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Wrigley Gum 21

Blanka Dobrynin of hedge fund Aurora Borealis saw an opportunity to create value by having Wrigley Company take on debt through a leveraged recapitalization. Wrigley had no existing debt but stable cash flows, allowing it to borrow $3 billion at a BB/B credit rating and 13% interest rate. Repurchasing shares with the debt proceeds would lower the share count and increase EPS over time, boosting the stock price without hurting the underlying business. While EPS would initially fall due to interest costs, shareholders would benefit more from the tax shield on debt payments and increased cash flows. Overall the leveraged recapitalization appeared able to increase shareholder value.

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193 views18 pages

Wrigley Gum 21

Blanka Dobrynin of hedge fund Aurora Borealis saw an opportunity to create value by having Wrigley Company take on debt through a leveraged recapitalization. Wrigley had no existing debt but stable cash flows, allowing it to borrow $3 billion at a BB/B credit rating and 13% interest rate. Repurchasing shares with the debt proceeds would lower the share count and increase EPS over time, boosting the stock price without hurting the underlying business. While EPS would initially fall due to interest costs, shareholders would benefit more from the tax shield on debt payments and increased cash flows. Overall the leveraged recapitalization appeared able to increase shareholder value.

Uploaded by

Fidelity Road
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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The William Wrigley Jr.

Company
Overview
Wrigley was the worlds largest manufacturer and distributor of chewing gum. The
firms industry, branded consumer foods and candy, was intensely competitive and
was dominated by a few large players

But, it was mature firm that has leading market share in a stable low-technology
business (chewing gum) and yet has no debt.
Overview
Blanka Dobrynin is managing partner of Aurora Borealis LLC, a hedge fund with an
investment strategy that focused on distressed companies, merger arbitrage, change-
of-control transactions, and recapitalizations.

As an active-investor strategy , her typical mode of operation was to identify


opportunities for a corporation to restructure, invest significantly in the stock of the
target firm, and then undertake a process of persuading management and directors
to restructure.

And Wrigley Jr. Company was the right company for Blanka to pursue.
Key Information
1. Wrigley could borrow $3 billion at a credit rating between BB and B, to yield 13%.
2. Over the preceding two years, revenues had grown at an annual compound rate of 10%
(earnings at 9%), reflecting the introduction of new products and foreign expansion
3. Wrigley would borrow $3 billion and use it either to pay an equivalent dividend or to
repurchase an equivalent value of shares.
4. Impact on Share Value
5. Impact on Debt Rating
6. Impact on Cost of Capital
Potential costs of bankruptcy and distress or the effects of leverage as a signal about
future operations.
7. Impact on EPS
8. Impact on Voting Control
Estimating the Effect of a Leveraged Recapitalization
Impact on Share Value
Current Stock Price = $56.37

Impact after borrowing Debt


Current Price + Tax Debt Shield = Share Value

$56.37 + $5.162 = $61.532

Tax Debt Shield = (40% x $3 Billion) / 232.441 million = $5.162


Share repurchase = $ 3 Billion / $61.532 = 48.755 million shares
Equity Value (After Recap) = ($61.532 x (232.441 - 48.755 million) = $11.303 Billion
Debt Value = $ 3 Billion
D/E ratio = 3/11.3
Impact on Debt Rating
Current Debt Rating = AAA ( No Debt )
Suggested rating = BB/B
Interest expense = 13% x $3 Billion = $ 390 million
EBIT Interest Coverage Ratio (in million) = $580/$390 = 1.32

We use suggested 13% yield, because Wrigley fulfill the most critical criteria (between BB & B).
BB B Wrigley

EBIT / Coverage Ratio 2.2 1 1.32


Impact on Debt Rating
Impact on Cost Of Capital

*Tax = 40%
Impact on EPS (Before Recapitalization)
Impact on EPS (Share Repurchase)
)
Impact on EPS (Special Dividend)
Impact on Voting Control
Why Blanka Dobrynin interested in Wrigley Company?

Most important fact is that Wrigley Company almost has no long-term debt.
Its a chance to create value by buying the stock then persuading management
to issue debt.
Dividend or Repurchase?
Mathematically, both will offer same value to shareholder at the time.
However, we choose repurchase, because :
Dividend get taxed right away. Capital Gain isnt.
Repurchase reduces amount of shares. Normally, it means higher profitability (EPS) and
higher perfomance measures (ROE)
Over time, higher EPS & ROE will generate impact on share price. That means higher
capital gain for shareholders & higher stock price to issued.
Financial Flexibility
Executive Compensation
Reduces Dilution
Why WACC isnt lower after recapitalization?
First, gain from tax
shield on debt is offset
by financial distress
costs.

Second, cost of equity


(10.9%) supposedly
higher than cost of
debt (13%). Levered
beta failed to reflect
financial distress cost.
Will lower EPS gives any impact to shareholder?
No. Even interest expense reduce EPS, shareholder will realize that using
leverage give them advantage in value and more cash flow.
Morever EPS is diluted because of the change in capital structure, not the
reduce in sales.
Cash Flow
- Leveraged = Dividend + Capital Gain ($5.162)
- Unleveraged = Dividend Only
Restructure or not?
Base of all the information above, yes

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