Gaines Boro Case 26

Gainesboro Case AnalysisApplied Business Finance UNC Charlotte – MBAD 6154

“Dividends are real money. That's the hallmark of a blue chip stock. If a company doesn't pay a dividend, it's a speculation.”

Geraldine Weiss (Sullivan, “Dividend Stocks Pay Off”)

•(When) asked if the company planned to start paying a dividend or initiate a stock buyback program, "At this time, we have no plans to do either. We don't think it's our job to manage our shareholders. It's our job as the management team to manage the company, to manage it through when the stock price is going up and to manage it when the stock price is going down.”

Steven Jobs (Hillis, “Apple Plans no Dividend or buyback”)

GAINESBORO MACHINE TOOLSPAYOUT POLICY FOR A NEW IDENTITY

Clay FowlerJabbar Jamison

Applied Business Finance UNC Charlotte MBAD 6154

AGENDA

Applied Business Finance UNC Charlotte – MBAD 6154 Gainesboro Case Analysis

• Gainesboro• Their dilemma

• Payout policy• Dividends

• Relevant theories• Repurchases• Signaling• Payout policy in the 21st century

• Recommendation• Forecasts and supporting evidence

• Suggested Readings

…

GAINESBORO

Gainesboro Case Analysis

• Conventional industry: Machine tools manufacturing

• Historically strong earnings and regular dividends

• 25% of revenue

• New industry: CAD/CAM software industry

• Expensive restructuring

• Enormous growth potential, domestic and international

Applied Business Finance UNC Charlotte – MBAD 6154

…/Gainesboro_and_their_dilemma


GAINESBORO MACHINE TOOLS CORP.

Consolidated Income Statements (in thousands of dollars, except per-share data)

Shares Outstanding 18,600,000

For the Years Ended December 31, Projected

2002 2003 2004 2005

Net sales $ 858,263 $ 815,979 $ 756,638 $ 870,000

Cost of sales 540,747 501,458 498,879 549,750

Gross profit 317,516 314,522 257,759 320,250

Research & development 77,678 70,545 75,417 77,250

Selling, general, & administrative 229,971 223,634 231,008 211,500

Restructuring costs 65,448 0 89,411 0

Operating profit (loss) (55,581) 20,343 (138,077) 31,500

Other income (expense) (4,500) 1,065 (3,458) (4,200)

Income (loss) before taxes (60,081) 21,408 (141,534) 27,300

Income taxes (benefit) 1,241 8,415 (750) 9,282

Net income (loss) ($61,322) $12,993 ($140,784) $18,018

Earnings (loss) per share ($3.25) $0.69 ($7.57) $0.98

Dividends per share $0.77 $0.25 $0.25 $0.39

…/Gainesboro_and_their_dilemma /Income_statements


DILEMMA

• Two expensive realignments

• $61.3 million loss in 2002

• $140 million loss in 2004

• Still paid $.25 / share dividend

• Share price down 24% from one year ago

• Avg$29.15 in 2004, currently

…/Gainesboro_and_their_dilemma


…/Payout_policy

PAYOUT POLICY

How can a company increase its value through its choice

of distribution policy, defined as the level of distribution, the

form of distribution, and the stability of distributions?

• Optimal distribution policy


…/Payout_policy/Dividends_and_dividend_theory

DIVIDENDS AND DIVIDEND THEORY

• Dividend Irrelevance Theory

• Distribution method is irrelevant to firm value

• Investor creates their own distribution




• Bird-in-hand theory

• Suggests dividends preferred over capital gains

• Reliability trumps potential




• Tax preference theory

• Capital gains preferred over dividends

• Capital gains taxes are avoidable and deferrable

• Tax liability begets dividend avoidance




• Clientele effect

• Different strokes

• One clientele is as good as another


…/Payout_policy/Stock_repurchases

STOCK REPURCHASES

• Buybacks via open market or tender transaction

• Boosts EPS

• Adjusts capital structure

• Flexibility / Timing effects

• Signals confidence in future earnings


…/Payout_policy/Signaling

SIGNALING

• Information implicitly revealed

• Market uses and consumes information content

• Emperical studies show …

• Potential consequences


…/Payout_policy/_in_the_21st_century

PAYOUT POLICY IN THE 21ST

CENTURY• 66.% in 1978 to 20.8% in 1999

• Lower propensity to pay

• Changing company characteristics


…/Payout_policy/Recommendation/Alternatives

THE ALTERNATIVES

• Alternative options

• Various dividend payout ratios (exhibit 8a)

• 40%

• Residual dividends (18%)

• Revenue-mix adjusted dividend (~10%)

• 0%


…/Payout_policy/Recommendation

RECOMMENDATION

• Zero-dividend high-growth stock with residual

repurchases

• New industry offers considerable growth opportunities

• Prior income-seeking clientele have divested


…/Payout_policy/Recommendation/Optimal

Exhibit 4 - Revised

GAINESBORO MACHINE TOOLS CORP.Stockholder Comparative Data, 1994 and 2004(thousands of shares)

1994 2004 Percentage Change in Clientele

Shares Percentage Shares Percentage

Founders' families 2,390 13% 2,421 13% 0%Employees and families 3,677 20% 3,155 17% -15%Institutional investors

Growth-oriented 2,390 13% 1,138 6% -53%Value-oriented 1,471 8% 2,421 13% 63%

Individual investorsLong-term; retirement 6,803 37% 4,806 26% -30%Short-term; trading-oriented 919 5% 2,421 13% 160%Other; unknown 735 4% 2,239 12% 201%

Total 18,385 100% 18,600 100%



RECOMMENDATION


repurchases



• Industry peers comparison


Annual growth rate of cash flow (%)

Sales ($mm) Last 5 yearsNext 3-5

years

Current payout

ratio (%)

Current dividend yield (%)

Debt/ equity (%)1

Insiderowner- ship

(%)P/E ratio

(x)

Gainesboro Machine Tools Corp. 504 (1.5) 15.0 0.0 0.0 28.0 30.0 nmf

CAD/CAM companies (software and hardware)Autodesk, Inc. 1,234 4.5 10.5 6.0 0.3 0.0 3.2 25.3 Ansys, Inc. 135 16.5 13.0 0.0 0.0 0.0 4.4 23.3 Cadence Design 1,198 (1.5) 6.0 0.0 0.0 24.7 3.5 21.4 Intergraph Corp. 551 (8.0) 12.0 0.0 0.0 0.2 3.1 25.7 Mentor Graphics 711 4.5 2.0 0.0 0.0 65.5 5.9 21.9 Moldflow Corp. 49 nmf 11.5 0.0 0.0 0.0 15.4 36.2 Parametric Technology Corp. 660 (6.5) 6.0 0.0 0.0 0.0 5.4 33.4 Synopsys, Inc. 1,092 6.5 6.0 0.0 0.0 0.0 5.6 26.5

Electrical-industrial equipment manufacturersCooper Industries, Inc. 4,463 1.5 3.0 39.0 2.4 30.6 1.0 16.4 Emerson Electric Company 15,615 2.5 3.5 54.0 2.6 43.3 0.8 20.5 Hubbell Inc. 1,993 5.0 6.0 52.0 3.0 21.1 2.9 17.6 Thomas & Betts Corp. 1,516 (10.0) 5.0 0.0 0.0 60.2 2.4 17.7

Machine tool manufacturersActuant Corp. 976 (21.5) 12.5 0.0 0.0 180.8 5.9 19.1 Lincoln Eletric Holdings, Inc. 1,334 2.5 10.0 32.0 2.2 28.4 5.2 15.0 Milacron, Inc. 774 (15.5) (2.5) 0.0 0.0 468.1 4.6 nmfSnap-On Inc. 2,407 5.0 3.5 71.0 3.1 18.3 3.0 22.9



RECOMMENDATION


repurchases



• Industry peers comparison

• Repurchases: Flexibility and signaling effects

• Pursue re-branding initiatives


CLASS COMMENTARY

Gaines Boro Case 26

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