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 .they are only two borrows in the history, both under very unique condition. 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.7Takeover 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 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 writes down and integration cost.to valuate the acquisition, we need to apply below formula.

[Net value added = (stand-alone value- actual value) + (synergy value – premium)]

The goodwill on BKI’S balance sheet increases sharply from $8 million in 2004 to $38 million in 2006, indicating BKJI has paid high premium for acquisitions. Although it’s hard to quantify the synergy value, we can still apply EVA approach to assess BKI’S performance. We found a negative EVA (see Table 3 and Appendix 6 for detail) in 2006, suggesting these acquisitions haven’t helped BKI to generate enough return over BKI’S cost of capital.

Table 3: EVA  analysis for BKI’S 2006 fiscal year               

ROIC                                                                                      8.31%

-                          WACC                                              8.46%

=                     Spread                                           -0.15%

*                        Invested capital                           532,556

       =                                                                              (776)

Inappropriate dividend policy-Dividend payout has more psychological reasons than economic value. For investors, the periodical dividend is a symbol of health company business and management’s confidence for continued success. Dividend also allows the investors to make profit without selling the stock.

However, the management 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 investors 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.

BKI’S RECAP: LEVERAGED REPURCHASE

The investment banker. Dubinski’s  friend. Recommended a leveraged share repurchase plan. In this section, we will exam whether this plan will benefit the BKI, the board and the rest of investors.

Leveraged Recapitalization-There is a lot of benefit related to debt financing. The most important is the tax shield which will be captured by equity holders. Healthy borrowing will increase the firm 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 take overs. 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 purchase-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 management needs to do. Another concern Dubiriski has is the interest expense. However, he also needs to know that interest expense is tax deductible while dividend is not. We’ll take look at BKI’S capacity 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 of attractive investment. Another potential problem is “Buying High, Selling low”. If the business foundation is not enough, the stock price will decrease after the buyback, and then the company will end with lots of treasury stock with less value.

There are lots of benefits associate with share buyer back thought. According to the case, the Dubinski family’s shares are diluted by the acquisitions since its IPO Share repurchase will decrease the number of share outstanding and increase the family ownership. If BKI also have ESOP, the buyer back will increase the management‘s proportion of share which will help the management to concentrate on performance. From investors’ perspective, instead of being passively given dividend which subject to income tax. They have more flexibility to choose when they want to sell to taxed, and the capital gain tax will be slightly lower than the income tax.in addiction, share repurchase might send a signal to the market that the share is undervalued thus boosting the share price. If the share is fairly valued, market can also interpret buyback as appositive signal that management is confident in their future business.

All in all, leveraged share repurchase can get rid of the surplus cash, decrease the cash carrying cost, reduce the risk of unattractive reinvestment and increase buying cost of hostile takeover. By discharging the cash, BKI can decrease its asset and equity on book and improve its ROE.
from the above case study assess the relationship between equity capital, liguidity and investments in relations to the capital structure of BKI


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