Blaine Kitchenware

rP os t 4040 OCTOBER 8, 2009 TIMOTHY LUEHRMAN JOEL HEILPRIN op yo Blaine Kitchenware, Inc. great construction On April 27, 2007, Victor Dubinski, CEO of Blaine Kitchenware, Inc. (BKI), sit in his office reflecting on a meeting he had had with an investment banker earlier in the week. The banker, whom Dubinski had known for old age, asked for the meeting after a group of common soldier equity investors made discerning inquiries about a possible acquisition of Blaine. Although Blaine was a public company, a majority of its trades were controlled by family members descended from the firms founders together with various family trusts.Family interests were strongly equal on the room of directors as well. Dubinski knew the family had no flowing interest in sellingon the contrary, Blaine was interested in acquiring other companies in the kitchen appliances layso this overture, like a few others before it, would be politely rebuffed. No tC Nevertheless, Dubinski was struck by the bankers assertion that a private equity buyer could unlock value inherent in Blaines strong operations and chemical equilibrium opinion poll. Using cash on Blaines balance sheet and new borrowings, a rivate equity firm could purchase all of Blaines outstanding shares at a price high schooler than $16. 25 per share, its current stock price. It would then repay the debt over time using the companys future earnings. When the banker pointed out that BKI itself could do the same thingborrow funds to buy back its own sharesDubinski had asked, But why would we do that? The bankers response was blunt Beca intent youre over-liquid and under-levered. Your shareholders are paying a price for that. In the days since the meeting, Dubinskis thoughts kept returning to a share repurchase.How many shares could be bought? At what price? Would it sap Blaines financial strength? Or prevent it from making future acquisitions? Blaine Kitchenwares Business Do Blaine Kitchenware was a mid-sized prod ucer of mark small appliances primarily practice sessiond in residential kitchens. in the first place founded as The Blaine Electrical Apparatus Company in 1927, it produced then-novel electric home appliances, such as irons, vacuum cleaners, waffle irons, and cream separators, which were touted as modern, clean, and easier to use than counterparts supply by oil, coal, gas, or by hand.By 2006, the companys products consisted of a wide range of small kitchen appliances used for food and beverage dressing and for cooking, including several branded tasks of deep fryers, griddles, waffle irons, toasters, small ovens, blenders, mixers, pressure cookers, steamers, slow cookers, shredders and slicers, and coffee makers. ________________________________________________________________________________________________________________ HBS Professor Timothy A. Luehrman and Illinois Institute of Technology Adjunct Finance Professor Joel L.Heilprin prepared this slip-up solely as a basis f or class discussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective management. This case, though based on real events, is fictionalized, and any resemblance to actual persons or entities is coincidental. There are occasional references to actual companies in the narration. copyright 2009 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing, Boston, MA 02163, or go to http//www. bsp. harvard. edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. This document is authorise for use only by Atul Singh at JRE Group of Institutions until June 2013. write or board is an usurpation of copyright. emailprotected harvard. edu or 617. 783. 7860. rP os t 4040 Blaine Kitchenware, Inc. Capital Structure Blaine had beneficial under 10% of the $2. 3 billion U. S. market for small kitchen appliances.For the point in time 20032006 the industry posted modest annual unit sales harvest-feast of 2% despite positive market conditions including a strong housing market, growth in affluent householders, and product innovations. Competition from inexpensive imports and aggressive pricing by mass merchandisers limited industry dollar volume growth to just 3. 5% annually over that same period. Historically, the industry had been fragmented, but it had new-madely experienced some consolidation that many participants anticipate to continue. In recent old age, Blaine had been expanding into contradictory markets.Nevertheless in 2006, 65% of its revenue was generated from shipments to U. S. wholesalers and retailers, with the balance coming from sales to Canada, Europe, and Central and South America. The company shipped approximately 14 million units a year. op yo There were terzettosome major segments in the small kitc hen appliance industry food preparation appliances, cooking appliances, and beverage-making appliances. Blaine produced product for all three, but the majority of its revenues came from cooking appliances and food preparation appliances.Its market share of beverage-making appliances was only 2%. Most of BKIs appliances retailed at medium price points, at or just down the stairs products offered by the known national brands. BKIs market research consistently showed that the Blaine brand was well-known and well-regarded by consumers. It was associated somewhat with nostalgia and the creation of familiar, wholesome dishes. tC Recently, Blaine had introduced some goods with smart engineering science features and sleeker styling, targeting higher-end consumers and intended to compete at higher price points.This strategy was in response to increased competition from Asian imports and private label product. The majority of BKIs products were distributed via a network of wholesalers, wh ich supplied mass merchandisers and department stores, but its upper-tier products were sold directly to specialty retailers and catalogue companies. Regardless of the distribution channel, BKI offered consumers standard warranty terms of 90 days to one year, depending on the appliance. No Blaines monthly sales reached a seasonal peak during October and November as retailers increased stock in prospicience of the holiday season.A smaller peak occurred in May and June, coinciding with Mothers Day, a summer surge in weddings, and the seasonal peak in home purchases. Historically, sales of Blaine appliances had been cyclical as well, tending to track overall macroeconomic activity. This also was the case for the industry as a whole in particular, changes in appliance sales were correlated with changes in housing sales and in home renovation and household formation. BKI owned and operated a small factory in Minnesota that produced cast iron parts with specialty coatings for certain o f its cookware offerings. early(a)wise, however, Blaine, like most companies in the appliance industry, outsourced its production. In 2006 BKI had suppliers and contract manufacturers in China, Vietnam, Canada, and Mexico. Do Victor Dubinski was a great-grandson of one of the founders. An engineer by training, Dubinski served in the U. S. Navy after graduating from college in 1970. After his discharge, he worked for a wide aerospace and vindication contractor until joining the family business in 1981 as head of operations. He was elected to the board of directors in 1988 and became Blaines CEO in 1992, succeeding his uncle.Under Dubinskis leadership, Blaine operated much as it always had, with three no legislate in exceptions. First, the company completed an IPO in 1994. This provided a measure of liquidity for certain of the founders descendants who, collectively, owned 62% of the outstanding shares 2 BRIEFCASES HARVARD BUSINESS condition This document is authorized for use on ly by Atul Singh at JRE Group of Institutions until June 2013. Copying or posting is an infringement of copyright. emailprotected harvard. edu or 617. 783. 7860. rP os t Blaine Kitchenware, Inc. Capital Structure 4040 ollowing the IPO. Second, beginning in the 1990s, Blaine gradually moved its production abroad. The company began by taking gain of NAFTA, engaging suppliers and performing some manufacturing in Mexico. By 2003, BKI also had established relationships with several Asian manufacturers, and the large majority of its production took place outside the joined States. Finally, BKI had undertaken a strategy focused on rounding out and complementing its product offerings by acquiring small independent manufacturers or the kitchen appliance product lines of large diversified manufacturers.The company carefully followed changes in customer purchasing behavior and market trends. Victor Dubinski and the board were eager to continue what they believed had been a fruitful strategy . The company was particularly keen to increase its presence in the beverage appliance segment, which demonstrated the strongest growth and where BKI was weakest. Thus off the beaten track(predicate), all acquisitions had been for cash or BKI stock. op yo financial carrying out During the year ended December 31, 2006, Blaine earned net income of $53. 6 million on revenue of $342 million.Exhibits 1 and 2 present the companys recent financial statements. Approximately 85% of Blaines revenue and 80% of its operating income came from the sale of mid-tier products, with the line of higher-end goods accounting for the remainder. The companys 2006 EBITDA margin of nearly 22% was among the strongest within the peer group shown in Exhibit 3. Despite its recent shift toward higher-end product lines, Blaines operating margins had decreased slightly over the exist three years. Margins declined due to integration costs and inventory write-downs associated with recent acquisitions.Now that in tegration activities were completed, BKI executives expected the firm to achieve operating margins at least as high as its historical margins. tC The U. S. industry as a whole faced considerable pressure from imports and private label products, as well as a shift in consumer purchasing preferences favoring larger, big box retailers. In response, some of Blaines more aggressive rivals were cutting prices to maintain sales growth. Blaine had not followed suit and its organic revenue growth had suffered in recent years, as some of its core products lost market share. egress in Blaines top line was attributable almost exclusively to acquisitions. No Despite the companys profitability, returns to shareholders had been somewhat below average. Blaines return on equity (ROE), shown below, was pregnantly below that of its publicly traded peers. 1 Moreover, its earnings per share had fallen significantly since 2004, partly due to dilutive acquisitions. Companies 2006 ROE Do situation & Hear th Design AutoTech Appliances XQL Corp. Bunkerhill Incorporated EasyLiving Systems cerebrate 11. 3% 43. 1% 19. 5% 41. 7% 13. 9% 25. 9%Median 19. 5% Blaine 11. 0% 1 ROE is computed here as net income divided by end-of-period book equity. HARVARD BUSINESS SCHOOL BRIEFCASES This document is authorized for use only by Atul Singh at JRE Group of Institutions until June 2013. Copying or posting is an infringement of copyright. emailprotected harvard. edu or 617. 783. 7860. 3 rP os t 4040 Blaine Kitchenware, Inc. Capital Structure During 20042006, compounded annual returns for BKI shareholders, including dividends and stock price appreciation, were approximately 11% per year.This was higher than the S&P 500, which returned approximately 10% per year. However, it was well below the 16% annual compounded return earned by shareholders of Blaines peer group during the same period. Financial Policies op yo Blaines financial posture was conservative and very much in keeping with BKIs long-s tanding practice and, indeed, with its management style generally. Only twice in its history had the company borrowed beyond seasonal working capital needs. The first time was during World War II, when it borrowed from the U. S. government to retool several factories for war production.The sec time was during the first oil shock of the 1970s. On both occasions the debt was repaid as quickly as possible. At the end of 2006, Blaines balance sheet was the strongest in the industry. Not only was it debtfree, but the company also held $231 million in cash and securities at the end of 2006, down from $286 million two years earlier. Given such substantial liquidity, Blaine had terminated in 2002 a revolving credit agreement designed to provide standby credit for seasonal needs the chief financial officer argued that the fees were a waste of money and Dubinski agreed.In recent years the companys largest uses of cash had been common dividends and cash consideration paid in various acquisiti ons. Dividends per share had risen only modestly during 20042006 however, as the company issued new shares in connection with some of its acquisitions, the number of shares outstanding climbed, and the payout ratio rose significantly, to more than 50% in 2006. tC 2004 $ 53,112 $ 18,589 41,309 $ 1. 29 $ 0. 45 35. 0% 2005 $ 52,435 $ 22,871 48,970 $ 1. 07 $ 0. 47 43. 6% 2006 $ 53,630 $ 28,345 59,052 $ 0. 91 $ 0. 48 52. 9% No Net income Dividends Average shares outstanding cabbage per shareDividend per share Payout ratio Do The next largest use of funds was capital expenditures, which were modest due to Blaines extensive outsourcing of its manufacturing. Average capital expenditures during the past three years were just over $10 million per year. While they were expected to remain modest, future expenditures would be driven in part by the boundary and nature of Blaines future acquisitions. In recent years, after-tax cash generated from operations had been more than four times average capital expenditures and rising, as shown in the table below. 4 2004 EBITDA Less Taxes After-Tax Operating Cash Flow 2005 69,370 24,989 44,380 $ 68,895 24,303 44,592 2006 $ 73,860 23,821 50,039 AVG. 46,337 BRIEFCASES HARVARD BUSINESS SCHOOL This document is authorized for use only by Atul Singh at JRE Group of Institutions until June 2013. Copying or posting is an infringement of copyright. emailprotected harvard. edu or 617. 783. 7860. Reassessing Financial Policies in 2007 rP os t Blaine Kitchenware, Inc. Capital Structure 4040 In 2007 Blaine planned to continue its policy of keeping prices firm in the face of competitive pressures. Consequently, its managers were expecting top line growth of only 3% for fiscal year 2007.However, this growth rate assumed no acquisitions would be made in 2007, unlike the previous two years. While the board remained receptive to opportunities, Dubinski and his team had no target in mind as yet at the end of April. op yo As he reflected on the po ssibility of repurchasing stock, Dubinski understood that he could consider such a move only in conjunction with all of BKIs financial policies its liquidity, capital structure, dividend policy, ownership structure, and acquisition plans. In addition, he wondered about timing. Blaines stock price was not far off its all-time high, yet its performance clearly lagged that of its peers.A summary of contemporaneous financial market information is provided in Exhibit 4. Dubinski had begun to suspect that family members on the board would welcome some of the possible effects of a large share repurchase. Assuming that family members held on to their shares, their percentage ownership of Blaine would rise, reversing a downward trend date from BKIs IPO. It also would give the board more flexibility in setting future dividends per share. Both Dubinski and the board knew that the recent trend in BKIs payout ratio was unsustainable and that this concerned some family members.Do No tC On the ot her hand, a large repurchase might be unpopular if it forced Blaine to give up its war chest and/or discontinue its acquisition activity. Perhaps even more unsettling, it would cause Blaine to borrow money. The company would be paying significant interest expense for only the third time in its history. As Dubinski turned his chair to face the window, he glanced at the framed photo merchantman his desk of his great grandfather, Marcus Blaine, demonstrating the companys first cream separatorits best-selling product during Blaines first decade.A real Blaine Electrical Cream Separator sat in a glass case in the corner the last one had been manufactured in 1949. HARVARD BUSINESS SCHOOL BRIEFCASES This document is authorized for use only by Atul Singh at JRE Group of Institutions until June 2013. Copying or posting is an infringement of copyright. emailprotected harvard. edu or 617. 783. 7860. 5 Exhibit 1 rP os t 4040 Blaine Kitchenware, Inc. Capital Structure Blaine Kitchenware, Inc. , Income Statements, years ended December 31, ($ in Thousands) Operating Results 2004 2005 2006 $291,940 204,265 Net Income Dividends 63,946 9,914 68,895 73,860 60,682 16,057 63,946 3,506 78,101 24,989 76,738 24,303 77,451 23,821 52,435 $ 22,871 53,630 $ 28,345 5. 5% 11. 1% op yo Earnings Before Tax Less Taxes 60,682 8,213 53,112 $ 18,589 EBIT Plus Other Income (expense) 92,458 28,512 62,383 15,719 EBITDA 87,731 27,049 69,370 Operating Income Plus Depreciation & Amortization $342,251 249,794 62,383 6,987 Gross Profit Less Selling, General & Administrative $307,964 220,234 87,676 25,293 Revenue Less Cost of Goods Sold Margins Revenue Growth 3. 2% Gross Margin 30. 0% 28. 5% 27. 0% 21. 4% 19. 7% 18. 7% 23. 8% 22. 4% 21. 6% 32. 0% 31. 7% 30. 8% Net Income Margin 18. 2% 17. 0% 15. 7% Dividend payout ratio 5. 0% 43. 6% 52. 9% EBIT Margin EBITDA Margin Blaines future tax rate was expected to rise to the statutory rate of 40%. Do No a. tC Effective Tax Ratea 6 BRIEFCASES HARVARD BUSINESS SCHOOL This document is authorized for use only by Atul Singh at JRE Group of Institutions until June 2013. Copying or posting is an infringement of copyright. emailprotected harvard. edu or 617. 783. 7860. Exhibit 2 rP os t Blaine Kitchenware, Inc. Capital Structure 4040 Blaine Kitchenware, Inc. Balance Sheets, December 31, ($ in Thousands) Assets 2004 Cash & Cash Equivalents 2005 2006 $ 67,391 Goodwill Other Assets Total Assets p yo Property, Plant & Equipment 48,780 49,728 54,874 3,871 5,157 376,351 Total Current Assets 43,235 2,586 Other Current Assets 164,309 47,262 ancestry $ 66,557 196,763 40,709 Accounts Receivable $ 70,853 218,403 tradeable Securities 364,449 339,678 99,402 138,546 174,321 8,134 20,439 38,281 13,331 27,394 39,973 $497,217 $550,829 $592,253 $ 26,106 $ 28,589 $ 31,936 22,605 24,921 27,761 14,225 17,196 16,884 62,935 70,705 76,581 1,794 3,151 4,814 15,111 18,434 22,495 79,840 92,290 103,890 Liabilities & Shareholders Equity Accounts Payable Accrued Liabili ties Taxes Payable Total Current Liabilities Other liabilitiesDeferred Taxes tC Total Liabilities Shareholders Equity Total Liabilities & Shareholders Equity 458,538 488,363 $550,829 $592,253 some items in BKIs historical balance sheets (e. g. , Property, Plant & Equipment) have been affected by the firms acquisitions. Do No Note 417,377 $497,217 HARVARD BUSINESS SCHOOL BRIEFCASES This document is authorized for use only by Atul Singh at JRE Group of Institutions until June 2013. Copying or posting is an infringement of copyright. emailprotected harvard. edu or 617. 783. 7860. 7 This document is authorized for use only by Atul Singh at JRE Group of Institutions until June 2013.Copying or posting is an infringement of copyright. emailprotected harvard. edu or 617. 783. 7860. 45. 18% 31. 12% Net Debt/Equity Net Debt/ opening Value b. Net debt is total long-term and short-term debt less excess cash. a. Net working capital excludes cash and securities. 1. 91x 10. 56x 9. 46x 1. 63x 1. 03 776,427 $1,127,226 $ 350,798 372,293 475,377 LTM Trading Multiples MVIC/Revenue MVIC/EBIT MVIC/EBITDA Market/Book equity Equity beta Market capitalization Enterprise value (MVIC) Net debtb Total debt Book equity $ 21,495 54,316 900,803 $ 976,613 31. 74% 24. 10% 1. 02x 7. 35x 6. 03x 4. 26x 1. 24 17. 97% 15. 23% 1. 5x 8. 65x 7. 84x 2. 51x 0. 96 5,290,145 $6,240,947 $ 950,802 972,227 2,109,400 $ 21,425 353,691 3,322,837 $3,697,952 $4,313,300 721,297 796,497 $ 412,307 XQL Corp. -15. 47% -18. 31% 1. 87x 18. 05x 15. 15x 4. 41x 0. 67 418,749 $ 353,949 $ (64,800) 177,302 94,919 $ 242,102 21,220 68,788 $ 332,110 $ 188,955 19,613 23,356 $ 13,173 EasyLiving Systems 4040 -8- -24. 06% -31. 68% 2. 13x 11. 40x 9. 87x 1. 96x 0. 56 959,596 $ 728,730 $(230,866) 488,363 $ 230,866 32,231 174,321 $ 592,253 $ 342,251 63,946 73,860 $ 53,630 Blaine Kitchenware rP os t 6. 01% 5. 67% 1. 14x 7. 42x 6. 88x 4. 93x 0. 92 3,962,780 $4,200,836 $ 238,056 391,736 04,400 $ 153,680 334,804 815,304 $1,303,788 $3,671 ,100 566,099 610,399 $ 335,073 Bunkerhill, Inc. op yo 13,978,375 $18,415,689 $4,437,314 4,973,413 3,283,000 $ 536,099 1,247,520 7,463,564 $9,247,183 $18,080,000 2,505,200 3,055,200 $1,416,012 AutoTech Appliances tC No $ 589,747 106,763 119,190 $ 53,698 Home & Hearth Design Selected Operating and Financial entropy for Public Kitchenware Producers, 12 months ended December 31, 2006, ($ in Thousands) Cash & securities Net working capitala Net decided assets Total assets Revenue EBIT EBITDA Net income Exhibit 3 Do Exhibit 4 rP os t Blaine Kitchenware, Inc. Capital Structure 4040Contemporaneous Capital Market Data (April 21, 2007) Yields on U. S. Treasury Securities Maturity 30 days 60 days 90 days 1 year 5 years 10 years 20 years 30 years op yo 4. 55% 4. 73% 4. 91% 4. 90% 4. 91% 5. 02% 5. 26% 5. 10% Default spread 0. 86% 1. 02% 1. 33% 1. 70% 2. 86% 3. 92% Do No tC Seasoned corporate bond yields Moodys Aaa 5. 88% Aa 6. 04% A 6. 35% Baa 6. 72% Ba 7. 88% B 8. 94% HARVARD BUSINESS PUBLI SHING BRIEFCASES This document is authorized for use only by Atul Singh at JRE Group of Institutions until June 2013. Copying or posting is an infringement of copyright. emailprotected harvard. edu or 617. 783. 7860. 9