Blaine Kitchenware Questions:
1) Do you believe that Blaine’s current capital structure and payout policies are appropriate? Why or
why not?
Blaine Kitchenware is a medium-sized company and it captures 10% market share in US. The company
has a reputation of high quality with lower price than best-known brands. BKI’s recently strategic moves
include global expansion, growing its beverage preparation appliance segment and competing in higher-
end segment with higher price point. BKI has a very strong net margin, a ratio at 15.67% which is far
beyond industry average. However, BKI lacks of organic growth these years and all recent growth is
achieved by acquisitions. Now BKI has more and more equity on its book which drags its ROE to 11%,
a ratio significantly below industry average. n the other side, BKI is paying out larger dividend per
share, which leads to an over 50% dividend payout ratio in 2006.
Although BKI is a public company, a large portion of its shares is held in the family members. Under
their management, BKI is very conservative in terms of financing strategy. There are only two borrows
in the history, both under very unique conditions. In 2007, BKI has $231 million cash and securities
sitting on its balance sheet with no debt. High surplus cash level and debt capacity have several
disadvantages to BKI.
Takeover Threat – The $231 cash and securities will attract hostile takeovers because the acquirer can
use the cash to pay the acquisition cost. Cash, also can be called as negative debt, and reduces the
Enterprise Value of BKI from $959 million to $ 729 million, making the acquisition a better deal to
potential buyers.
Reinvestment Risk – If the company has a lot of surplus cash, there will be big risks of capital
misallocation. The management would think that capital is free, and they will invest in value-destroying
projects. For BKI, all recent growth comes from acquisitions of small companies instead of organic
growth. These acquisitions have cost BKI a lot, for example, inventory write-down and integration cost.
, Inappropriate dividend policy – Dividend payout has more psychological reasons than economic value.
For investors, the periodical dividend is a symbol of healthy company business and management’s
confidence for continued success. Dividend also allows the investors to make profit without selling the
stock.
However, the management’s goal is to maximize shareholder’s value. Rather than paying dividend,
management should use all available cash in attractive investments. From investor perspective, the
dividend payout is not a guarantee of company’s success and it’s not any kind of obligation to investor
as well. From the firm perspective, dividend is not tax deductible and it can’t bring any tax benefit.
Once a company starts to pay periodical dividend, the investors will expect the dividend to continue.
Stopping paying dividend might give the investor a perception that the company isn’t doing well. In the
BKI case, we assume BKI’s management want to maintain the current dividend payment schedule, but
decrease the payout ratio. So the only thing BKI can do is to reduce the share numbers, with a share
repurchase.
2) Should Dubinski recommend a large share repurchase to Blaine’s board? What are the primary
advantages and disadvantages of such a move?
Leveraged Recapitalization – There are lots of benefits related to debt financing. The most important is
the tax shields which will be captured by equity holders. Healthy borrowing will increase the firm’s
value. The obligation of payoff debt will force management to focus on cash flows. Using up BKI’s
debt capacity will increase its enterprise value and discourage the takeovers. But there are both benefits
and cost associate with debt financing and such cost, especially cost of financial distress, need to be
considered. We’ll discuss the details later.
Share Repurchase – Dubinski is concerned about the discharging of cash because he is worried about
giving up Blaine’s war chest to continue its acquisition activities. However, considering negative EVA
in and the deteriorating of EBIT and Net margin, stopping acquisition activities might be the correct
thing the management needs to do. Another concern Dubinski has is the interest expense. However, he
also needs to know that interest expense is tax deductible while dividend is not. We’ll take a look at
BKI’s capability to pay interest later. Besides Dubinski’s concerns, there are potential problems of share
repurchase. One problem is that the market might interpret such move as a negative indication of lacking
1) Do you believe that Blaine’s current capital structure and payout policies are appropriate? Why or
why not?
Blaine Kitchenware is a medium-sized company and it captures 10% market share in US. The company
has a reputation of high quality with lower price than best-known brands. BKI’s recently strategic moves
include global expansion, growing its beverage preparation appliance segment and competing in higher-
end segment with higher price point. BKI has a very strong net margin, a ratio at 15.67% which is far
beyond industry average. However, BKI lacks of organic growth these years and all recent growth is
achieved by acquisitions. Now BKI has more and more equity on its book which drags its ROE to 11%,
a ratio significantly below industry average. n the other side, BKI is paying out larger dividend per
share, which leads to an over 50% dividend payout ratio in 2006.
Although BKI is a public company, a large portion of its shares is held in the family members. Under
their management, BKI is very conservative in terms of financing strategy. There are only two borrows
in the history, both under very unique conditions. In 2007, BKI has $231 million cash and securities
sitting on its balance sheet with no debt. High surplus cash level and debt capacity have several
disadvantages to BKI.
Takeover Threat – The $231 cash and securities will attract hostile takeovers because the acquirer can
use the cash to pay the acquisition cost. Cash, also can be called as negative debt, and reduces the
Enterprise Value of BKI from $959 million to $ 729 million, making the acquisition a better deal to
potential buyers.
Reinvestment Risk – If the company has a lot of surplus cash, there will be big risks of capital
misallocation. The management would think that capital is free, and they will invest in value-destroying
projects. For BKI, all recent growth comes from acquisitions of small companies instead of organic
growth. These acquisitions have cost BKI a lot, for example, inventory write-down and integration cost.
, Inappropriate dividend policy – Dividend payout has more psychological reasons than economic value.
For investors, the periodical dividend is a symbol of healthy company business and management’s
confidence for continued success. Dividend also allows the investors to make profit without selling the
stock.
However, the management’s goal is to maximize shareholder’s value. Rather than paying dividend,
management should use all available cash in attractive investments. From investor perspective, the
dividend payout is not a guarantee of company’s success and it’s not any kind of obligation to investor
as well. From the firm perspective, dividend is not tax deductible and it can’t bring any tax benefit.
Once a company starts to pay periodical dividend, the investors will expect the dividend to continue.
Stopping paying dividend might give the investor a perception that the company isn’t doing well. In the
BKI case, we assume BKI’s management want to maintain the current dividend payment schedule, but
decrease the payout ratio. So the only thing BKI can do is to reduce the share numbers, with a share
repurchase.
2) Should Dubinski recommend a large share repurchase to Blaine’s board? What are the primary
advantages and disadvantages of such a move?
Leveraged Recapitalization – There are lots of benefits related to debt financing. The most important is
the tax shields which will be captured by equity holders. Healthy borrowing will increase the firm’s
value. The obligation of payoff debt will force management to focus on cash flows. Using up BKI’s
debt capacity will increase its enterprise value and discourage the takeovers. But there are both benefits
and cost associate with debt financing and such cost, especially cost of financial distress, need to be
considered. We’ll discuss the details later.
Share Repurchase – Dubinski is concerned about the discharging of cash because he is worried about
giving up Blaine’s war chest to continue its acquisition activities. However, considering negative EVA
in and the deteriorating of EBIT and Net margin, stopping acquisition activities might be the correct
thing the management needs to do. Another concern Dubinski has is the interest expense. However, he
also needs to know that interest expense is tax deductible while dividend is not. We’ll take a look at
BKI’s capability to pay interest later. Besides Dubinski’s concerns, there are potential problems of share
repurchase. One problem is that the market might interpret such move as a negative indication of lacking
