should Dubinski recommend a

large share repurchase to Blaine’s
board? What are 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.
Advantages Disadvantages

1. Debt has a lower cost of 1. The company's asset base will

capital
2. Increase leverage - invest in its
business without increasing
shareholders' equity
3. Deliver better return on equity
4. Increased control for family
members - reversing downward
trend from IPO.
5. More flexibility in setting future
dividends per share
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
Q3

Blaine will use $209 million in cash from its

Balance Sheet and $50 million in new debt bearing
interest at the rate of 6.75% to repurchase 14
million shares at a price of $18.50 per share.

How would such a buyback affect Blaine?

Balance-Sheet (Post-Leverage)
Share-Repurchase (With Leverage)
Liablilities Amount Assets Amount2

Accounts Payable 31936 Cash & Equivalents 21866

Accrued Liabilities 27761 Marketable Securities 0
Taxes Payable 16884 Liquid Assets 21866
Accounts Receivable 48780
Total Current Liabilities 76581 Inventory 54874
Other Liabilities 4814 Other Current Assets 5158
Deferred Taxes 22495 Total Current Assets 130678
Debt 50000
Total Liabilities 153890 Property, Plant & Equipment 174321
Shareholders'Equity 229363 Goodwill 38281
Other Assets 39973

TOTAL 383253 TOTAL 383253

• Asset base has decreased substantially due to the cash being used for share repurchase

• Shareholder’s Equity has also declined due to the outstanding shares being repurchased

• The company has added debt to fund the share-repurchase

Projections, 2007
Particulars 2004 2005 2006 2007
EBITDA 69370 68895 73860 83765
Depreciation 6987 8213 9914 10211
Other Income 15719 16057 13506 0
EBIT 78102 76739 77452 73553
Interest Expense 0 0 0 3375
EBT 78102 76739 77452 70178
Tax 24989 24303 23821 28071
Net Income 53113 52436 53631 42107
Shares Outstanding 41309 48970 59052 45052
EPS 1.29 1.07 0.91 0.93
Equity 417377 458538 488363 253018
ROE 0.13 0.11 0.11 0.17
Dividend 18589 22871 28345 18452.32

Div/NI 0.35 0.44 0.53 0.44

Financial Ratios
Ratios 2004 2005 2006 2007

Interest Coverage N.A N.A N.A 22

Debt/Equity N.A N.A N.A 0.20
EPS 1.29 1.07 0.91 0.93
RoE 0.13 0.11 0.11 0.18
Family Ownership
(%) 0.62 0.62 0.62 0.81

Shareholding Structure:

Family – 36612 (81%)

Public - 8440 (19%)

Q4

As a member of Blaine’s controlling

family, would you be in favour of this
proposal? Would you be in favour as a
non family shareholder?
Q5

How does the proposal above differ

for a special dividend of $4.39 a
share?
Proposal Vs Special Dividend
• Buyback saves on Dividend distribution tax.
• Through buyback , company can save on dividends that
need to be paid in future.
• Raising money in future will be difficult for the company
• Higher D/E ratio.
• Current share price is $16.25, whereas proposal is to buy
shares at a $18.50,offering a premium of $2.5.
• In comparison, the special dividend is proposed at $4.39,
which far exceeds the premium offered in buyback.
• For Promoters: BUYBACK
• For Shareholder: DIVIDEND
Q6

• What do the quotes for default spreads over 10

year Treasury bonds imply about BKI’s cost of
debt at the various levels of debt?
• What do your calculations imply about Blaine’s
optimal capital structure?
• Based on these calculations, how many shares
should Blaine purchase and at what price?
Treasury Stock Default Spreads
10 Yr Treasury Yield 5.02%
Interest Coverage Ratio Rating Spread
13.00 AAA 0.65%
9.50 AA- 0.80%
7.00 A 0.85%
5.00 BBB+ 1.83%
4.00 BB+ 2.98%
2.50 B+ 4.10%
What do these quotes imply about BKI’s cost of
debt at the various levels of debt?
Deteriorating Interest payment capacity increases the
risk of default and thus the default spread
Buyback
Calculations

Cash Available & Debt that can be raised

Total Amount available for repurchase

New Shareholder Equity

No. of Shares Bought Back

PAT and other Ratios

 EPS at different Price Levels

Share 16.25 17 18 19 20 21 22 25
Price
Rating
AAA 0.774 0.761 0.747 0.735 0.724 0.714 0.706 0.685
AA- 0.780 0.766 0.749 0.735 0.7228 0.712 0.702 0.679
A 0.788 0.771 0.753 0.736 0.7225 0.710 0.700 0.674
BBB+ 0.770 0.753 0.733 0.716 0.702 0.689 0.678 0.651
BB+ 0.742 0.723 0.702 0.684 0.669 0.656 0.644 0.617
B+ 0.706 0.687 0.666 0.648 0.632 0.619 0.608 0.580
Promoters’ Holdings After Buyback

16.25 17 18 19 20 21 22 25

AAA 84.96% 83.59% 82.00% 80.63% 79.44% 78.39% 77.46% 75.21%

AA- 88.27% 86.65% 84.78% 83.17% 81.78% 80.55% 79.47% 76.87%

A 91.87% 89.96% 87.76% 85.88% 84.26% 82.84% 81.60% 78.62%

BBB+ 94.39% 92.26% 89.83% 87.75% 85.97% 84.41% 83.05% 79.80%

BB+ 97.78% 95.35% 92.58% 90.24% 88.23% 86.49% 84.96% 81.35%

B+ 100.27% 97.61% 94.59% 92.05% 89.87% 87.99% 86.34% 82.46%

Share Premium
Outstanding
Shares Share Premium Share Price
16.25 39.85 0.48 16.73
17 40.70 0.47 16.72
18 41.72 0.46 16.71
19 42.63 0.45 16.70
20 43.45 0.44 16.69
21 44.19 0.43 16.68
22 44.87 0.43 16.68
25 46.57 0.41 16.66