Question : At what price should Mr. Kohler make a settlement offer to the dissident shareholders, and why?
This case is about a challenging legal situation that Kohler, a manufacturer of plumbing products and small engine generators, faces. In the year 2000, the company extended its product portfolio to include the production of furniture and luxury resorts. The chairman of the company is Herbert Kohler. In the presented case study, the company is facing a serious dispute with its shareholders related to the recent acquisition in which the company entered. The problem started in the year 1998 after a recapitalization and continues to create a great dilemma for Kohler and the company. Notably, the recapitalization was meant to help Kohler repurchase back the shares and change the company into full owned family businesses as opposed to the publicly traded one. However, this new strategy would not go well will a section of shareholders who went ahead and filed a lawsuit challenging the buyout. Their grounds for the dispute were that the buyout undervalued their shares by a factor of 5. Both outside and family shareholders wanted the stock price for the final buyout to be determined through judicial proceedings. They did this while exercising their dissenters’ rights as captured in the law. In their proposal, the dissenting shareholders believe that the fairest value for the stock should be $230,000 per share. In his proposal, Kohler’s offer was $55,400, a figure that is seen to be quite low by the shareholders whose shares are to be bought.
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The question posted above tries to determine the price that Mr. Kohler should offer to the dissenters and why. This can be determined by first making various assumptions. First, it can be assumed that Kohler’s proposal of $55,400 is based on the expectation that it will continue its growth strategy and ownership and control structure. With this proposed buy-back price, the assumption is that the company will continue with its growth rate and ultimately become a successful private firm. Eventually, the Terminal Value and the value of the enterprise will increase significantly.
The maximum share price that Herbert Kohler should be willing to settle the dissenters if the trial proceeds is based on a 70% and 30% probability. As noted, the dissenters require $230,000 per share while Kohler was willing to pay $55, 4000. Therefore the calculation is as follows:
Dissenters’ proposal price: $230,000 with a probability of 30% = $81900
Kohler’s proposed price: $55,400 with a probability of 70% = $38780
Hence, the average share price: 230,000 ×30 (%) + 55,400 ×30 (%) = $120,680
Considering the two prop ability outcomes, it is informed to say that the expected maximum share price that Kohler can offer is: $120,680
Moreover, enterprise value can further help justify the figures above. This can be calculated by taking various aspects including the cash flow into consideration so an accurate figure is generated.
Using a discounted cash flow approach:
First, it is necessary to determine the value of WACC by weighting the unlevered betas. This is based on the competitions that apply to Kohler Company.
Second, the cost of debt is calculated by dividing the annual company interest by the total debt. This includes the long-term debts plus the annual maturities. Moreover, the Cost of Equity can be determined using the Capital Asset Pricing Model Approach:
Therefore, Cost of Equity: Risk Free Rate +Market Premium × Beta
Capital Asset Pricing Model: kf = (Krf +kM)-kRM) Beta
DCF: ks=D1/PO +g
Given this formula, the enterprise value for the firm is: $1, 113,343
The equity value (EV) is calculated by: EV- debt=$1, 113,343-$681038
EV becomes $:432305
Based on this calculation, the value of each share is:
432305 ÷7587.9 =56.97
The enterprise value can also be determined using Multiple Approaches. In this case, the calculations are as follows:
TEV=
Sales multiple= Total Enterprise value/ Sales EBITDA multiple= Total Enterprise value/ EBITDA Cash multiple = Total Enterprise Value/ Cash Flow
EBIAT multiple= Total Enterprise value/ EBIAT
In this case, the total enterprise value becomes $2058, 110.
Just like in the previous approach, the equity value= EV-debt
This gives 2058, 110-681,038=1377072
The value of a share=1377072/7587.9
The share value is: 181.48
Discussion
Given the calculations above, it would be prudent to claim that the share price of $230,000 proposed by the dissenters is slightly higher. It is double of what the above calculation reveals. It is also five times what Kohler was willing to offer. However, this price was proposed at the time of recapitalization. It cannot be considered the accurate price today because of the changes in the organization including cash flow, marketing among other essential factors. Notably, it was not easy to manipulate both the marketability premium and the lack of control assumption to attain the targeted value. Therefore, if the court determines that the value is $230,000 as postposed by the dissenting shareholders, then a heavy tax burden will be placed on Kohler. The higher the value, the bigger the taxes and vice versa.
In case the issue is not taken to court then the maximum amount of the share price that Kohler will be paying the dissenters will be $120,680. However, this will also attract a fifty percent share on the 489 shares that Kohler will have. There is half a chance that the IRS will make a move to take action if this settlement goes through successfully. As already been noted, the tax will be 50% on the total number of shares which will come to 489 after the settlement. Based on this notion, the expected tax that the company will pay is $29,506,260.
Moreover, the concept of ‘fair value’ comes up when looking at this case that cannot be overlooked. It relates to the perceived value of a share that is paid when transferring an asset or a liability in a company (Magnan, Menini & Parbonetti, 2015) . As previously mentioned, the fair value perceived by the dissenters was entirely different from that of Kohler. Justifiably, the proposed value by the dissenters was too high. At the same time, the proposal made by Kohler was a bit low and would need an adjustment. Kohler strongly maintained that their voting control and ownership structure would stay unchanged. It has also been shown that some of these shareholders feared that Kohler would go public. This influenced how their fair value was shaped. They went for higher values so they could attain higher prices. However, based on the calculations presented in this discussion, it would be informed for Kohler to pay $120,680 in the buyout scheduled for April 1, 2000. This is the most reasonable share price that can favor both parties.
References
Magnan, M., Menini, A., & Parbonetti, A. (2015). Fair value accounting: information or confusion for financial markets?. Review of Accounting Studies , 20 (1), 559-591.
