Kohler Co. was founded in 1883, by John Michael Kohler, in Sheboygan, Wisconsin. One of the oldest and largest privately held firms in the US, Kohler Co., in 1998, employed 17,500 employees and reached over $2 billion in sales. Its business portfolio ranged from its well-known plumbing fixtures to small engines and generators; and recently diversifying into furniture and luxury resorts. Known for its ability to innovate, Kohler Co. considered one of its main core competencies its ability to keep the company private and family owned, in its over 100 year history. As a privately held company, Kohler Co. was not required to disclose its financial statements. Furthermore, Kohler believed in keeping the business within the family for future generations.
However, in 1998, after an unsuccessful attempt in 1978 to allocate outside shares back into the hands of family members, Herbert V. Kohler Jr., Chairman and CEO of Kohler Co., proposed to recapitalize the company. The recapitalization process would allow family members to either a) sell their stock back to the company at fair market value (exit opportunity for them), or b) convert their stock to a new class that could not be sold to any non-family members moving forward. On the advice of an independent valuation firm, Kohler set the final repurchase price at $55,400/share.
Related Issues/Contextual Analysis
Dissatisfied with Kohler’s proposed final buyout price, outside shareholders, along with some family shareholders, exercised their dissenters’ rights to have the fair value of Kohler Co. stock to be determined in judicial proceedings. The dissenting shareholders believed the valuation should be $273,000/share.
Faced with the upcoming trial, Kohler was unsure with how to proceed. The economic implications for the company and the family would potentially establish a precedent for the assets pledged to the Kohler Foundation. Furthermore, the determined share price would likely be considered by the IRS among the factors used to determine the value of Kohler Co. stock owned by the estate of Kohler’s late brother, Frederic.
Therefore, any value higher than Kohler’s proposed final buyout price would lead to a significantly higher estate tax on the value of the shares held by the estate. In fact, the difference between the valuations each side proposed would present an estate tax liability of approximately $117 million (Exhibit M). As a result, this tax effect would play a role in any settlement offer Kohler may make in order to prevent this case from proceeding in court. Based on these factors, Kohler was tasked with either going to trial or settling; and if he settles, the negotiated price would need to be determined.
Financial Health Assessment
Throughout its over 100 year history, Kohler Co. has always had to ability to innovate. After first establishing the bathtub in 1883, Kohler expanded to develop a Kohler village, in 1900, to allow employees to live near the manufacturing operations at cost. Thirty-five years later, Kohler Co. expanded into becoming a leader in plumbing fixtures manufacturing. As times changed, Kohler Co. was always able to evolve. Even as technology changed, Kohler Co. continued to innovate and stand firm on its core competencies; remain private, family-owned, continue to reinvest 90% of its earnings back into the company, and pledge 5% to its foundation. Kohler Co. had no intention to go public, nor sell its company. The only and last debenture was in 1977, and Kohler Co. decided to completely pay off those bonds a year later.
In light of the recent litigation, we evaluated the baseline value of Kohler Co. based on management’s projections, made minor variations that were more aligned with historical performance (Exhibit C&D), calculated the WACC (Exhibit B) by weighting the unlevered betas based on the competition’s relevant operations to Kohler Co. (Exhibit A), applied the WACC to our FCF calculations using the DCF approach (Exhibit E), and arrived at a baseline intrinsic value of Kohler Co. equity of over $1 billion. With 7,588 outstanding shares, the DCF approach generated a baseline value of $132,662/share.
However, due to the limited availability of financial information from private companies, the multiples approach was also considered in evaluating Kohler Co.’s baseline fair value stock price. Based on the weights used in the WACC calculations, we were able to derive at a multiples baseline fair value of Kohler Co.’s stock price of $205,539/share (Exhibit F). However, our group felt its competition was too dissimilar to Kohler Co. and therefore, decided to arrive at an overall fair value of Kohler Co. stock using a weight of 90% DCF and 10% multiples in future minority and majority shareholder calculations. Upon arriving at our projected baseline fair value of Kohler Co. stock, our group applied baseline discounts for marketability and lack of control to the minority shareholder stock and baseline premiums for marketability and controlling interest for the majority shareholder stock (Exhibit G).
First and foremost, based on the main assumption that Kohler Co. stock will not go public or no longer be traded to non-family shareholders minimizes any speculation that most likely adds to the six-figure prices of the recently paid shares by non-family shareholders before the recapitalization. This fact should actually discount the price per share due to the lack of marketability of the new class of shares. Secondly, since the dissenting shareholders are a significant minority, a minority shareholder discount needs to be applied. Their only claim on the company are to its declared dividends, which have always been modest – around 10% of earnings for the last thirty years.
Our group firmly believes the DCF calculations of Kohler Co. management were fair and consistent with historical trends. Therefore, in evaluating the option of going to court, our application of baseline discount/premiums were based on previous court rulings, such as Estate of Weinberg vs. Commissioner (Exhibit G); applying a 20% marketability discount and a 37% minority control discount in the DCF approach, and a 37% minority discount ONLY for our multiples approach.
These values are consistent with how the courts have applied values to these variables in past cases. Based on the numerous ways our discount assumptions could be changed to arrive at the minority share price of $55,400/share, we defined the upper bounds of the independent decrease in discounts in Exhibits H & I. However, realistically, we believe that due to the 70% chance that Kohler will be victorious, based on historical trends and the fair assumptions applied in the valuation analysis, the realistic assumption would be a 37% marketability discount and a 45% control discount that results in a weighted share price of $55,324.
Based on our baseline model, the dissenting shareholders were unrealistic in determining the share price of $273,000. It was impossible to manipulate either the marketability premium or lack of control assumptions to reach their target price. Without making some heroic changes to the variables in our base DCF model, Exhibit J shows that if we keep the minority discount level, the marketability discount would need to be -185%, which is not possible. Furthermore, keeping the marketability discount level, the minority discount level would need to be -169% (Exhibit K). However, we could increase revenue projections by 15% over our baseline, decrease COGS by 3%, and assume control and marketability discounts of only 5%, respectively, to get a share value of $246,000. However, we believe these assumptions to be impractical (Exhibit L).
Conclusion & Recommendations
In evaluating the firm, Kohler Co.’s management team was reasonable and realistic in forecasting future growth. The 5-year historical trend of the common-size income statements and balance sheets aligned with projections. Future growth remained steady and was not overly aggressive. Past family management leaders have remained consistent in their pledge to always return 90% of earnings back into the company for reinvestment in innovation for technological advances. Therefore, the only two variables between Kohler’s independent valuation and those presented by the dissenting shareholders would be present in the calculation of WACC and the amount discounted for marketability and minority control. Because the WACC is best determined by Kohler Co., not a WACC determined by outside shareholders, the discounts are the largest variables; and where Kohler Co. may need to be flexible in order to reach a settlement.
In order to come up with a settlement range that we would propose to Kohler Co. to avoid going to court, we took the probability of each party’s successful outcome; and added the related potential estate tax liability that could be incurred if the dissenting shareholders prevailed. Although the assets pledged to the Kohler Foundation would be impacted by the determined fair value of Kohler Co. stock, the potential tax implications on Kohler’s late brother’s estate would be more significant. The IRS would likely use the fair value determined in its factors to value Frederic’s estate. The marginal estate tax in 1998 was an estimated to be 55%.
The late estate had 975 shares and the difference in estate value (for tax purposes) fluctuated between $54 million and $266 million, based on the opposing share price values (Exhibit M), resulting in a tax liability of almost $117 million. The tax impact on the fair value price would be $143,882/per share. Based on the 70% probability that Kohler Co.’s fair value share price will win in court and the 30% chance the dissenter’s fair value will win in court, gives us the probable payout w/o estate tax impact of $120,680/share (Exhibit N). Therefore, the range for negotiation would be from $120,680 to $264,562. The closer the settlement price is $265,562, the higher the dissenters and the government’s benefit will be.