Wrigley Jr. Company – Capital Structure
The managing partner of Aurora Borealis LLC, a hedge fund that strategized to focus on distressed companies, asked an associate to initiate the research for a potential investment in Wrigley. Aurora specialized in finding opportunities for corporate restructures, to invest significantly in the stock of the target firm and then persuade management to restructure. They noted that Wrigley had about $13.1 billion in common equity and did not have any debt on their balance sheet. Chandler was asked to perform an analysis to support the assumption that Wrigley can borrow $3 billion at a credit rating of BB to B, to yield ...view middle of the document...
One of the considerations that Chandler did not make is what the effect will be on Wrigley’s book value if a repurchase or dividend payout is done. Wrigley’s estimated tax rate is 40%, therefore they have a shield of $1.2 billion. Wrigley’s market value of equity will decline by $1.8 billion.
If Wrigley decides to move forward with the recapitalization plan they can take the $3 billion of debt to either buy back shares or pay a dividend on the existing shares. If they repurchased shares this would result in a decrease of their current shares outstanding and an increase to treasury stock. At a price of $56.37 (exhibit 5), Wrigley’s would apply the current tax shield of $5.163 (1.2billion/232.44billion shares). This would make the new equity value $61.53. At that price they would repurchase 48,756,704 shares of outstanding stock. This would decrease current shares outstanding from 232.44 million to 232.39 million. Debt would grow from $0 to $3 billion and assets would grow by $1.2 billion. If they paid out a dividend there would be no affect to the company’s current outstanding stock status.
If there is a recapitalization there will be an impact on the reported earnings per share. In 2001, Wrigley’s had an EPS of $1.61. If there was a share repurchase done the EPS would change to $0.49. The number of outstanding shares would decrease and if the EBIT remained constant this would result in an increased EPS, however, the EBIT would decrease as well because there would be $390 million in interest payments ($3billion * 13% cost of debt). Since both the numerator and denominator both took sharp declines this would cause the EPS to drop drastically.
This will also determine the bond rating that should be used. If we consider the amount of the debt coverage ratio and compare it to the chart shown in Exhibit 6 it...