Strategic Financial Management

Syed Shaharyar Husain Jaffari Ali Akber Morkas Hayat Omer Malik

Outlay

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

Companys Background
Wrigley operated in the branded consumer foods and candys industry which was the worlds 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

Stock Performance at value of $1,000 investment

1410

1320

730

Wrigleys principal brands comprised of Doublemint , Spearmint, Juicy Fruit, Big Red, Winter Fresh, Extra, Orbit & Freedent Wrigleys 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

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 ?
What will be its effects on
Share Value Debt Rating Cost of Capital Earning per share Voting Control If yes, How should recapitalization be done? Dividend Share repurchase

Impact on Share Value

Before Recapitalization After Recapitalization Dividend After Recapitalization Repurchase

Market Value Equity

No. of Outstanding Shares Share Price Value to Shareholders

$13.1 billion
232.441 million $56.36 $56.36

$11.3 billion
232.441 million $48.61 $61.52

$11.3 billion
183.68 million $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 Interest Coverage FFO/Total Debt FOCF/Total Debt Return on Capital Operating Income/Sales Long Term Debt/Capital 13.3 65.7% 33.6% 26.6% 24.0% 21.1% A 6.3 42.2% 22.3% 18.1% 18.1% 33.8% BBB 3.9 30.6% 12.8% 13.1% 15.5% 40.3% BB 2.2 19.7% 7.3% 11.5% 15.4% 53.6% Wrigley 1.35 6.3% 0.2% 11.2% 21.1% 29.7% B 1 10.4% 1.5% 8.0% 14.7% 72.6%

Interest Coverage FFO/Total Debt FOCF/Total Debt Return on Capital Operating Income/Sales Long Term Debt/Capital

BB/B B B BB/B AA A

Corporate Debt Obligations BBB BB B

Yield 10.894% 12.753% 14.663%

Impact on Debt Rating

Comparing Wrigleys projected results to the benchmarks suggests that BB/B is a reasonable call

14 12 10 8 6 4 2 0 AA A BBB BB Wrigley B

Interest Coverage

80.0% 70.0% 60.0% 50.0% 40.0% 30.0% FFO/Total Debt FOCF/Total Debt Return on Capital Operating Income/Sales Long Term Debt/Capital

20.0%
10.0% 0.0%

AA

BBB

BB

Wrigley

13% yield is justified

Impact on Cost of Capital

Before Recapitalization
Weight of Equity Weight of Debt Pre-tax Cost of Debt Beta 100% 0 13% 0.75

After Recapitalization
77% (77.22%) 23% (22.9%) 13% 0.869

Cost of Equity
WACC

10.9%
10.9%

11.74%
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
Operating Income Interest Expense EBT Investment income Other expenses Taxable income Taxes Net Income Shares Outstanding Earnings per Share Before Recapitalizatioin Worst Case Most Likely Best Case 462,020 513,356 564,692 462,020 18,553 4,543 476,030 184,808 277,212 232,441 1.193 513,356 18,553 4,543 527,366 205,342 308,014 232,441 1.325 564,692 18,553 4,543 578,702 225,877 338,815 232,441 1.458

Capitalization Status

Worst Case

Most Likely

Best Case

Before Recapitalization After Recapitalization No Repurchase After Recapitalization Repurchase

$1.19 $0.19 $0.24

$1.33 $0.32 $0.40

$1.46 $0.45 $0.57

Operating Income Interest Expense EBT Investment income Other expenses Taxable income Taxes Net Income Shares Outstanding Earnings per Share

After Recapitalizatioin (Repurchase) Worst Case Most Likely Best Case 462,020 513,356 564,692 390,000 390,000 390,000 72,020 123,356 174,692 18,553 18,553 18,553 4,543 4,543 4,543 86,030 137,366 188,702 28,808 49,342 69,877 43,212 74,014 104,815 183,680 183,680 183,680 0.235 0.403 0.571

Operating Income Interest Expense EBT Investment income Other expenses Taxable income Taxes Net Income Shares Outstanding Earnings per Share

After Recapitalizatioin (Dividend) Worst Case Most Likely Best Case 462,020 513,356 564,692 390,000 390,000 390,000 72,020 123,356 174,692 18,553 18,553 18,553 4,543 4,543 4,543 86,030 137,366 188,702 28,808 49,342 69,877 43,212 74,014 104,815 232,441 232,441 232,441 0.186 0.318 0.451

Impact on EPS
1.458 1.325 1.193

Worst

Likely

Best

0.571 0.403 0.235 0.186 0.451 0.318

Before

Repurchase

Dividend

After Recapitalization
2001 Earnings per Share (Repurchase) Earnings per Share (Dividend) 0.403 0.318 2002 0.571 0.451 2003 0.755 0.597 2004 0.958 0.757 2005 1.181 0.933 2006 1.427 1.127 2007 1.697 1.341

Impact on Voting Control

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
Max Class B 17.9 30.86 48.76 209.86 616.21 287.18 46.6% 406.35 70.7% Max Common 0 48.76 48.76 48.76 616.21 287.18 46.6% 567.45 50.6% Same ratio 8.77 39.99 48.76 127.69 616.21 287.18 46.6% 488.52 58.8%

Class B 18%

Class B Shares purchased Common shares purchased Total shares purchased Total Votes reduced

Common Stock 82%

Total Votes old

Wrigley votes Wrigley votes old % Total Votes new Wrigley votes new %

Wrigley owns 21% of common shares

Whether to Recapitalize or not?

Before Recapitalization

After Recapitalization (Repurchase)

After Recapitalization (Dividend

Impact on Share Value Value to Shareholders Impact on Debt Rating Impact on Cost of Capital Impact on EPS Impact on Voting Control

$56.36 $56.36 AA 10.9% $1.33 Wrigley 46.6%

$61.52 $61.52 BB 10.84% $0.4 Wrigley 50.6%

$48.61 $61.52 BB 10.84% $0.32 Wrigley 46.6%

Whether to Recapitalize or not?

Debt 23%

Equity 77%

On these grounds, it would appear that a leveraged recapitalization would be attractive

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

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 companys affairs This option would be good for Aurura, as it later aims towards exercising control by purchasing a good percentage of Wrigleys 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 shares 3) 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

Further analysis, based on our assumptions, show that WACC will continue to decline till the Debt amount reaches approximately $ 4.5 billion

10.900%

10.922%

10.819%

10.746%

10.758% 10.721%
10.713% 10.710%

$2.5 billion

$3 billion

S3.5 billion

$4 billion

S4.5 billion

$5 billion

S5.5 billion

$6 billion

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

The End