Durham

FINANCE ECON42415

Mergers and Acquisitions Seminar 1
Material covered in this seminar:
Lecture 1 The Mergers and Acquisitions Environment
Lecture 2 The Acquisition Process
Suggested reading: DePamphilis (2015) Chapters 1 to 6.
The structure of these questions is in the style of exam questions.
The main topic to discuss during the seminar is motivation for takeovers.
We will also cover some fundamental technical exercises which aim to refresh your
understanding on share repurchases – book value, etc.
Question 1
Read the following case study:
Assessing Procter & Gamble’s Acquisition of Gillette
The potential seemed almost limitless, as Procter & Gamble Company (P&G) announced that it
had completed its purchase of Gillette Company (Gillette) in late 2005. P&G’s chairman and
CEO, A.G. Lafley, predicted that the acquisition of Gillette would add one % age point to the
firm’s annual revenue growth rate, while Gillette’s chairman and CEO, Jim Kilts, opined that the
successful integration of the two best companies in consumer products would be studied in
business schools for years to come.
Five years after closing, things have not turned out as expected. While cost savings targets were
achieved, operating margins faltered due to lagging sales. Gillette’s businesses, such as its pricey
razors, have been buffeted by the 2008– 2009 recession and have been a drag on P&G’s top line
rather than a boost. Moreover, most of Gillette’s top managers have left. P&G’s stock price at
the end of 2010 stood about 12% above its level on the acquisition announcement date, less
than one-fourth the appreciation of the share prices of such competitors as Unilever and
Colgate-Palmolive Company during the same period.
On January 28, 2005, P&G enthusiastically announced that it had reached an agreement to buy
Gillette in a share-for-share exchange valued at $55.6 billion. This represented an 18% premium
over Gillette's preannouncement share price. P&G also announced a stock buyback of $18
billion to $22 billion, funded largely by issuing new debt. The combined companies would retain
the P&G name and have annual 2005 revenue of more than $60 billion. Half of the new firm's
product portfolio would consist of personal care, healthcare, and beauty products, with the
remainder consisting of razors and blades, and batteries. The deal was expected to dilute P&G's
2006 earnings by about 15 cents per share. To gain regulatory approval, the two firms would
have to divest overlapping operations, such as deodorants and oral care.
P&G had long been viewed as a premier marketing and product innovator. Consequently, P&G
assumed that its R&D and marketing skills in developing and promoting women's personal care
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products could be used to enhance and promote Gillette's women's razors. Gillette was best
known for its ability to sell an inexpensive product (e.g., razors) and hook customers to a
lifetime of refills (e.g., razor blades). Although Gillette was the number 1 and number 2 supplier
in the lucrative toothbrush and men's deodorant markets, respectively, it has been much less
successful in improving the profitability of its Duracell battery brand. Despite its number 1
market share position, it had been beset by intense price competition from Energizer and Ray
vac Corp., which generally sell for less than Duracell batteries.
Suppliers such as P&G and Gillette had been under considerable pressure from the continuing
consolidation in the retail industry due to the on-going growth of Wal-Mart and industry
mergers at that time, such as Sears and Kmart. About 17% of P&G's $51 billion in 2005 revenues
and 13% of Gillette's $9 billion annual revenue came from sales to Wal-Mart. Moreover, the
sales of both Gillette and P&G to Wal-Mart had grown much faster than sales to other retailers.
The new company, P&G believed, would have more negotiating leverage with retailers for shelf
space and in determining selling prices, as well as with its own suppliers, such as advertisers and
media companies. The broad geographic presence of P&G was expected to facilitate the
marketing of such products as razors and batteries in huge developing markets, such as China
and India. Cumulative cost cutting was expected to reach $16 billion, including layoffs of about
4% of the new company's workforce of 140,000. Such cost reductions were to be realized by
integrating Gillette's deodorant products into P&G's structure as quickly as possible. Other
Gillette product lines, such as the razor and battery businesses, were to remain intact.
P&G's corporate culture was often described as conservative, with a "promotefrom-within"
philosophy. While Gillette's CEO was to become vice chairman of the new company, the role of
other senior Gillette managers was less clear in view of the perception that P&G is laden with
highly talented top management. To obtain regulatory approval, Gillette agreed to divest its
Rembrandt toothpaste and its Right Guard deodorant businesses, while P&G agreed to divest its
Crest toothbrush business.
The Gillette acquisition illustrates the difficulty in evaluating the success or failure of mergers
and acquisitions for acquiring company shareholders. Assessing the true impact of the Gillette
acquisition remains elusive, even after five years. Though the acquisition represented a
substantial expansion of P&G’s product offering and geographic presence, the ability to isolate
the specific impact of a single event (i.e., an acquisition) becomes clouded by the introduction of
other major and often uncontrollable events (e.g., the 2008–2009 recession) and their lingering
effects. While revenue and margin improvement have been below expectations, Gillette has
bolstered P&G’s competitive position in the fast-growing Brazilian and Indian markets, thereby
boosting the firm’s longer-term growth potential, and has strengthened its operations in Europe
and the United States. Thus, in this ever-changing world, it will become increasingly difficult
with each passing year to identify the portion of revenue growth and margin improvement
attributable to the Gillette acquisition and that due to other factors.

1. Mergers and acquisitions are a common form of corporate restructuring discuss the various
motivations for this type of activity?
2. What are the motives for the deal? Discuss the logic underlying each motive you identify.
3. Immediately following the announcement, P&G’s share price dropped by 2% and Gillette’s
share price rose by 13%. Explain why this may have happened?
4. P&G announced that it would be buying back $18 to $22 billion of its stock over the eighteen
months following closing. Much of the cash required to repurchase these shares requires
significant new borrowing by the new companies. Explain what P&G’s objective may have been
trying to achieve in deciding to repurchase stock? Explain how the incremental borrowing help
or hurt P&G achieve their objectives?
5. Explain some of the obstacles that P&G and Gillette are likely to face in integrating the two
businesses. How would you overcome these obstacles?
Question 2: Please also, do the following quick revision exercises to refresh your knowledge:
1. Company X has a balance sheet reading as follows:

Please calculate the following:
a) Nominal value of shares
b) Book value of shares
c) Market value of shares
d) Market to book ratio
e) Earnings per share
f) Earnings for the company
g) Dividend yield
h) Dividend cover
i) RoE
j) If the return on a 3-month government bond is 4% and on FTSE100
is 7%, what is the beta for X Plc?

2. Rights issue to raise money