Analyzing Proposed Recapitalization of Wrigley jr. Company

Syed Shaharyar Husain Jaffari

Ali Akber MorkasHayat Omer Malik

Strategic Financial

Management

• Introduction• Major Problem• Analysis & Support

– Impact on Share Value – Impact on Debt Rating– Impact on Cost of Capital – Impact on Earning per share– Impact Voting Control

• Conclusion

Outlay

Company’s Background

• Wrigley operated in the branded consumer foods and candy’s industry which was the world’s largest manufacturer and distributor of ‘Chewing gum’

• The industry faced a fierce competition from a few large players which dominated the entire market

• Wrigley has been growing at a rate of 10% on an average over the last two years due to the introduction of new products and foreign expansion

• The market value of common equity of Wrigley states $13.1 billion which clearly specifies that it is about 12 times more than the Book value of common equity which accumulated about $1.76 billion

… Continued

• Wrigley’s principal brands comprised of ‘Doublemint’, ‘Spearmint’, ‘Juicy Fruit’, ‘Big Red’, ‘Winter Fresh’, ‘Extra’, ‘Orbit’ & ‘Freedent’

• Wrigley’s had nearly 10,800 employees & 38,701 common shareholders

• William Wrigley Jr. owned 21% of common stock & 58% of Class B stock

S&P Food, Beverage and Tobacco Index

Wrigley S&P 500

13201410

730

Stock Performance at value of $1,000 investment

Wrigley has been performing better than the S&P food beverage &

tobacco index and even better than the industry

Major Problem

Whether Recapitalization will be a wise and profitable decision ?

• Share Value • Debt Rating• Cost of Capital • Earning per share• Voting Control

What will be its effects on

• Dividend• Share repurchase

If yes, How should recapitalization be done?

Impact on Share Value

Before Recapitalization

After Recapitalization - Dividend

After Recapitalization - Repurchase

Market Value Equity $13.1 billion $11.3 billion $11.3 billion

No. of Outstanding Shares 232.441 million 232.441 million 183.68 million

Share Price $56.36 $48.61 $61.52

Value to Shareholders $56.36 $61.52 $61.52

• New MV of Equity = $ 13.1 billion - $ 3 billion + 0.4( $ 3 billion ) = $ 11.3 billion

• Share Price (Repurchase) = 0.4 * $ 3 billion = $1.2 billion$1.2 billion/232.441 million shares = $5.16$56.36 + $5.16 = $ 61.52

• Share Price (Dividend) = New MV of equity $11.3 billion/232.441 million shares = $ 48.61

• Outstanding Shares (Repurchase) = $11.3 billion/$61.52 = 183.677 million shares

• No. of shares to be repurchased = $3 billion / $61.52 = 48.76 million shares

Impact on Debt Rating

AA A BBB BB Wrigley B

Interest Coverage 13.3 6.3 3.9 2.2 1.35 1

FFO/Total Debt 65.7% 42.2% 30.6% 19.7% 6.3% 10.4%

FOCF/Total Debt 33.6% 22.3% 12.8% 7.3% 0.2% 1.5%

Return on Capital 26.6% 18.1% 13.1% 11.5% 11.2% 8.0%Operating Income/Sales 24.0% 18.1% 15.5% 15.4% 21.1% 14.7%Long Term Debt/Capital 21.1% 33.8% 40.3% 53.6% 29.7% 72.6%

Interest Coverage BB/B

FFO/Total Debt B

FOCF/Total Debt B

Return on Capital BB/B

Operating Income/Sales AA

Long Term Debt/Capital A

Corporate Debt Obligations Yield

BBB 10.894%

BB 12.753%

B 14.663%

AA A BBB BB Wrigley B0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

FFO/Total DebtFOCF/Total DebtReturn on CapitalOperating Income/SalesLong Term Debt/Capital

Impact on Debt Rating

Comparing Wrigley’s projected results to the benchmarks suggests that BB/B is a reasonable call

AA A BBB BB Wrigley B0

2

4

6

8

10

12

14

Interest Coverage

13% yield is justified

Impact on Cost of Capital

Before Recapitalization After Recapitalization

Weight of Equity 100% 77% (77.22%)

Weight of Debt 0 23% (22.9%)

Pre-tax Cost of Debt 13% 13%

Beta 0.75 0.869

Cost of Equity 10.9% 11.74%

WACC 10.9% 10.84%

BetaL = 0.75 (1+ ((1-0.4)*($3 billion/$11.3 billion)) =

0.869

REUL = 0.0565 + 0.75 (0.07) = 10.9%

REL = 0.0565 + 0.869 (0.07) = 11.74%

WACCAfter = 22.78% (1-40%) 13% + 77.22%

(11.74%) = 10.84%

RRF = 5.65%, MRP = 7%

Impact on EPS

Worst Case Most Likely Best CaseOperating Income 462,020 513,356 564,692Interest ExpenseEBT 462,020 513,356 564,692Investment income 18,553 18,553 18,553Other expenses 4,543 4,543 4,543Taxable income 476,030 527,366 578,702Taxes 184,808 205,342 225,877Net Income 277,212 308,014 338,815Shares Outstanding 232,441 232,441 232,441Earnings per Share 1.193 1.325 1.458

Before Recapitalizatioin

Worst Case Most Likely Best CaseOperating Income 462,020 513,356 564,692Interest Expense 390,000 390,000 390,000EBT 72,020 123,356 174,692Investment income 18,553 18,553 18,553Other expenses 4,543 4,543 4,543Taxable income 86,030 137,366 188,702Taxes 28,808 49,342 69,877Net Income 43,212 74,014 104,815Shares Outstanding 183,680 183,680 183,680Earnings per Share 0.235 0.403 0.571

After Recapitalizatioin (Repurchase)Worst Case Most Likely Best Case

Operating Income 462,020 513,356 564,692Interest Expense 390,000 390,000 390,000EBT 72,020 123,356 174,692Investment income 18,553 18,553 18,553Other expenses 4,543 4,543 4,543Taxable income 86,030 137,366 188,702Taxes 28,808 49,342 69,877Net Income 43,212 74,014 104,815Shares Outstanding 232,441 232,441 232,441Earnings per Share 0.186 0.318 0.451

After Recapitalizatioin (Dividend)

Capitalization Status Worst Case Most Likely Best Case

Before Recapitalization $1.19 $1.33 $1.46

After Recapitalization – No Repurchase

$0.19 $0.32 $0.45

After Recapitalization - Repurchase

$0.24 $0.40 $0.57

Impact on EPS

Before Repurchase Dividend

1.193

0.235 0.186

1.325

0.4030.318

1.458

0.5710.451

Worst Likely Best

After Recapitalization

2001 2002 2003 2004 2005 2006 2007

Earnings per Share (Repurchase) 0.403 0.571 0.755 0.958 1.181 1.427 1.697

Earnings per Share (Dividend) 0.318 0.451 0.597 0.757 0.933 1.127 1.341

Impact on Voting Control

Common Stoc

k82%

Class B18%

Wrigley owns 58% of Class B Stock

• 189.8 million Common shares – 1 vote/share• 42.641 million Class B shares – 10

votes/share• Total Votes = 189.8(1) + 42.641(10) =

616.21 million votes• Shares Repurchased = 48.764 Million

Wrigley owns 21% of common shares

Max Class B Max Common Same ratio

Class B Shares purchased 17.9 0 8.77

Common shares purchased 30.86 48.76 39.99

Total shares purchased 48.76 48.76 48.76

Total Votes reduced 209.86 48.76 127.69

Total Votes old 616.21 616.21 616.21

Wrigley votes 287.18 287.18 287.18

Wrigley votes old % 46.6% 46.6% 46.6%

Total Votes new 406.35 567.45 488.52

Wrigley votes new % 70.7% 50.6% 58.8%

Whether to Recapitalize or not?

Before Recapitaliza

tion

After Recapitaliza

tion (Repurchase

)

After Recapitaliza

tion (Dividend

Impact on Share Value

$56.36 $61.52 $48.61

Value to Shareholders

$56.36 $61.52 $61.52

Impact on Debt Rating

AA BB BB

Impact on Cost of Capital

10.9% 10.84% 10.84%

Impact on EPS $1.33 $0.4 $0.32

Impact on Voting Control

Wrigley 46.6%

Wrigley 50.6%

Wrigley 46.6%

Whether to Recapitalize or not?

• Analysis suggests that the recapitalization will create returns in the range of 9%

• Wrigley trades at a price/earnings multiple that is materially larger than its peers

• Projections prove that EPS will be at its current levels in within the next 6 years

• Also, given the very large asset value underlying the debt, the costs of financial distress appear to be negligible

• Other effects, including signaling, investment, and clientele considerations, are more difficult to gauge but probably balance out positively

On these grounds, it would appear that a leveraged recapitalization

would be attractive

Debt23%

Equity77%

Repurchase or Dividend?

As we earlier demonstrated, recapitalization through Repurchase of Stocks or through distributing Dividends will end up in the same total value of the share

Now, the question is which one to go for; Repurchase OR Dividend?

If the firm goes for Repurchase, then the benefit to the shareholders will be realized upon selling those shares whenever it might be, which means shareholders will have to give away the shares and thus lose any say in the company’s affairs

This option would be good for Aurura, as it later aims towards exercising control by purchasing a good percentage of Wrigley’s shares

If the firm goes for Dividend distribution, then shareholders will benefit more, though the value of the share will remain the same but; 1) They will realize the cash dividend

of $12.91 immediately 2) They would still get to keep the

constantly growing value of shares3) Share Repurchase will constantly

put the “minority” at risks of loss and will like to attract legislative ways in protecting them against the 50.6% voting control by Wrigley family (assuming the other group is consolidated too)

Repurchase Dividend

P/E ratio 152.5 153

Further

$2.5 billion $3 billion S3.5 billion $4 billion S4.5 billion $5 billion S5.5 billion $6 billion

10.900%

10.746%10.721% 10.713%

10.710%

10.758%

10.819%

10.922%

Further analysis, based on our assumptions, show that WACC will

continue to decline till the Debt amount reaches approximately $ 4.5 billion

This indicates that firm value will be at its highest at this level of Debt/Equity ratio

Q&AThe End