9902224, 9081683, 9678513, 9253262 Financial Analysis Spring 2014 William Wrigley Jr. Company: Efficiently Financed or Financially Conservative? Introduction Blanka Dobrynin, a managing partner of Aurora Borealis LLC, is considering a potential investment in William Wrigley Jr. Company. Aurora Borealis LLC typically focuses on distressed companies that are in need of restructuring. Ms. Dobrynin believes that if Wrigley were to take on debt, it could create significant new value for the company. Ms. Dobrynin and her associate, Ms. Susan Chandler, have concluded that Wrigley could take on $3 billion in debt, assuming a credit rating between BB and B, at a yield of 13%; Ms. Chandler remains undecided on whether or not to suggest this $3 billion be used to pay an equivalent dividend or to repurchase an equivalent value of shares. Although leveraging a firm can create value, a detailed analysis is necessary to determine if doing so is the right path for Wrigley. The following analysis will evaluate the assumptions made by Ms. Dobrynin and her associate, examine Wrigley’s financial position under each alternative option, and provide suggested recommendations for Ms. Chandler to present to Wrigley’s board of directors. Key Issues Debt Rating: Ms. Chandler’s estimations regarding Wrigley’s credit rating may not be entirely accurate; therefore, the debt rating in which Wrigley should be categorized may not be BB/B. Each of the factors in Standard & Poor’s Corporate Ratings Criteria table (Exhibit 1) should be assessed in order to appropriately score William Wrigley Jr. Company, in terms of investment grade. Post Recapitalization Share Value, WACC, and EPS: A recapitalization based on the issuance of dividends will not impact the number of shares outstanding; however, with recapitalization based on a repurchase, the number of shares will change substantially. Share price will adjust accordingly; the return on such an adjustment should be analyzed. The increase in leverage will impact Wrigley’s weighted average cost of capital in at least three ways: cost of debt, beta, and the capital weights. Taking on $3b in debt will make the company undeniably riskier in financial terms; this risk may be reflected through Wrigley’s estimated WACC. Because Wrigley will face an increased interest expense and some variation in its number of shares outstanding, shareholders should brace themselves for poor EPS results after recapitalization. 1

Voting Control: Should Wrigley decide to utilize the leverage to repurchase shares, the number of shares outstanding will decrease. The impact that the share­repurchase alternative has on the Wrigley family’s voting­control position should be considered. Information, Evidence and Assumptions The information and evidence provided is suitable for the purposes of valuation for this paper. William Wrigley Jr. Company is a publicly traded company; it must submit its income statement and financials to its shareholders, and the government. This level of scrutiny ensures that the information is correct and of high quality. Most of the assumptions used in calculations are derived from the company’s regulatory filings and a Value Line Investment Survey, compiled by Bloomberg LP. Additionally, it is assumed that, should Wrigley choose to take on the $3 billion, the company will either repurchase an equivalent value of company shares or issue an equivalent dividend. These assumptions should allow for a sound evaluation by Ms. Chandler. Analysis Debt Rating: An increase in leverage will cause Wrigley’s debt rating to change from AAA (consistent with no debt) to a BB/B rating, which reflects the addition of risk. Although the post recapitalization rating is a matter of judgement, the range of measures included in Standard and Poor’s Corporate Ratings Criteria table (Exhibit 1) were computed in order to determine where in the ratings range Wrigley would fall. Comparing Wrigley’s projected results to the benchmarks given in S&P’s table suggests that BB/B is a reasonable call on Ms. Dobrynin’s part. Share Value: If the current stock price is adjusted to reflect the estimate of tax benefits, the repurchase price would be $61.53. Wrigley currently has 232.4 million shares outstanding. At a share price of $61.53, 48.755 million shares will be repurchased ($3 billion/$61.53), leaving 183.686 million shares outstanding. This suggests that the recapitalization will create a return of approximately 9%. Weighted Average Cost of Capital: (Before Recapitalization) Wrigley’s pre recapitalization WACC is 10.9%. The cost of equity is computed using: a risk­free rate of 5.65%, which is appropriate for 20­year U.S. Treasuries; a risk premium of 7%; Wrigley’s current, unlevered beta of 0.75. 2

(After Recapitalization) The cost of debt used for this analysis is 13%, as decided by Ms. Dobrynin. The market values for equity and debt calculated out to be a 78/22 percentage mix. Relevering beta to reflect the new mix of capital resulted in a beta of .87. Assuming a similar risk­free rate and equity­market risk premium yielded an estimated cost of equity for Wrigley of 11.7%. Combining the costs of equity and debt with the revised capital weights yielded a post recapitalization WACC of 10.91%. This number is essentially the same as the pre recapitalization WACC. Earnings Per Share: By drawing data from Wrigleys Income Statement and Consolidated Balance Sheet, the EPS under present circumstances (assuming no recapitalization) can be compared to an EPS after the addition of $3 billion in debt (Exhibit 2). Such analysis suggests that shareholders should expect considerably worse EPS results if Wrigley moves forward with the recapitalization. Voting Control: The Wrigley family owns 21% of the company’s common stock and 58% of its Class B stock. After the repurchase, the family will own 28% of the common stock and continue to own 58% of the Class B stock. Because common shares are the type of stock being repurchased, the Wrigley family’s percent of ownership over the Class B Stocks will not be impacted. As Class B stock holds superior voting privileges over the common stock, the Wrigley family’s voting­control position within the company will not change. Recommendation William Wrigley Company, at its projected BB bond rating, should recapitalize its company and take on debt. This decision will create additional value in the form of a debt tax shield, an efficient financial opportunity which the company has previously ignored. At EBIT values of $514 million and above, a share repurchase produces higher EPS values than does the dividend­based recapitalization. Additionally, a dividend payout is an ongoing commitment; once the dividend is paid, stockholders expect ongoing, if not increasing, dividends. Any reduction in dividends may disappoint stakeholders, which could result in a significant decline in Wrigley's stock price. On the other hand, the repurchasing of shares is a temporary phenomenon. By choosing to repurchase shares over paying out a dividend, Wrigley remains more flexible in regards to its future financial options. Alternative Perspective If Wrigley were to face an economic recession or sudden rise in prices, sales may be adversely impacted, and the company's bottom line could take a rather large hit. If the company is levered during that time, the effective weighted­average cost of capital would increase significantly, putting Wrigley at a 3

disadvantage. Additionally, although Ms. Dobrynin’s hedge fund would certainly see a return if Wrigley chose to lever itself, a long­term growth perspective of the firm suggests that the best policy would be to use debt towards re­investment in Wrigley, rather than the immediate satisfaction of an increased share price. Therefore, unless control over the firm is an issue of urgency, or until management has plans to utilize debt towards Wrigley’s long­term growth, the company should refrain from taking on additional debt.

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