KOHLR &Co (A&B)Asish K Bhattacharyya

Chairperson, Riverside Management Academy Private Limited

Herbert Kohler’s MotiveWhy does Herbert Kohler want to do the

recapitalisation?Why does he want to buy the minority

shareholders out when he already controls about 90% of the company?

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Aversion To Publicity And Public Disclosure

Is Herbert Kohler correct that private is better?Is Mr. Kohler reaping private benefits of control?

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The Dissenters’ MotiveWhat do minority shareholders want?

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ValuationHow do you determine the share price to be

offered to dissenters?

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Comparable CompaniesKitchen and bath products

American StandardAmerican Wood markMasco

Power and generatorsBriggs StrattonCumminsDetroit Diesel

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ValuationMinority shareholders have de facto no voting rights.Control premium and minority discountMinority discount =

1– 1/(1+Control Premium)Control premium of 25% relative to minority share is equivalent to minority discount of 20% relative to controlling interest

Lack of marketability Illiquidity

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Minority DiscountSources of empirical data:Acquisition premium: 36 – 49%Voting premium (in dual class companies): 10 –

80% [Factors for variation: the degree of shareholder protection and the possibility of change in the management]

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Discount For Lack of Marketability

Sources of empirical evidence:Discount on sale of restricted stockPrivate placement (before IPO)Estimates: 25% - 40%

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Valuation: Cost of Debt Interest expenses (Projected):

1998: 11,521 [Ex: 6b]1999: 14,325 [Ex: 6b]

LT Debt: 1997: 228,940 [Ex: 3a]1998: 243,939 [Ex: 6a]

Interest rate (pre-tax): 1998 5.03%1999: 5.87%

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Valuation: Cost of Debt Interest expenses (Projected):

1998: 11,5211999: 14,325

LT Debt: Average 1998: 236,440Average 1999 : 223,939

Interest rate (pre-tax): 1998: 4.87%1999: 6.40%

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Valuation: Cost of Debt Interest expenses (Projected):

1998: 11,521 1999: 14,325

LT Debt: 1998: 243,9391999 : 203,939

Interest rate (pre-tax): 1998: 4.72%1999: 7.02%

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Valuation: Tax RateTax Expense:

1998: 38,585[ Ex: 6b]1999: 46,071

Income Before Tax:1998: 87,1751999: 106,103

Tax Rate:1998: 44.26%1999: 43.60%

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Post-Tax Cost of Debt6.40×(1− 0.4360) = 3.61%

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Cost of EquityWhat should be the ‘risk-free rate of return’?What should be the β?What should be the market premium?

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Risk-Free Rate of Return20-year US Government Bond: 6% [Exhibit 8]

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Market PremiumAverage difference between stock and bond

annual returns over the period 1926-19977.2%

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Determination of Beta (β)Net Sales [Ex: 4]:

Kitchen and Bath Group: 1,485,831 (67%)Power systems Group: 540,260 (24%) Interior Group: 145,414 (7%)Hospitality& R. Estate Group: 50789 (2%)

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Determination of Beta (β)Net Income [Ex:4]:

Kitchen and Bath Group: 87,411(77%)Power systems Group: 20,339 (18%) Interior Group: 4,001 (4%)Hospitality& R. Estate Group: 1,121 (1%)

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Determination of Beta (β)Sales and Net Income of two major GroupsSales:

Kitchen and Bath Group: 1,485,831 (73.33%)Power systems Group: 540,260 (26.67%)

Net Income:Kitchen and Bath Group: 87,411(89%)Power systems Group: 20,339 (11%)

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Determination of Beta (β): Most Current Data

ASDASD AMWAMWDD

MASMAS BGGBGG CUMCUM DDCDDC

EquityEquityBeta [7b]Beta [7b]

0.820.82 0.760.76 1.281.28 0.660.66 1.091.09 1.301.30

E/VE/V 0.590.59 0.950.95 0.890.89 0.810.81 0.650.65 0.840.84

DebtDebtBetaBeta

0.000.00 0.000.00 0.000.00 0.000.00 0.000.00 0.000.00

AssetAssetBetaBeta

0.490.49 0.720.72 1.141.14 0.530.53 0.700.70 1.091.09

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Determination of Beta (β): Average of Latest Three Years

ASDASD AMWAMWDD

MASMAS BGGBGG CUMCUM DDCDDC

EquityEquityBetaBeta

0.820.82 0.760.76 1.281.28 0.660.66 1.091.09 1.301.30

E/VE/V 0.550.55 0.870.87 0.820.82 0.890.89 0.750.75 0.800.80

DebtDebtBetaBeta

0.000.00 0.000.00 0.000.00 0.000.00 0.000.00 0.000.00

AssetAssetBetaBeta

0.450.45 0.660.66 1.041.04 0.580.58 0.820.82 1.041.04

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Determination of Beta (β): Most Current Data

Asset Asset BetaBeta

E/VE/V Equity Equity BetaBeta

Average ofAverage of Kitchen and Bath Kitchen and Bath comparable companiescomparable companies

0.780.78 0.810.81 0.970.97

Average ofAverage of Power and Systems Power and Systems comparable companiescomparable companies

0.780.78 0.770.77 1.021.02

Average ofAverage of six comparable companiessix comparable companies 0.780.78 0.790.79 0.990.99

Weighted Average 80% Kitchen and Weighted Average 80% Kitchen and Bath and 20% Power and Systems Bath and 20% Power and Systems

0.780.78 0.800.80 0.970.9704/22/23 24

Determination of Beta (β): Most Current Data

Equity Equity BetaBeta

Cost of Cost of equityequity

After After tax cost tax cost of debtof debt

WACWACCC

Average ofAverage of Kitchen and Bath Kitchen and Bath comparable companiescomparable companies

0.970.97 13.0%13.0% 3.7%3.7% 11.2%11.2%

Average ofAverage of Power and Systems Power and Systems comparable companiescomparable companies

1.021.02 13.3%13.3% 3.7%3.7% 11.1%11.1%

Average ofAverage of six comparable six comparable companiescompanies

0.990.99 13.1%13.1% 3.7%3.7% 11.1%11.1%

Weighted Average 80% Kitchen Weighted Average 80% Kitchen and Bath and 20% Power and and Bath and 20% Power and Systems Systems

0.970.97 13.0%13.0% 3.7%3.7% 11.2%11.2%

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Determination of Beta (β): Average of Latest Three Years

Asset Asset BetaBeta

E/VE/V Equity Equity BetaBeta

Average ofAverage of Kitchen and Bath Kitchen and Bath comparable companiescomparable companies

0.720.72 0.750.75 0.960.96

Average ofAverage of Power and Systems Power and Systems comparable companiescomparable companies

0.810.81 0.810.81 1.001.00

Average ofAverage of six comparable six comparable companiescompanies

0.770.77 0.780.78 0.980.98

Weighted Average 80% Kitchen and Weighted Average 80% Kitchen and Bath and 20% Power and Systems Bath and 20% Power and Systems

0.740.74 0.760.76 0.970.97

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Determination of Beta (β): Average of Latest Three Years

Equity Equity BetaBeta

Cost of Cost of equityequity

After After tax cost tax cost of debtof debt

WACWACCC

Average ofAverage of Kitchen and Bath Kitchen and Bath comparable companiescomparable companies

0.960.96 12.9%12.9% 3.7%3.7% 10.6%10.6%

Average ofAverage of Power and Systems Power and Systems comparable companiescomparable companies

1.001.00 13.2%13.2% 3.7%3.7% 11.4%11.4%

Average ofAverage of six comparable six comparable companiescompanies

0.980.98 13.1%13.1% 3.7%3.7% 11.0%11.0%

Weighted Average 80% Kitchen Weighted Average 80% Kitchen and Bath and 20% Power and and Bath and 20% Power and Systems Systems

0.970.97 13.0%13.0% 3.7%3.7% 10.8%10.8%

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Total BetaCAPM fundamental assumptions do not hold for

a family-owned company like Kohler. Indeed, if most of the Kohler family’s wealth is

tied to the company, they will not only be exposed to systematic risk (measured by beta), but also to Kohler Co.’s idiosyncratic risk.

This may be true for Herbert Kohler, his sister, and his children, as well as for those dissenters who are Kohler family members, although not for the outside shareholders, particularly the Sogen and Franklin funds.

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Total BetaOne way to adjust the standard CAPM to account

for total risk is to use a “total beta” instead of the usual market beta.

Total beta is defined as the ratio of the standard deviations of the investment and the market, without multiplying it by the correlation between the investment and the market as we do for the standard (market) beta

Total β= σi/σm

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END

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