Monday, February 26, 2007



Executive Summary
Aurora Borealis LLC is an activist Hedge fund. They are trying to buy a large stake in the company and thereby force the management to reorganize the capital structure by raising the debt and using it to pay the dividends or buy back the shares. The effect of restructuring on various financial parameters will be discussed in the concluding parts.
Hedge Fund Strategy

The buyback of shares would increase the EPS for the firm as a natural consequence of reduction in number of shares outstanding. The increase in EPS will signal towards a positive market sentiment, which would result in increase in share price. Also, raising debt at lower cost of debt i.e. at good credit ratings lowers the WACC due effect of the tax shield and hence the value of the firm. Aurora Borealis LLC, like any other hedge fund, banks on instantaneous rise and fall in stock prices than the long term investment in growth and stability of the firm. The hedge fund plans to short the stock at the moment it rises to the optimal level due to strong signals the hedge fund is trying to pursue.

Effect of recapitalization on WACC

The current WACC of Wrigley is 10.9%. Since it is all equity firm the WACC is same as cost of equity. Raising $3billion debt for repurchase of stock or dividend would change the capital structure of the firm. The raised debt, because of the debt tax shield under good credit ratings, would reduce WACC and hence increase value of the firm. But in our case, the WACC after including the debt structure almost remains the same(10.9 to 10.91). The reason of this change is the increase in Beta due to re-levering at new debt level, which consequently brings the beta up to the same level at relevant debt ratios. Hence although re-levering shows no effect on value of the firm, the EPS rises and the stock price rises due to the repurchase. A possible explanation for this would be the decreasing financial stability of the firm and its ability to make profits in the future.

Effect of recapitalization on Financial Indicators

The effect of using the new debt to repurchase shares would result in reduction in number of outstanding shares by and decrease in book value by $3,222,250. We understand that the stockholders are mostly mature investors desiring gains from growth of the firm, instead of short-term yields from dividends. Wrigley’s share prices in the past have shown consistent growth against S&P500. The calculated price paid for stock repurchase is $62, which will be The EPS will increase to 1.97 from 1.61 due to decrease in number of outstanding shares. The debt interest coverage would decrease to 1.2, but this still keeps the company within acceptable industry standards from Standard & Poor's CreditStats. Moreover, other key financial ratios like Long-term debt/capital will still remain on high end of the credit spectrum (A to AA).

Financial Flexibility

The dividend payout, in our view is an ongoing commitment, as once the dividend is paid, stockholders expects at least the same dividends in the future. The reduction in dividends in future may disappoint many of the stakeholders and the stock price may drop significantly after an announcement or in anticipation of any such announcements. A share repurchase is a temporary phenomenon and the company remains more flexible in terms of its financial decisions in the future.

Financial Stability

Any adverse factors on like loss in sales due to economic recession or sudden rise in prices, may hit the bottom line of the company hard. If the company is levered at those times, the effective WACC would become much higher because of increased cost of equity due to re-levered WACC and cost of debt without the tax shield.

Valuation by DCF and APV

The value of the firm is $15.3b by APV valuation as compared to $13.6b by DCF analysis using the WACC after relevering. The difference in the analysis is because the bankruptcy risk and agency costs which APV method is unable to realize. This risk is covered and evaluated by credit rating agencies by increasing the marginal cost of debt.

Decision on recapitalization

It will be favorable for hedge funds if the company re-levers itself to raise the price of the stock. But from the long-term growth perspective of the firm, the best policy would be to re-invest in the firm for growth in form of sales or pursuing more profitable acquisitions. The share buyback would although raise the price of the firm, but if control of the firm is not an issue of urgency and the management do not plan an appropriate utilization of the retained earnings and the new debt, then the company should refrain from adding on additional debt. Moreover, using debt to payout the dividends would result in decrease the value of the firm and hence the share price using assuming market to be efficient.


The critical issue is having an exploitative HR policy structure and implementation.

1. Violation of standards in child labor, workplace safety etc by suppliers. [ More than 1/2 international suppliers violated...1/3 were in "serious violation"]

2. Lower Wages than competitors. [..$2-$3 less than unionized competitors...managers received base salary of $52k- less than counterparts]

3.Discrimination against Female Worker[...class action lawsuit against Walmart...although more than 2/3 of hourly employees, hold only 1/3 of store mgmt job, and less than 15% store mgmt positions....women in every category paid less]

4.Low spending in health benefits for employees.[..estimated $3500/employee, verses $4800 fro wholesale retailing sector & $5600 for US employers in general]

5. Resistance to unionization efforts by Walmart.
[...Walmart has aggresively resisted unionization efforts through profit sharing plans and open door policy...tough enforcing of anti-trsspassing law.]