The-Wm.-Wrigley-Jr.-Company-Capital-Structure--Val

UVA-F-1482Version3.1ThiscasewaspreparedbyRobertF.BrunerandSeanD.Carr,researchassistant,frompublicdataabouttheWm.WrigleyJr.Company.Otherpersonsandeventsarefictional.Copyright©2005bytheUniversityofVirginiaDardenSchoolFoundation,Charlottesville,VA.Allrightsreserved.Toordercopies,[e-mail]aybereproduced,storedinaretrievalsystem,usedinaspreadsheet,ortransmittedinanyformorbyanymeans—electronic,mechanical,photocopying,recording,orotherwise—withoutthepermissionoftheDardenSchoolFoundation.THEWM.WRIGLEYJR.COMPANY:CAPITALSTRUCTURE,VALUATION,ANDCOSTOFCAPITALInterestratesareattheirlowestpointin50years.Yettheuseofdebtfinancingbycorporationsisdeclining—thishappensanywayinarecession.Andsomedeleveragingisduetostrategicchangesinanindustry,suchastechnologicalinnovationorotherdevelopmentsthatincreasebusinessrisk.Butcorporatedeleveragingseemstohavegonetoofar.CEOsaremissingvaluableopportunitiestocreatevaluefortheirshareholders.Intheextremecase,youhavematurefirmswhousenodebtatall!TakeWilliamWrigleyJr.Company,forinstance.Ithasaleadingmarketshareinastablelow-technologybusiness—itmakeschewinggum—andyethasnodebt.IbetthatifwecouldpersuadeWrigley’sboardtodoaleveragedrecapitalizationthroughadividendormajorsharerepurchase,wecouldcreatesignificantnewvalue.Susan,pleaserunsomenumbersonthepotentialchangeinvalue.AndgetmethenamesandphonenumbersofallofWrigley’sdirectors.Withthosewords,BlankaDobrynin,managingpartnerofAuroraBorealisLLC,askedSusanChandler,anassociate,toinitiatetheresearchforapotentialinvestmentinWrigley.AuroraBorealiswasahedgefundwithabout$3billionundermanagementandaninvestmentstrategythatfocusedondistressedcompanies,mergerarbitrage,change-of-controltransactions,andrecapitalizations.DobryninhadimmigratedtotheUnitedStatesfromRussiain1991,andhadrisenquicklytobecomepartneratamajorWallStreetfirm.In2000,shefoundedAuroraBorealistopursuean“active-investor”strategy.Hertypicalmodeofoperationwastoidentifyopportunitiesforacorporationtorestructure,investsignificantlyinthestockofthetargetfirm,andthenundertakeaprocessofpersuadingmanagementanddirectorstorestructure.Now,inJune2002,Dobrynincouldlookbackonthelargereturnsfromtheuseofthatstrategy.ChandlernotedthatWrigley’smarketvalueofcommonequitywasabout$13.1billion.DobryninandChandlerdiscussedthecurrentcapital-marketconditionsanddecidedtofocusontheassumptionthatWrigleycouldborrow$3billionatacreditratingbetweenBBandB,toyield13%.Chandleragreedtoreturnsoontodiscusstheresultsofherresearch.DardenBusinessPublishing:[e-mail]foruseonlybyXinyuFangatTheUniversityofHongKong.Page1of11UVA-F-1482-2-TheWilliamWrigleyJr.CompanyWrigleywastheworld’slargestmanufactureranddistributorofchewinggum.Thefirm’sindustry,brandedconsumerfoodsandcandy,wasintenselycompetitiveandwasdominatedbyafewlargeplayers.Exhibit1givesproductprofilesofWrigleyanditspeers.Overtheprecedingtwoyears,revenueshadgrownatanannualcompoundrateof10%(earningsat9%),reflectingtheintroductionofnewproductsandforeignexpansion(Exhibit2).Historically,thefirmhadbeenconservativelyfinanced.Attheendof2001,ithadtotalassetsof$1.76billionandnodebt(Exhibit3).AsExhibit4shows,Wrigley’sstockpricehadsignificantlyoutperformedtheS&P500CompositeIndex,andwasrunningslightlyaheadofitsindustryindex.EstimatingtheEffectofaLeveragedRecapitalizationUndertheproposedleveragedrecapitalization,Wrigleywouldborrow$3billionanduseiteithertopayanequivalentdividendortorepurchaseanequivalentvalueofshares.Chandlerknewthatthiscombinationofactionscouldaffectthefirm’ssharevalue,costofcapital,debtcoverage,earningspershare,andvotingcontrol.Accordingly,shesoughttoevaluatetheeffectoftherecapitalizationonthoseareas.ShegatheredfinancialdataonWrigleyanditspeercompanies(Exhibit5).ImpactonsharevalueChandlerrecalledthattheeffectofleverageonafirmcouldbemodeledbyusingtheadjustedpresent-valueformula,whichhypothesizedthatdebtincreasedthevalueofafirmbymeansofshieldingcashflowsfromtaxes.Thus,thepresentvalueofdebttaxshieldscouldbeaddedtothevalueoftheunleveredfirmtoyieldthevalueoftheleveredenterprise.ThemarginaltaxrateChandlerproposedtousewas40%,reflectingthesumoffederal,state,andlocaltaxes.ImpactondebtratingAkeyassumptionintheanalysiswouldbethedebtratingforWrigley,afterassuming$3billionindebt,andwhetherthefirmcouldcovertheresultinginterestpayments.DobryninhadsuggestedthatChandlershouldassumeWrigleywouldborrow$3billionataratingbetweenBBandB.WasaratingofBB/Blikely?Inthatregard,Chandlergatheredinformationontheaveragefinancialratiosassociatedwithdifferentdebt-ratingcategories(Exhibit6).DobryninthoughtthatWrigley’spretaxcostofdebtwouldbearound13%.Chandlersoughttocheckthatassumptionagainstthecapital-marketinformationgiveninExhibit7.ImpactoncostofcapitalChandlerknewthatthemaximumvalueofthefirmwasachievedwhentheweightedaveragecostofcapital(WACC)wasminimized.Thus,sheintendedtoestimatewhatthecostofequityandtheWACCmightbe,ifWrigley