Gillette Valuation Report

8/12/2019 Gillette Valuation Report

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Project for Business Analysis and Valuation using Financial Statements

Gillette Valuation Report

Proter and Gamble Acquires Gillette Case

Group Members:

Junyong Zheng

Adele Valentin

Daniel Diesinger

Jonathan Karp

Harald Getrey


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Gillette Valuation Report: Procter & Gamble Acquires Gillette Case

Content

Part 1 History and Background..............................................................................................1

1.1 History of Procter&Gamble.................................................................................1

1.2 History of Gillette ...............................................................................................21.3 Continuing of both companies .............................................................................2

Part 2 Strategy Analysis.........................................................................................................3

2.1 Gillette and P&Gs Main Areas ...........................................................................3

2.2 Synergy effect and Risk Analysis ........................................................................4

2.3 Conclusion..........................................................................................................6

Part 3 Financial Ratios Analysis ............................................................................................7

3.1 Sales ...................................................................................................................7

3.2 Profitability .........................................................................................................7

3.3 Capital Management ...........................................................................................8

3.4 Leverage Analysis...............................................................................................9

3.5 Conclusion........................................................................................................10

Part4 Assumptions analysis .................................................................................................11

4.1 Salesgrowth and EBITDA margin ...................................................................11

4.2 Tax rate.............................................................................................................15

4.3 Operating working capital to the sales ...............................................................15

4.4 Net long term assets to the sales ........................................................................16

4.5 Net debt to capital .............................................................................................17

4.6 Depreciation & amortization to sales .................................................................17

4.7 Capital expenditures to sales..............................................................................174.8 Conclusion........................................................................................................18

Part 5 Valuation...................................................................................................................19

5.1 FCFF Valuation Methods ..................................................................................19

5.2 Discount rate.....................................................................................................19

5.3 Valuation as an independent firm ......................................................................21

5.4 Valuation of target after acquisition...................................................................23

5.5 Value of merger benefits ...................................................................................26

5.6 Conclusion........................................................................................................26

Appendix:............................................................................................................................27


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Part 1 History and Background

1.1 History of Procter&GambleIn the year 1837, William Procter and James Gamble create a new company: Procter&Gamble.

In this year Procter&Gamble starts to sell only soap and candles. This are first objects which P&C

sells.

After 22 years, P&C employs 80 employees and made a turnover of $ 1 million.

In the year 1890 P&C is selling more than 30 different types of soap and William A. Procter

assumes the leadership of the enterprise.

1907, the son of William A. Procter, William Cooper Procter became the new chief of thecompany because his father died.

1930, William C. Procter gives the business into another hand.

Richard R. Deupree will be, now, the new chairman of P&C.

In the year 1931, Neil McElroy, the Companys Promotion Department Manager, gives out a new

marketing strategy. This strategy should specialize every brand in a different way.

The brand management of P&C was born.

In the years from 1934 until 1937, the last member of the origin family, William C. Procter died.The company reinforce his engagement in the Far East with an acquisition of the Philippine

Manufacturing Company.

1937, the company celebrates his 100thbirthday and the sales reached about $ 230 million.

Neil H. McElroy will be the next leader of P&C in the 1948.

In the Sixties, the company make some more big acquisition to continue the growth of the

company. 1957, Howard J. Morgens is the successor of Mr. McElroy.

The Seventies are the years of the big expansion. The company creates sub-companies for

example in Germany, Belgium, the Middle East, Japan and other big companies.

1974, Ed Harness will be the next chief-executive-officer of P&C.

The Eighties are also exciting. The company reached a turnover of $10 billion, another CEO will

get the reins for the company and the company makes new acquisitions, for example:

The acquisition of Norwich Eaton Pharmaceutics.

1990, again a new chief for the company: Edwin L. Artzt became the new boss of P&C.


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In the year 1993, the company sales reached $ 30 billion. It is the first time for the company, that

50% of the sales came from outside the U.S.

John E. Pepper will be the ninth chairman of the company and Durk. I. Jager became the first

Chief Operating Officer in the year 1995.

In 1999 Jager will be the next chairman of the company.

In the Millennium P&C gets again a new chairman, A.G. Lafley is the next President and Chief

Executive.

2002, P&C celebrates the 165thanniversary of the company.

P&C has $ 12 billion brands in its portfolio, this is representing more of the half of the company

sales.

1.2 History of GilletteIn the year 1901 the Gillette Company is founded in Boston, Massachusetts.

1904 King C Gillette receives the US patent for razor with replaceable blade.

1905 is the first successful year for the company, because Gillette sold 90.000 razors and 12

million blades. After the year 1907 Gillette Blades will be to have in Germany.

In the year 1967 the BROWN GmbH, an important manufacturer of drying electric shavers and

electrical small devices, will be part of the Gillette Company.

1984 Gillette takes another big partner in to the company. !ORAL B", the company of

toothbrushes and mouth care.

In the year 1996 Gillette takes over !DURACELL", the company of big batteries.

1998 is a great year for Gillette. Gillette has created a new shaving system: the Gillette MACH3-

Shaving-System.

2001, Gillette has got its 100.Birthday. The Company exists now 100 years and has made in this

100 years a huge success.

In the year 2004/2005 there are some phrases about a big merger with another big company.

1.3 Continuing of both companies

01.02.2005 Procter and Gamble is nearing a deal to purchase Gillette in a stock swap value at

about $ 55 billion.

Under the terms of deal, P&G is offering 0,975 P&G share for each share of Gillette outstanding.

That would value Gillette shares at $ 53,94 based on P&Gs Thusrday closing price of $ 55,32, the

Journal said. The offer represents a 17,6% premium to Gillettes closing price of $ 45,85.


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Part 2 Strategy Analysis

2.1 Gillette and P&Gs Main AreasP&G works in 5 main areas: House, Personal Beauty, Baby, Health & Wellness and Pet

Gillette works in 2 Gillettes traditional sectors: Personal beauty with the Gillette Range and

Health & Wellness with the Oral B Toothbrushes brand.

Gillette is also working in the batteries sector with the Duracel brand.

Gillette and P&Gs main areas

Procter & Gamble works in 5 traditional sectors:

Personal

BeautyHouse

Health &

WellnessBaby Pet

The 3 gilettes sectors will be considerate as 2 P&Gs sub-sectors "

Razors, blades,

personal products

Oral Care:

Toothbrushes,"

"and one new sector:

Batteries

Gillette brand Oral B brand

Duracel brand

2 from the top 100

world brand


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Will many references be suppressed ?

All Gillettes brands are strong brands which will ad value to the

P&G!s portfolio

We can suppose that most of Gillette's references will be conserved

Gillette products portfolioGillette products portfolio

2 of the 5 P&G sectors will be impacted:

Personal Beauty: P&G and Gillette have exactly the same products intothe Mens deodorants segment. The Gillette notoriety is so high on this

segment that P&G may suppress 1/3 of its Men deodorants activity

Health & Wellness: P&G and Gillette sell exactly the same products for

Childs on the Tooth Brushes and the Toothpaste market. Each One pay

big licenses (Spiderman & Disney) for a product. They can do big

economies with the suppression of one of it

P&G products portfolioP&G products portfolio

Few brand suppressed but 2 P&Gs sectors enlarged will enable

economy of scale

2.2 Synergy effect and Risk Analysis

Thanks this analysis we can assume that Synergies will be realized though:

Similar Brands Cutting in the Child toothpaste and in the Mens deodorant sector.

Suppression of Similar jobs in the company

The worldwide brand Gillettes knowledge

So we can assume that synergies anticipated by the P&Gs analyst are good.


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A Great opportunity for both companies

The new shareholder will enable Gillette to develop their brands withmore resources

They will have benefits from the P&G marketing strcuture

An opportunity for GilletteAn opportunity for Gillette

The most important benefits for the P&G group are

More Bargain power: The biggest group of its sector: No one can deal w ithout them

2 news for the top 100 brands: Gillette & Duracell: Retailers can not a fford

them not to sell its

A higher share in 2 department and a new department: the batteries

Economy of scales: Job cuttings into central functions, some expensive

segments and products will be suppressed, R&D, marketing andcommunications expenses will be reduced

An opportunity for P&GAn opportunity for P&G

Bargain Power and Economy of Scale are the most important factors about a merger in the goods

industry.

We can say that there is a good completion between both companies and there differences can lead

to a new strength.


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A risk for P&G: the Gillette's integration

Global Marketing

approach: 1

product for the world

market

1 team working for

the world market

Gilette structureGilette structure

Diversity and

regional approach:

quite the same

product declined in

10 brands

Patchwork of team

for each region

P&G StructureP&G Structure

++ P&G can realize

economies of scales

thanks the gillette

"world brand#

knowledge but they

must not impose

theirs own methods

to gilette structure

ImpactImpact

Innovation culture,

how to be the most

competitive though

technologies

Social

responsibility

approach

+ P&G can have

benefits from the

Gillette R&D

structure and use its

technologies in some

project

P&G can have benefits if they adopt an hybrid structure (keeping the

Gillette's structure and use it for big world projects) but this changes has a

cost, and they will have to do integration effort

2.3 Conclusion

As a conclusion, we can assume that :

1. This merger seems to be very positives:

l Some Synergiesare possible

l Many Economy of Scalewill be realized

l The bargain powerof the group will be much important

l P&G will learn from the Gillettes Technology knowledgeand R&D efforts

l And P&G will invest in some new Gillette's high value projects

2. But Many effort have to be done to do this merger a success:

l They have to create a new organization which not destroy the Gillettes structure

l They have to integrate the gillettes methods to lauch new !world product

l They have to invest a lot to manage the change and have only one business culture


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Part 3 Financial Ratios Analysis

3.1 SalesSales growth is not exactly a financial ratio as it has no immediate link to the balance sheethowever it is quite a useful way, at least to start with, of looking at how the company has

performed.

-5,00%

0,00%

5,00%

10,00%

15,00%

20,00%

2001 2002 2003 2004

Gillette

P&G

3.2 ProfitabilityProfitability is the core measure for a firm in order to determine its past and future performance.

So in this first section I will try to determine how well both companies have performed in terms of

profitabiltity.

First I let us consider the ROE. Gillette has had in the four year period averaged an ROE 54,5%.

Compared to the average of American firms (that stands at 12%), this is at first sight a very

impressive figure.

Initially that means that they have compared to other companies rewarded their shareholders with

more profits that other companies, and that revenues have been much higher.

However how did Gillette arrive at this number? They might have used a leverage effect and put

lots of debt in the company so that ceteris paribus the ratio would have increased or they might

have used some accounting cosmetics that would have increased profits.

Compared to other companies Gillette has actually had quite a high leverage of about on average

3.6 debt/equity. This becomes especially significant as P&G which has a significantly lower

leverage also has got a lower ROE. On average Gilette has had 1,5 times the debt to equity ratio

than P&G.


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Also the share of equity in the balance sheet (or the proportion of total assets) has been 1,5 times

higher for P&G.

Taking account of this P&G has averaged an ROE of about 47% over this period. Compared to the

average this is quite an impressive number.

As ROE is pretty similar next thing to look at is operating profit margin. It takes only into account

the profit that has been generated from operations that means there is no influence of non $

operating factors.

Here Gillette has had an average operating profit margin of 21,3% whereas P&G was 16,5%.

A very important strategic issue for both companies is advertising expenses. As they both produce

consumer goods not industrial goods this will naturally be a high percentage of sales.

Examining this figure more closely is important as it shows on average how much $ of advertising

was necessary to generate 1$ of sales.

Here the both companies have roughly the same percentage, P&G at 9,6% and Gillette at 8,7%.

Concluding it can be said that Gillette has been slightly more profitable over the examined period.

3.3 Capital ManagementHere we will look at first at accounts receivable turnover. This ratio indicates how much money

one receivable is worth on average. The higher this ratio, the shorter the money collecting period.

This has also a significant impact on the cash flow.

There is a significant difference between the two. Gillette stands at 8,8, P&G at 13,3, so P&G is

more efficient.

However as the below diagram shows Gillette has become more efficient doing this.

Receivables turnover

-

2,00

4,00

6,00

8,00

10,00

12,00

14,00

2001 2002 2003 2004

Reihe1

The next ratio to look at is inventory turnover. This is an indication how often company turns over

its inventory.


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P&G has a value of 6,3 whereas Gillette only achieves 3,5.

Again P&G is more efficient.

The next area to look at is the long term performance of capital. The net long term asset turnover.

This measure evaluates how good a company manages its long term assets. The higher the ratiothe more efficient the use of it.

For P&G the ratio stands at 1,5 for Gillette at 1,7 suggesting no big differences between the 2

companies.

3.4 Leverage AnalysisLeverage Analysis takes account mostly of how well a company has been able to meet its

obligations, and how it could finance them if it would have to.

For the short run the obvious measure to look at are the current ratio as well as the quick ratio.

Here I will use the quick ratio as it is a more!strict

"approach of measuring a companies short

term ability of paying back debt. For example it doesnt include deferred income tax as this is a

really unsafe asset, often influenced by optimizing the firms tax payments.

Gilette has an ratio of 57% whereas P&G has 50%. This is somewhat surprising given the fact that

Gillette overall has got a much higher debt/equity ratio.

This might be a stragegic issue as Gillette wants to increase their leverage by taking on a lot of

long term debt whereas they want to be !save"paying off their short term liabilities.

The second part of debt is to look at the long term debt. As stated earlier Gillette has had on

average 1,5 more debt as P&G, which is mainly composed of long term debt.

The next ratio to look at is the ability of the company to cover interest payments out of the cash

flow (interest coverage ratio).Gillette%s average stands at 49 whereas P&G stands at 17.

This number is suggesting that Gillette is having a very strong cash flow, given its higher

leverage.


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Interest coverage

0,00

10,00

20,00

30,00

40,00

50,00

60,00

70,00

80,00

90,00

2001 2002 2003 2004

Gillette

P&G

3.5 ConclusionFrom these simple numbers the following can be derived:

l Gillette has a high leverage, leading to a high Return on Equity i.e. Gillette is a profitable

company, more that P&G

lGillette has a strong cash flow i.e. sound financial fundamentals

All these factors could explain a high possible net present value.


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Part4 Assumptions analysisAfter strategic analysis has allowed us to understand the underlying objectives for P&Gs

acquisition of Gillette; while financial analysis has helped identifying both companies strenghths

and weaknesses, conclusions must be drawn out of this to assess the benefits for P&G of merging

with Gillette. It has two aspects, and it involves the valuation of the firm in different ways.

The first step is to assess the value of Gillette as an independent firm. Indeed, this is the starting

point for analysing what it represents as potential value for an acquiring firm. The second step is to

include in this analysis the expected benefits of the merger. This will eventually lead us to

comment on the 18% premium offered by P&G for Gillette, which is 28 times projected 2005

earnings.

The value of Gillette as an independant firm can be derived from the free cash flow valuation

method, using a set of assumptions about Gillettes future.

These assumptions depend on the previous learnings about the firm accounting practices, about its

strategic choices and from the ratio analysis.

Some key drivers are needed for the forecast of Gillettes future cash flows, being:

l Salesgrowth

l EBITDA margin

l Interest rate on beginning debt

l Tax rate

l Operating working capital to the sales

l Operating long term assets to the sales

l Debt to capital

4.1 Salesgrowth and EBITDA marginWhat must be taken in account is that salesgrowth is usually !mean reverting", which means that

a very high path of growth (that is, way above the average) will eventually return to a more normal

level in the long run. However, situations may allow companies to keep a high growth rate when

they have a sustainable competitive advantage, which is Gillettes situation.

1. Business segments

Let us examine separately Gillettes business segments and projected evolution of sales.

Impact of exchange not taken in account

(1) Blades and razors

This segment represents Gillettes core business. It holds 70% of market shares. This position is

supported by regular launching of high-technology new products and high advertising.

In 2004, thanks to the launching of new products such as razor M3 Power, sales grew 12%,especially in the domestic market and in the UK. Growth in 2003 was 13%.


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This is also a highly profitable segment, thanks to premium-priced products and incentives for

consumer trade-up to premium brands. In 2004, operating profit was 37.6%, with an increase of

14% from 36,8% in 2003.

This trend is consistent with Gillettes strategy to keep its position on this segment withtechnology leadership and advertising.

As for sales, even though the main part of sales are located in mature markets, we can

expect them to keep on growing at this rate because of the new products and geographical

expansion in developing markets. Moreover, the 40% increase in total advertising

expenses in 2004, primarily focused on this segment, will only have its full effect one

year later. Therefore we can expect sales growth to be 14% in 2005, and 12% the

following years.

As for the operating profit, tow main factors account for its probable evolution. First, the

advertising efforts aim at increasing consumer trade-up to premium products with higher

margins. Second, Gillette set up in 2003 the Manufacturing Realignment Program aimed

at reducing costs, improving operating efficiency and streamlining manufacturing,

packaging and warehouse operations for the European blades and razors manufacturing

and distribution. Once completed, starting from 2006 it should lead to annual cost savings

of 50-60 million. In this context we can expect operating margin to remain at a high level

and the operating profit to keep the path with the growth of sales. We thus assume an

operating profit up to 40% for 2005 and thereafter.

(2) Duracell

In 2004, sales in the segment of battery grew 11% thanks to strong demand, as opposed to 6% in

2003. However, there is a strong competition of low-priced and low-performance batteries, and

Duracell kept its market share thanks to lowered prices after the price-realignment program in

North America and to the double-digit advertising expenses.

The industry of battery gives Gillette a good margin thanks to its big efforts for manufacturing

efficiencies in 2004. It grew 41%, from 17.2% to 22% of sales.

Different facts have to be taken in account for the forecast.

The sales are primarily located in the US and in Europe, which are mature markets. The

objective for Gillette is to keep its market share in those regions, while it keeps its

industry margin. But there is strong competition, and demand in 2004 was influenced by

unusually active hurricane season in the US. Yet, in 2003, Gillette acquired a majority

interest in the Fujian Nanping Nanfu Battery Company in China. Sales are thus expected

to grow in such a developing market. Indeed, it only contributed about 2% of the sales

growth in 2004. This part should increase. This should compensate the probable decrease

in growth rate in domestic market. Moreover, advertising efforts should also foster sales.

We can therefore expect a reasonable 9% in 2005 and 10% after.

As for operating margin, the continuing efforts of Gillette in Cost saving programs, with

the Companys Strategic Sourcing Initiative and the Functional Excellence Program set in

2002, should t least allow for a stable operating margin, consistent with the strategy of the


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firm, in spite of the probability that the firm will have to keep on lowering prices. We can

thus forecast a 22% of sales operating margin for 2005 and after.

Oral careThe segment of Oral Care was driven in 2004 by growth of global share and strong sales growth

of 20%, compared to 6% in 2003. This outstanding growth, which is the highest in all segments, is

due to the strengthening of Oral-B as the number one product in global brushing market, to the

launching of new products such as Professional Care 8000 and Sonic Complete rechargeable

brushes, and to relevant investments, with the acquisition of Rembrandt teeth-whitening products

to complete Gillettes product line. The advertising supported the introduction of the new

products.

In this segment the operating profit grew 14%, however the operating margin decreased from

16.4% in 2003 to 15.7% in 2004, which means the segment is less profitable.

For the forecast we should keep in mind that Gillettes strategy in this segment is to extend its

global share through investments and innovation.

Concerning sales, there is a high competition in the segment and especially from battery-

powered products. Therefore, Gillette plans to increase its market share with the

introduction of new products and with consumer trade-up from manual to power products.

In parallel, Gillette also pursues its geographic expansion.

As Gillette is having an offensive strategy on this market and has launched a number of

new products supported by advertising we can expect a 25% growth in 2005 and after.

In terms of operating profit, this segment can be seen as cost-consuming, because of the

important innovation and advertising efforts Gillette makes for growing its market share.

Therefore, although new products have higher prices, it will be difficult for the company

to keep the path with salesgrowth and we can expect the operating profits growth to be

lower than the salesgrowth. Thus we can assume the operating margin to decrease to

14.5% in 2005 and after.

(3) Braun

In this segment, Gillette has diversified a lot and holds a full product line. Thanks to the

introduction of new products and geographic expansion, sales grew 16% in 2004, compared with

11% in 2003. However, Gillette has decided to refocus on its core business with dry shaving

systems.

This segment is highly capital intensive and operating margins are low. However, due to product

rationalization, product sources changes and manufacturing efficiencies, operating profit for this

segment went 94%, from a 4.1% margin to a 7% margin in 2004.

Braun operates on quite mature markets. The companys objective on this segment is to keep

margins higher than the cost of capital. Therefore we can expect the company to continue its effort

of refocusing on core products and of launching attractive new products.


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Sales can therefore be expected to decrease for certain products and increase for others.

The companys strategy on this segment is not very offensive and focuses more on

improving operating profit. We can assume the growth rate to stay at a 15% level.

Operating profit should keep on growing as efforts are made to suppress non profitable

products and for cost savings. We can assume the operating margin to increase 50% morethanks to the remaining effects of rationalization, and to refocusing on products with

higher margins, up to a 10,5% margin for 2005, which should remain stable thereafter,

taking in account the specific capital-consuming level of this segment.

(4) Personal care

The last segment, the personal care products, was driven in 2004 by the high sales growth on

outside markets, in Europe, Africa, Middle East and Eastern Europe, making an 11% increase in

sales compared to 6% in 2003. In 2004, Gillette has reinforced its global share in shaving

preparations in key markets.

While the segment only accounts for a small part of the total operating profit of Gillette, operating

profit grew 30% in 2004, from a 8.4% margin up to a 9.9% margin thanks to manufacturing

savings and overhead cost lowering.

This evolution is consistent with the firms objective, which is to achieve modest growth and

increase margins.

l The sales can be expected to continue growing at the same rate because of geographic

expansion and introduction of new products, without any major action planned for this

segment. We can therefore assume a 11% salesgrowth for 2005 and after.

l Efforts in cost savings can further increase operating profit, however at a lower rate. We

can assume this growth in operating profit will maintain a 10% profit margin.

2. Synthesis

Assumptions about salesgrowth

% of net

sales 2004

Sales' growth

in 2005

Pondered

sales' growth

2005

% of

projected

sales 2005

Sales' growth

after 2005

Pondered

sales' growth

after 2005

Blades & Razors 41,32% 14,00% 5,78% 41,15% 12,00% 4,94%

Duracell 21,30% 9,00% 1,92% 20,29% 10,00% 2,03%Oral Care 15,17% 25,00% 3,79% 16,56% 25,00% 4,14%

Braun 13,04% 15,00% 1,96% 13,10% 15,00% 1,96%

Personal Care 9,17% 11,00% 1,01% 8,90% 11,00% 0,98%

Total 100,00% 14,46% 100,00% 14,05%


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Assumptions about EBITDA margin

% of PFO

2004

Profit margin

in 2005

Pondered

profit margin

2005

% of

projected

PFO 2005

Profit margin

after 2005

Pondered

profit margin

after 2005

Blades & Razors 63,68% 40,00% 25,47% 64,32% 40,00% 25,73%

Duracell 19,16% 22,00% 4,21% 17,44% 22,00% 3,84%

Oral Care 9,73% 14,50% 1,41% 9,38% 14,50% 1,36%

Braun 3,71% 10,50% 0,39% 5,37% 10,50% 0,56%

Personal Care 3,71% 10,00% 0,37% 3,48% 10,00% 0,35%

Total 100,00% 31,86% 100,00% 31,84%

4.2 Tax rateThe effective tax rate has been decreasing 1% every year: 32.2% in 2001, 31% in 2002, 30% in

2003 and 29% in 2004, due to the possibility of making a favourable mix of earnings to countries

taxed at rates lower than the US statutory rate.

Table 6.3 Reconciliation of the statutory Federal income tax rate to Gillettes effective tax rate

Source: Gillette Annual Report 2003

Form the above Table, we can see the effective tax rate of Gillette in 2003 is 30%. So we forecast

its stable and keep 30% in the following years.

4.3 Operating working capital to the salesGillette has been pursuing a policy of improvement of its working capital management. Operating

Working Capital related to the sales decreased from 16% in 2001 to 8% in 2002, and 2% in 2003

and operating working capital turnover grew from 12 million in 2002 to 54 million in 2003.

This is primarily due to a better management of Accounts receivable, which decreased 8% in 2003.

This trend was even stronger in 2004 with a 23% decrease in Accounts receivable, and combined

with a higher average day sales in the last quarter, let Day Sales Outstanding go down 32 to 24

days in 2004.


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Working capital management

2004 2003 2002 2001

Operating working capital1 NA 170 708 1333

Operating Working Capital/Sales NA 2% 8% 16%

Day Sales Outstanding2 24 32 43 55

Days Inventory On Hand3 110 108 97 108

Days Payable Outstanding4 NA 57 60 43

Operating working capital turnover5 NA 54,42 11,94 6,06

Accounts receivable turnover6 12,55 10,06 7,03 5,49

Inventory turnover7 3,30 3,39 3,78 3,37

Assessing the evolution of this trend needs to take in account different factors:

First of all, management of working capital should further improve because of the companys

statement to follow this strategy and due to the effects of the programs (Functional Excellence

program and Realignment program) aimed at optimizing inventory and supply chain management.

Another factor to take in account is the product mix, that influences DSO. It is traditionally lower

for blade and razors, manual oral care and personal care, and higher for Duracell, Braun and

power oral care. As pondered sales growth shows, sales in the segment of blades and razors

should be the highest, then product mix should support this trend. Although we dont know the

evolution of 2004, we can assume the operating working capital to go down 1%.

4.4 Net long term assets to the salesLong term assets management

2004 2003 2002 2001

Net long term assets8 na 5614 4968 4979

Net long term assets/Sales na 60,68% 58,77% 61,59%

Net long term assets turnover9 na 1,65 1,70 1,62

Capital expenditures 616,00 408,00 405,00 624,00

Capital expenditures % net sales 6% 4% 5% 8%

Since 2001, Gillette has had a quite stable fixed assets management, with a net long-term assets

turnover ranging around 160% to 170%.

1(Current assets-cash and marketable securities) - (current liabilities-loans payable and current portion of long-term debt)2Receivables/Average daily sales (3 last months sales/90)3Inventory/(Cost of sales/365)4Accounts payable/Cost of sales/3655Sales/OWC6Sales/Accounts receivable7

Cost of goods sold/Inventory8Sales/ net long-term assets


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We know from the firms statement in the annual report 2003 that the company expects over

the long term capital spending will average 7% of net sales. We can expect this growth of capital

expenditures to be aimed at maintaining the favourable long term asset turnover, and we assume

net long term assets to the sales will remain average 60% of sales.

4.5 Net debt to capital

Embedment

2004 2003 2002 2001

Long term debt 3195 2984 2984 2082

Net debt/equity ratio na 1,60 1,67 1,95

The company has had a net debt/equity ratio revealing a very healthy financial structure.

We can assume the level of net debt to capital to remain stable, around 1,60.

4.6 Depreciation & amortization to sales

Depreciation & amortization to sales percentage

2003 2002 2001 2000 1999 Average

Depreciation & Amortization 578 500 509 535 464

D&A/Sales 6.25% 5.92% 6.30% 6.44% 5.11% 6.00%

We can assume the level of Depreciation & amortization to sales percentage, around 6%.

4.7 Capital expenditures to sales

Capital expenditures to sales percentage

2004 2003 2002 2001 2000 1999 Average

Capital expenditures 616 408 405 624 793 889

Capital expenditures/Sales 5.88% 4.41% 4.79% 7.72% 9.54% 9.80% 7.02%

We can assume the level of Capital expenditures to sales percentage, around 7.02%.

9Sales/ net long-term assets


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4.8 ConclusionThe following assumptions can thus be used to calculate Gillettes value as an independent firm:

Assumptions for the valuation

2005 After 2005

Sales' growth rate 14,86% 14,05%

EBITDA margin 31,86% 31,84%

Tax rate 30% 30%

Operating working capital/sales 1% 1%

Net long term assets/sales 60% 60%

Net debt/equity 1,6 1,6


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Part 5 Valuation

5.1 FCFF Valuation MethodsTo value Gillette, we will use the Free Cash Flow Approach.

The free cash flow to the firm (FCFF) is the sum of the cash flows to all claim holders in the firm,

including stockholders, bondholders, and preferred stockholders.

A simple way of getting to free cash flow to the firm is to estimate the cash flows prior to any of

any of the above claims. Thus we could begin with the earnings before interest and taxes, net out

taxes (then we get NOPAT, net operating profit after-tax) and reinvestment needs, and arrive at an

estimate of the free cash flow to the firm:FCFF = NOPAT + depreciation&amortization $changes in NWC $Capex

Comparing to other valuation method, FCF has the following advantages:

l Capture the firms future growth system instead of final result logically;

l Suited for growth firm with low or zero dividend payout ratio;

l Absorb important assumption which include sales zgrowth rate, EBIT/sale ratio, tax rate,

depreciation&amortization portion, working capital percentage to sales, discount factor, etc.

So, we will use the FCFF model to value Gillette.

5.2 Discount rateThe discount rate to be used for Gillettes valuation would be the companys weighted average

cost of capital. To get the WACC of Gillette we need to figure out by the following steps:

(1) cost of debt

The Companys investment grade long-term credit ratings of AAfrom Standard & Poors and

Aa3 from Moodys and commercial paper ratings of A+ from Standard&Poors and A1 from

Moodys. So we can simply find out the spread on newly issued AA- rated bonds is. And adding

the benchmark yield, we can get the cost of debt for Gillette. For the spread, we can find it from

table 6.2. For the debt structure of Gillette, the weighting average of the debt term to maturity is

almost 5 year. So we choose the 5 year treasuries note yield as the benchmark and the 5 year

spread to get the cost of debt. The average weekly yield for 5 year t-note yield is 3.735% from

Table 6.2. So we can get the cost of debt for Gillette is 3.735%+0.46%= 4.295%.


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Table 5.1 Spread for bond with given ratings

Rating 1 year 2 year 3 year 5 year 7 year 10 year 30 year

Aa3/AA- 20 34 35 46 59 69 97

A1/A+ 39 43 47 53 67 81 105

Source: bondsonline.com

Table 5.2 Weekly 5 year T-note yield in 2005

Week Close date Yield (%)

1 2005-01-07 3.71

2 2005-01-14 3.72

3 2005-01-21 3.7

4 2005-01-28 3.71

5 2005-02-04 3.726 2005-02-11 3.66

7 2005-02-18 3.77

8 2005-02-25 3.89

Average weekly yield 3.735

Source: finance.yahoo.com

(2) Tax rate

Table 5.3 Reconciliation of the statutory Federal income tax rate to Gillettes effective tax rate

Source: Gillette Annual Report 2003

Form the above Table, we can see the effective tax rate of Gillette in 2003 is 30%. So we forecast

its stable and keep 30% in the following years.

(3) cost of equity

We can get the cost of equity form CAPM model.

Since Gillette lists in NASDAQ, we calculate the NASDAQ index average yearly return from

1985 to 2004 as the market return and we get 16.53%. As for the current risk-free rate, 3m


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Treasuries bill yield is trading at 2.70% per year. For the beta, we get 0.700 from

finance.yahoo.com. So the cost of equity of Gillette is :

Cost of equity = 2.70+0.772!(16.53-2.70) =12.38%

(4) WACC

At the end of year 2004, we get the following information from Gillettes Earning Report in Feb 3,

2005: In Dec 31, 2004, Total debt is $3,386 million, the StockholdersEquity is $2,836 million.

So the WACC is calculated as:

%28.7386,3836,2

386,3%)301(%295.4

386,3836,2

836,2%38.12 =

+

+

+

5.3 Valuation as an independent firmFrom the assumption part we get the following forecast:

Table 5.4 assumptions for the valuation

2005 After 2005

Sales' growth rate 14,86% 10,00%

EBIT margin 31,86% 31,84%

Tax rate 30% 30%

Depreciation and amortization to Sales

percentage6.00% 6.00%

Net working capital to sales percentage 1% 1%Capital expenditures to sales percentage 7.02% 7.02%

Discount rate 7.73% 7.73%

Before the valuation, we need to figure out the Terminal Value.

The terminal value in this model is critical, because it must capture all free cash flow value

flowing indefinitely into the future. Although the cash flows are estimated for the explicit period

of 2005 to 2011, Gillettes business will most likely continue far into the future. The typical

calculation of the terminal value uses a constant dividend growth model. Assuming a discount rate

of 7.73% (the WACC) and a free cash flow growth rate into the future of 1.0% per year

(conservative estimation) terminal value in year 11 of the analysis as:

7.53832)1(

ValueTerminal 2011 =

+=

gk

gFCFF

wacc

Then we can input the above input to the Excel Spreadsheet created by us. We can get the Value

of Gillette as an independent firm. See Table 6.6

From the result, we see that the equity of Gillette is valued at $51.275 billion or $48.09 per shareas an independent firm.


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Table 5.5


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5.4 Valuation of target after acquisitionFor Procter & Gamble, after the acquisition, they can create synergy effect. So we need to take

such synergy effect into account.

In a consumer analyst meeting, in describing the many strengths Gillette brings to the combination

with PROCTER & GAMBLE, Mr. Kilts, Gillette Company Chairman, President, CEO, said,

"Strength plus strength will equal success as a very strong Gillette combines with an equally

strong Procter & Gamble. We will create a global company built upon scale, diversity and brand

strength - all requisites for consistent growth in a consolidating, highly competitive global

environment. This is an opportunity to help build something that Gillette has been pursuing for

four years ... to become the best consumer products company in the world."

Mr. Kilts discussed the businesses and capabilities Gillette has created, which will continue to

deliver, strong consistent growth. He described four key growth drivers that give the Company a

unique competitive advantage: Gillette's presence in high-growth, advantaged global categories;

its technological leadership in these categories; its ability to drive consumer trade-up around the

world to better- performing, premium products; and the Company's culture, which is defined by a

constant turnaround mentality and a drive for total innovation.

The synergy effect as the following:

l Cost cut and EBIT margin:

Cost can be reduced in the aspects of Administrative overlap, advertisement expense, R&D,

employment cost, promotion expenditure. And we estimate the above 4 aspects decrease as

following:

Table 5.6 Selected cost item of Gillette

Item 2003 2002 2001 2000 1999

Advertising costs 827 647 576 539 513

Advertising costs to Sales 8.9 7.7 7.1 na na

Sales promotion 376 319 319 na na

Sales promotion to sales 4.1 3.8 3.9 na na

Other Selling, General and

Administrative Expenses2,338 2,206 2,112 na na

Other SG&A 25.3 26.1 26.1 na na

Cost of Sales 3,708 3,511 3,407 3,469 3,486

R&D expenditures 202 185 187 179 201

Source: Gillette annual report 2001,2002, 2003

From table 5.6, we see the advertising costs, sales promotion expense and other SG&A expense

are increasing sharply. And after the acquisition, since the new company can manage the


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advertising and marketing plan together and surely lower the cost for Gillette. For the sale

promotion, because PROCTER & GAMBLE have created a very good organic structural and the

new company with over $60bn revenue can increase the bargaining power to the retailer, such as

Wal-Mart Stores, Inc. And we estimate 15% cost cut from the advertising expenditures and 20%

cost cut from the sales promotion expense. So the advertising and sale promotion save should be

827!15%+2338!20%=591.65. From the labour, Gillette can lay off some employees especially

some managers for administrative lay lap to cut the cost. And we estimate conservatively this cost

cut will be 15%. And we reset the EBIT margin assumption 1 percentage up to 22.05% to reflect

the employment cost save.

l Sales growth

The similarities of the Gillette and Procter & Gamble organizations structures are remarkable,

with both companies using global business units to maximize brand strength and growth, and

market based commercial selling units to assure local customization and flexibility. The results

should be a smooth integration that will produce the ability to move Gillette products through the

existing Procter & Gamble infrastructure very efficiently. This combination will enable our

businesses to create more value in more ways than would ever have been possible as a stand-alone

company. The Gillette as a target after acquisition can get higher sales growth under the

combining synergy effect from PROCTER & GAMBLE deal. So we reset the assumption of Sales

growth to 15% since the fourth year after the deal, that is to say, the estimated sales growth from

2008 will be reassumed as 15%.

Then we can input the above input to the Excel Spreadsheet created by us. We can get the Value

of Gillette as target after acquisition. See Table 5.7

From the result, we see that the equity of Gillette is valued at $65.164 billion or $64.71per share

as an independent firm.


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Table 5.7


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5.5 Value of merger benefitsSince for the M&A deal the value of target after acquisition, value as an independent firm and

value of merger benefits satisfy the following equation:

Value of target after acquisition=Value as independent firm + Value of merger benefitsSo we can rearrange the equation:

Value of merger benefits= Value of target after acquisition - Value as independent firm

From the above formula, we can estimate the merger benefits for PROCTER & GAMBLE from

this M&A deal.

Table 5.8 Value of Merger Benefits

CategoryValue of Target

After acquisition

Value as an

independent firm

Value of

Merger benefits

Valuation of total equity

(Billion, $)65.16 51.28 13.88

Valuation per share

($ per share)64.71 50.92 13.79

5.6 Conclusion(1) Procter & Gamble should buy Gillette because the value of merger benefits is positive and

quite high to it. After the acquisition, PROCTER & GAMBLE and Gillette can share the

$13.88 billion merger benefits together.

(2) Under our assumptions, Procter & Gamble should pay from $51.28 billion to $65.16 billion to

Gillette for buying the 100% share. Finally, PROCTER & GAMBLE paid $57 billion for this

deal, which is within the above range.


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Appendix:Appendix 1


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Appendix 2


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Appendix 3


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Appendix 4


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Appendix 6

Documents

Gillette Valuation Report