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CORPORATE FINANCE - PROF. R.

C AGARWAL
Case study anayss
Bane Ktchenware Inc. - Capta Structure
51. Priyanka Shimpi
52. Dilip Singh
53. Prabhdeep Singh
54. Shalini Singh
55. Amin-ul-Aziz
3/9/2010
What is a Stock Split?
A stock split is a corporate action which splits the existing shares oI a particular Iace value into
smaller denominations so that the number oI shares increase, however, the market capitalization or
the value oI shares held by the investors post split remains the same as that beIore the split.
For e.g. II a company has issued 1,00,00,000 shares with a Iace value oI Rs. 10 and the current
market price being Rs. 100, a 2-Ior-1 stock split would reduce the Iace value oI the shares to 5 and
increase the number oI the company`s outstanding shares to 2,00,00,000, (1,00,00,000*(10/5)). The
share price would also halve to Rs. 50 so that the market capitalization or the value shares held by
an investor remains unchanged. It is the same thing as exchanging a Rs. 100 note Ior two Rs. 50
notes; the value remains the same.
The impact of this on the share holder: Ior example ABC is trading at Rs. 40 and has 100 million
shares issued, which gives it a market capitalization oI Rs. 4000 million (Rs. 40 x 100 million
shares). An investor holds 400 shares oI the company valued at Rs. 16,000. The company then
decides a 4-Ior-1 stock split (i.e. a shareholder holding 1 share, will now hold 4 shares). For each
share, they receive three additional shares. The investor will thereIore hold 1600 shares. So the
investor gains 3 additional shares Ior 59 each share held. But this does not impact the value oI the
shares held by the investor since post split, the price oI the stock is also split by 25 (1/4th), Irom
Rs. 40 to Rs.10, thereIore the investor continues to hold Rs. 16,000 worth oI shares. The market
capitalization stays the same - it has increased the amount oI stocks outstanding to 400 million
while simultaneously reducing the stock price by 25 to Rs. 10 Ior a capitalization oI Rs. 4000
million. The true value oI the company hasn't changed.
Pre-Split Post-Split
2-for-1 Split
No. oI shares 100 mill. 200 mill.
Share Price Rs. 40 Rs. 20
Market Cap. Rs. 4000 mill. Rs. 4000 mill
4-for-1 split
No. oI shares 100 mill. 400 mill.
Share Price Rs. 40 Rs. 10
Market Cap. Rs. 4000 mill. Rs. 4000 mill.
Why Stock Split?
Though there are no theoretical reasons in Iinancial literature to indicate the need Ior a stock split,
generally, there are mainly two important reasons.

1. As the price oI a security gets higher and higher, some investors may Ieel the price is too
high Ior them to buy, or small investors may Ieel it is unaIIordable. Splitting the stock brings
the share price down to a more "attractive" level.
In earlier example to buy 1 share oI company ABC you need Rs. 40 pre-split, but aIter the stock
split the same number oI shares can be bought Ior Rs.10, making it attractive Ior more investors to
buy the share.
2. Splitting a stock may lead to increase in the stock's liquiditv, since more investors are able to
aIIord the share and the total outstanding shares oI the company have also increased in the
market.
Buyback of Shares
A method Ior company to invest in itselI by buying shares Irom other investors in the market.
Buybacks reduce the number oI shares outstanding in the market. Buy back is done by the company
with the purpose to improve the liquidity in its shares and enhance the shareholders` wealth.
The company has to disclose the pre and post-buyback holding oI the promoters. To ensure
completion oI the buyback process speedily, the regulations have stipulated time limit Ior each step.
For example, in purchases through stock exchanges, an oIIer Ior buy back should not remain open
Ior more than 30 days. The veriIication oI shares received in buy back has to be completed within
15 days oI the closure oI the oIIer. The payments Ior accepted securities has to be made within 7
days oI the completion oI veriIication and bought back shares have to be extinguished within 7 days
oI the date oI the payment.
Companies making proIits typically have two uses Ior those proIits. Firstly, some part oI proIits is
usually repaid to shareholders in the Iorm oI dividends. The remainder, termed stockholder's equity,
are kept inside the company and used Ior investing in the Iuture oI the company. II companies can
reinvest most oI their retained earnings proIitably, then they may do so. However, sometimes
companies may Iind that some or all oI their retained earnings cannot be reinvested to produce
acceptable returns.
Share repurchases are one possible use oI leItover retained proIits. When a company repurchases its
own shares, it reduces the number oI shares held by the public. Share repurchases avoid the
accumulation oI excessive amounts oI cash in the corporation.
Why companies buyback?
1. Unused Cash : II they have huge cash reserves with not many new proIitable projects to
invest in and iI the company thinks the market price oI its share is undervalued. Eg. In India
Bajaj Auto went on a massive buy back in 2000 and Reliance's recent buyback.
2. Tax Gains : Since dividends are taxed at higher rate than capital gains companies preIer
buyback to reward their investors instead oI distributing cash dividends, as capital gains tax
is generally lower.
3. Exit option : II a company wants to exit a particular country or wants to close the company.
4. Increase promoter's stake : By reducing the number oI shares in the market.
Buybacks can be carried out in two ways:
1. Shareholders are presented with a tender oIIer where they have the option to submit a
portion oI or all oI their shares within a certain time period and at usually a price higher than
the current market value. Another varietv of this is Dutch auction, in which companies state
a range of prices at which its willing to buv and accepts the bids. It buvs at the lowest price
at which it can buv the desired number of shares.
2. Companies can buy shares on the open market over a long-term period subject to various
regulatory guidelines like SEBI in India.
In 1 promoters can participate in buyback and not in 2.
Buy Back Shares Split of Shares
Face vaue remans unaffected Face vaue decreases
It eads to cash outgo It does not ead to any cash outgo
It decreases he stake of pubc and
ncreases stake of promoters
It does not affect stake of any party
Foat (pubcy hed shares) decreases Foat (pubcy hed shares) ncreases
Can ead to a change n market
captazaton
Mosty does not affect market
captazaton
Decision of Repurchase- 1he dilemma
Blaine Kitchenware Inc. is Iaced with a dilemma as to not go Ior the suggested buyback or to pay
heed to the investment banker and repurchase its own shares. And also iI BKI does repurchase its
shares, should it only partially repurchase the market Iloat or should it go Ior complete buyback ( in
which the Blaine Iamily becomes the owner oI all the remaining shares).
Also they have to think oI the eIIect oI repurchase on the various Iactors like the risks involved in
raising a debt Ior repurchasing (especially when the company is by and large very conservative and
it is debt Iree), its acquisition plans ( which is mainly done by cash and BKI stocks), the earnings
per share, dividend per share (which will become more Ilexible as now the shares will be with the
Iamily shareholders only and thus a reduction in dividends can be easily accepted), ownership
structure, capital structure and oI course the reputation oI the company in the market aIter the
buyback.
ThereIore, we can consider three scenarios and then analyze the eIIect oI these on the above
mentioned Iactors and then decide whether Blaine should Iollow them keeping in mind the existing
shareholders' perspective as well as Blaine's controlling Iamily perspective.
These scenarios are:
1. BKI should not go Ior any buyback oI shares.
2. BKI should go Ior only partial repurchase, by using only its cash and cash equivalents and
marketable securities and not raising any debts.
3. The company should buy its entire market Iloat and let the controlling Iamily be the
shareholders oI the remaining shares.
Each oI these scenes is evaluated and calculations will give us an idea about whether the buyback is
justiIiable or not. And also the diIIerent perspectives oI Iamily and minority share holders have on
this issue.
Scenario one- BKI should not go for any buyback
Total no. oI shares: 59.052 Million
Net Income: 48.477 Million
Hence, Earning per share: Net Income/Total No. of shares
48.477/59.052
0.821
Market price oI the share: $16.25
Price to earnings ratio Market price of the share/EPS
16.25/0.821
19.79
Calculation of ROE:
ROE ($ 48.477 million/ $ 488.363 million)* 100
9.926
Conclusion:
This scenario will maintain the company` status as under leveraged and highly liquid
This scenario fails to create value for the shareholders and both minority shareholders
and promoters will suffer
There is a need to change the current capital structure as it is providing lower returns
Scenario two- A partial buy-back using only cash
and cash equivalents/ Market securities
Total Cash and Cash Equivalents $66.557 Million
We are keeping 10 oI the cash and cash equivalent aside Ior daily operations. ThereIore 6.557
Million have been kept as buIIer Ior rotating working capital requirements.
Remaining Cash and Cash equivalents $60 Million
Marketable Securities 164.309 Million
Total amount available Ior buy-back 224.309 Million
Assumption. The share price has increased from $16.25 to $16.50, an increase of 1.5 as it so
often happens when a companv puts out an offer to buv-back the shares.
No. oI shares bought 224.309/16.50
13.59 million
These shares are retired. ThereIore the no. oI remaining shares 59.052-13.59
45.462 million
Calculation of EPS:
Earnings per share: net income in the year 2/ total no. of shares
Now, net income will change because we will also have to account Ior the loss in the interest which
the company could have got iI it had invested its cash and cash equivalents and market securities in
the US treasury securities. This interest rate is the average oI all the yields on U.S treasury securities
provided in the exhibit 4 which is 4.92.
ThereIore, net earnings aIter reducing 4.92 oI $224.309 million $ 48.477- (0.0492* 224.309)
48.477- 11.036
$ 37.441 million

ThereIore EPS 37.441/45.462

$ 0.824
Expected Market price oI the share now Expected EPS*P/E ratio
Assuming. P/E ratio remains constant
ThereIore, Expected Market price 0.824*19.79
$ 16.307
Increase in value per share for shareholders $16.307-$16.25
$ 0.057
Money spent per share for partial buyback $224 million/59.052 million
$3.793
ThereIore, increase in value per share is lesser than money spent per share
Calculation of ROE:
Net income $ 37.441 million
Shareholders' equity $ 488.363 million - $ 224.00 million
$ 264.363 million
] shareholders' equity will be reduced as cash and cash equivalents and market securities are
being used up for the buyback indication a reduction in the asset side of the balance sheet of the
company and thus an appropriate adjustment will have to be done on the liabilities side as well}
ThereIore ROE ($ 37.441 million/ $ 264.363 million) * 100
14.163
Conclusion:
The company`s management which appears to be reluctant to raise any debt, will not
have to forego its zero debt policy
The company will have a better Return on Equity
The company might have to raise debt if it has to continue its growth through inorganic
route
The share holders will have a better value after this whole exercise
The management will have an increased stake and will have more discretion in making
decisions
Scenario three: When Blaine repurchases its entire
market float
Assumption.
1. The controlling familv of Blaine Kitchenware Inc. still owns 62 of its average
outstanding shares and the market float is 38 of the total outstanding shares.
2. As in case of partial buvback, the companv will use all of its cash and cash equivalents
(except some about 10 for its dailv operations), and market securities and for the
remaining amount required for the total buvback, Blaine will raise a debt at an interest
rate of 6.35 (assuming that the companv has a rating of 'a` on Moodvs scales of
corporate ratings.)
3. The shares are bought back at a premium of 13.8 on the market price of $16.25/share
i.e. at $18.5/share, because otherwise the outside investors would not be interested to
give up their shares at the existing share price as thev are expecting it to increase in
the coming vears considering the profitabilitv of the companv.
So Ior complete buyback Blaine needs to repurchase 38 oI 59.052 million shares, that is 22.439
million shares.
ThereIore, total number oI shares leIt aIter complete buy-back 62 oI 59.052 million shares
36.612 million Shares.
Calculation for the amount of debt to be raised:
No. oI shares to be bought back 22.439 million shares.
ThereIore the total price oI all the shares to be bought back 22.439*$18.5
$415.121 million
Less cash and cash equivalents and market securities $224.309 million
ThereIore the debt to be raised Ior complete buyback 415.121- 224.309
$190.812 million a rate oI 6.35
Calculation of EPS:
Interest to be paid 6.35 oI 190.812 million dollars:
$ 12.116 million
Now, EBIT in the year 2006 $ 70.010 million
Less: loss due to use up oI
cash & cash equivalents and
market securities 4.92 $ 11.036 million
Revised EBIT $ 58.974 million
Less interest ( 6.35) $ 12.116 million
Earnings beIore tax $ 46.858 million
Tax ( 40) $ 18.743 million
Net income $ 28.115 million
EPS Net income/total no. oI shares remaining
28.115/ 36.612
$0.768
Expected Market price EPS* P/E ratio
0.768* 19.79
$ 15.199
The money spent per share in case of complete buyback of shares:
Total price Ior the entire market Iloat to be bought back/total no. oI outstanding shares
$ 415.121 million/59.052 million
$ 7.029
And since the new market price is $ 15.199 and the earlier market price was $ 16.25,
ThereIore, decrease in value per share for the shareholders 16.25-15.199
$ 1.051
Hence, in this case the outgo per share is greater than the value per share; it does not lead to
creation of more shareholder value (for the shareholders who retain shares)
Calculation of ROE:
Net income $ 28.115 million
Shareholders' equity $ 264.363 million
ThereIore, ROE ($ 28.115 million/ $ 264.363 million) * 100
10.635
Conclusion:
The company will have to raise considerable debt Ior the required buyback
The promoter will have the complete stake and absolute decision making powers, dividend
policy can be made suiting the Iamily`s need
The company`s debt-equity ratio will remain below 1 which is comIortable
The return on equity will improve which will help Iamily realize better value Ior their stake
The minority shareholders will gain in the Iorm oI 13.48 premium
The complete stake in hands will provide a buffer that may allow company to issue
shares in case of an acquisition without reducing the promoter`s stake below crucial
51 level.
Conclusion
Looking at the scenarios mentioned, one thing we can say Ior sure is that remaining as-it-is is not a
good option. The company is over-liquid and under-levered. Since it is a Iamily owned business,
there is a conservative debt policy. This has led to Blaine building up a huge war-chest to remain
staid & debt-Iree. This scenario Iails to create value Ior the shareholders and both minority
shareholders and promoters will suIIer. ThereIore, the real question now is what to do with the
burgeoning coIIers.
In the second scenario, all the cash & cash securities plus the market securities are used by the
company to buy-back the shares. Since no debt is being raised, it might Iind Iavour with the Iamily
which seems risk-averse to us. The management will have an increased stake, will Iind oII the
acquisition chances and will be able to provide more dividends to the remaining share-holders.
A natural doubt raised is, why would the existing shareholders be willing to sell their equity back to
the company? We discussed this within our group and have reached a common stand that since the
company, in comparison with its peers, has a low market-beta better thing Ior the stock-holders to
do will be to sell the stock and invest in alternates.
Another scenario pointing to the extreme is to completely buy-back the market Iloat. This will
involve the company raising a signiIicant debt. But this will give a complete control to the
promoters. Family`s needs concerning the dividend amount/growth can be better met through this
option. The policy can be set according to their expectations. The return on equity will improve
which will help Iamily realize better value Ior their stake. From the share-holders point oI view,
they are getting a premium on the current market price iI they go ahead with the oIIer. Since, debt is
being raised the WACC will come down as a) cost oI equity decreases b) the contribution oI cost
oI equity to WACC decreases with cost oI debt being included; which is usually less than COE due
to tax beneIits involved.
Hence, it can be said that the best option to exercise is to go Ior a complete buy-back oI the market
Iloat.

References
Internet reIerences:
1. www.wikipedia.com
2. www.investopedia.com
Textbook reIerences:
1. Corporate Finance: by Breaerly and Meyers
2. Financial Management: by Prasanna Chandra
3. BuIIetology: by Mary BuIIet
4. NCFM handbooks
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