FI 602: Financial Strategy and Valuation Fang Chen September 21, 2012
In July of 2007, California Pizza Kitchen (CPK), a casual dining pizzeria started in California by co-owners Rick Rosenfield and Larry Flax, was faced with the decision to invest in a stock repurchase program. Led by Chief Financial Officer Susan Collyns, the financial team of CPK was reviewing the preliminary results for the second quarter to determine if the stock repurchase program would provide a significant financial leverage for the company. The goal was to determine if the company can maintain the necessary financial stability to meet the expected growth trajectory for 2008 while utilizing debt financing for the buyback program. Having started the company using the original funding from the initial public offering in 2000, the co-owners were able to have zero debt financing on the balance sheets while maintaining a substantial borrowing capacity of $75 million with an interest rate of 6.16%. With the recent 10% stock decline, the timing to roll out a stock buyback program would be questionable, however it would reduce the corporate income-tax liability, which was previously $10 million in 2006, and would allow for a debt tax shield. Utilizing the CPK financial statements from 2003-2007, recommendations will be provided to determine the best recapitalization approach for the buyback program.
Before indulging in the financials of CPK, a SWOT analysis will give an understanding of the internal and external factors that are influencing the current business and industry. Based upon information provided in the case, it appears that CPK has an abundance of strengths, with minimal weaknesses, that are currently affecting the company. There are several opportunities that the company could utilize to potentially increase revenues and help maintain a competitive advantage in the market. With the current threats of the economy and competitors, some of the 2
opportunities may provide additional ways for CPK to boost their sustainability while investing in the stock repurchase program. The SWOT analysis can be found in Table 1, below, and provides additional factors that could affect the company in the near future. Table 1. SWOT Analysis of CPK Strengths > Inventive products > Consumer loyalty > Kraft partnership for frozen goods > Projection of increased consumer spending on dining out > Experienced minimal impact of rising labor & food costs > Recent revenue and royalties increase in 2007
> Loss of ASAP development > Below industry advertising expenses > Balancing stock repurchase while expanding operations
> Online marketing > International expansion > Consistent new products > Increase advertising funding > Growth from acquisition of LA Food Show > Stock repurchase > Continued enhancements in restaurant operations
> Economic decline > Increased competitors in market > Activist investors affecting major food companies > Rising commodity, labor, and energy costs
Although there appears to be minimal weaknesses and threats, it is important for CPK to address these with caution considering the amount of risk with a debt-financed approach for the stock buyback program. If an economic decline impacts the company in the upcoming years, an investment of 30% could result in a potential loss much greater than the amount originally financed.
Financial Leverage and ROE
The primary goal of CPK in 2007 was to increase its financial leverage utilizing the stock buyback program while ensuring the company will have enough funding for future growth. Using the Pro Forma Tax Shield Effect of Recapitalization Scenarios, the different debt to capital ratios were analyzed at 10%, 20%, and 30% respectively. (See Appendix A) According to the calculated values, it appears that the higher the debt to capital ratio, the higher the return on 3...