STUDENT INVESTMENT FUND

SIF

Patrick Chaffee California State University, Fresno May 23, 2005

Pre-Merger Analytical Report

Gillette Company

Charts provided by Big Charts

With companies holding excess cash reserves and fear of any economic catastrophes cleared, a reemergence of mergers and acquisitions has appeared. Large conglomerates prepared for a long haul in economic recovery are now putting their cash reserves to work toward expansion. At the beginning of 2005, Procter and Gamble Company (PG) put in a bid valued at $57 billion dollars that would combine the two largest consumer goods companies in the industry. This is a pre-merger analysis intending to find if Gillette is a good investment, and if the combined company would benefit from synergies or overlap.

This report will show the combined company will have benefits from overlaps in services and minimal overlap in products that will benefit diversification. Gillette focuses on more technical consumer products and PG focuses more on disposable goods. The combined company will also benefit from different regional dominations and a broader distribution network. Combine this with cuts in the management, marketing and manufacturing departments, and the firms largest expense (labor and administration) is dramatically reduced.

STUDENT INVESTMENT FUND

SIF

Patrick Chaffee California State University, Fresno May 23, 2005

Company Breakdown Industry Gillette is part of the consumer products industry which is a component of consumer non-cyclical companies. Competitors Gillette is ranked second by market cap in the industry to its acquirer Procter and Gamble Products Gillette operates with three main product lines of razors, batteries, and oral care. These are generally low margin areas but Gillette includes value added quality and innovation to each area with their Mach III razor line, Duracell batteries, and Oral B toothbrush line that set them apart with quality name brand recognition. Company Strengths The firm has a strong brand name recognized internationally for quality. Their brand names allow them to charge a premium to generally recognized disposable products. Weaknesses Gillette has a narrow line of products that focus on general hygiene disposable products. They also primarily market towards men with lesser emphasis on their feminine brands. Synergies Procter and Gamble holds over 300 brand names world wide in over 160 countries. Their main strength is in marketing their products. The combined company with Gillette will offer a large benefit from marketing and management overlap. It will

also offer an expanded product line. Hence the end result will be more quality products for raised revenue at a lower cost. Company Valuation Steps in finding figures The underlying assumptions for any of the valuations requires measurements of the Risk-Free Rate, the companys correlation eta to the market, and the Market Risk Premium. These figures were found using the 10 year Treasury bond rate, a 3 year weekly correlation statistic to market return, and the difference between average market return for the last 10 years and the Treasury bond rate. This results in a final Required Rate of Return or Cost of Equity of about 6.8% Quick Valuation: Earnings Multiple Using three to five year Projected Earnings Method expectations for earnings Projected 3-5 year EPS: 2.45 and the earnings multiple Projected 3-5 year P/E: 27.5 ratio, a quick valuation Beta: 0.5 would make this company ROR = rRF + (MRP) = 6.8% worth just over $67. Discounted back, it results V = _(2.45*27.5)_ = 51.38 in a present value of about (1 + .068/4)4*4 $51, or about the same price that PG offered to pay for the company. Other Assumptions Cost of Debt was analyzed to have an averaged holding period of about five years, and the average yield on new debt for Dec 31, 2004 was about 4.11%. Base WACC was found taking the cost of equity and debt and

STUDENT INVESTMENT FUND

SIF

Patrick Chaffee California State University, Fresno May 23, 2005

associating them to average portions of each for the last ten years. The final value for the WACC was 6.2%. Free Cash Flow to the Firm Method In order to forecast cash flows for the next 10 years, it was assumed that Gillette has spent the last two years preparing for sale and polishing up earnings for an optimum selling price. The assumption was that the figures would drop one standard deviation in five years and level to the average for the terminal year 10. Forecasts were made as percentages of revenue to predict future components of cash flows. Terminal Value In order to obtain the Terminal Value, it was assumed that it would be equal to the projected Future Cash Flow to the Firm times the average Enterprise Value to Free Cash Flow to the Firm ratio. Enterprise value was derived from the shares outstanding multiplied by the price for each year, plus the value of debt and preferred shares minus cash and cash equivalents. The average value of 50 times FCFF was used and multiplied by the projected FCFF in year ten for the final terminal value

Total Value of the Firm Total value came from adding the present value of projected FCFF and terminal value for a total firm value of $55 billion, or $2 billion below what Procter and Gamble is paying for the firm. When debt is subtracted the value to the shareholders is around $52 or right at the point the shares jumped to upon the announcement of the purchase in late January. Valuation Value This valuation is only based on what Gillette is worth on its own. The extra few billion dollars can easily be accounted to the value of added synergies and expanded product line to Procter and Gamble. This valuation also has weaknesses in the assumptions of predicting revenues and expenses to the free cash flow to the firm. These include amateur assumptions that the company knew it was going to be sold and has worked for a premium in the last few years. The most important model for value of the combined company would be in combined distribution networks, lower operating and administration expenses to revenues, and lower competition from an expanded global market share. All of which are not measured very well off of a few financial statements alone, rather upon a qualitative merger analysis through deeper examination of the two firms.

STUDENT INVESTMENT FUND

SIF

Patrick Chaffee California State University, Fresno May 23, 2005

Spreadsheet Valuation o f Gillette (Dec 31, 2004)

t=0 2004A Total Revenue Revenue Growth Rate Operating income Cash Tax Rate Income Taxes NOPAT + Depreciation - Change In W C - Capital Expenditures +/- Change In OA Free Cash Flow W ACC Discount Factor Present Value NOI NOPAT Depreciation Change in W C Capital Expenditures Change in OA Free Cash Flow Risk-Free Rate Beta Levered (3yr) Equity Risk Premium Cost of Equity Cost of Debt (Before Tax) Cost of Debt (After Tax)
Capital Structure, % Equity

t=1 2005E 11,558,144 10.32% 2,297,444 31.70% 728,291 1,569,153 634,265 56,213 -670,594 91,357 1,385,253 6.21% 1.0621 1,304,253 22.25% 15.55% 5.49% 0.49% -5.80% 0.79% 11.99%

10,477,000 13.24% 2,465,000 29.07% 716,546 1,748,454 610,000 -127,000 -616,000 127,000 1,742,454 6.21%

23.53% 16.69% 5.82% -1.21% -5.88% 1.21% 16.63% 4.22% 0.493 5.30% 6.83% 4.11% 2.92% 84.10% 6.21%

t=3 t=4 t=5 t=6 2007E 2008E 2009E 2010E Panel A. Input for Present Value Calculations 12,413,222 12,968,947 13,170,708 12,990,869 13,015,566 7.40% 4.48% 1.56% -1.37% 0.19% 2,603,227 2,554,006 2,425,396 2,226,234 2,301,801 31.70% 31.70% 31.70% 31.70% 31.70% 825,224 809,621 768,852 705,717 729,672 1,778,002 1,744,384 1,656,544 1,520,517 1,572,129 639,644 624,875 590,517 538,977 564,282 271,215 503,638 735,182 945,798 730,614 -710,569 -732,313 -733,482 -713,382 -767,274 45,760 -6,890 -62,547 -116,485 -65,239 1,390,102 1,14 0,199 840,944 516,798 703,763 6.21% 6.21% 6.21% 6.21% 6.21% 1.1281 1.1981 1.2725 1.3516 1.4355 1,232,288 951,654 660,843 382,371 490,256 Panel B. Operating Relationships (% of Revenues) 20.97% 19.69% 18.42% 17.14% 17.68% 14.41% 13.27% 12.13% 10.99% 11.43% 5.15% 4.82% 4.48% 4.15% 4.34% 2.18% 3.88% 5.58% 7.28% 5.61% -5.72% -5.65% -5.57% -5.49% -5.90% 0.37% -0.05% -0.47% -0.90% -0.50% 11.20% 8.79% 6.38% 3.98% 5.41% Panel C. Valuation Calculations Terminal Value PV of Cash Flows, 2004-2013 PV of Terminal Value Marketable Securities Total Value of the Firm 85,897,877 8,051,548 47,022,996 0 55,074,544

t=2 2006E

t=7 2011E 13,242,775 1.75% 2,414,562 31.70% 765,418 1,649,145 598,838 522,597 -834,121 -14,013 905,278 6.21% 1.5247 593,761 18.23% 11.87% 4.52% 3.95% -6.30% -0.11% 6.84%

t=8 2012E 13,679,948 3.30% 2,569,248 31.70% 814,453 1,754,795 644,128 311,791 -916,874 39,618 1,130,639 6.21% 1.6193 698,211 18.78% 12.31% 4.71% 2.28% -6.70% 0.29% 8.26%

t=9 2013E 14,344,352 4.86% 2,772,648 31.70% 878,931 1,893,717 702,172 87,800 -1,019,303 98,264 1,390,522 6.21% 1.7199 808,487 19.33% 12.75% 4.90% 0.61% -7.11% 0.69% 9.69%

t=10 2014E 15,264,158 6.41% 3,034,098 31.70% 961,811 2,072,287 775,673 -161,039 -1,146,276 164,923 1,697,800 6.21% 1.8267 929,425 19.88% 13.19% 5.08% -1.06% -7.51% 1.08% 11.12%

Total Value of the Firm Value of Debt Value of Equity Shares Outstanding Intrinsic Share Price*

55,074,544 2,853,000 52,221,544 999,000 52.27

Base W ACC

*Value on 12/31/2004

STUDENT INVESTMENT FUND

SIF

Patrick Chaffee California State University, Fresno May 23, 2005

Sources
Mergent Online www.mergentonline.com Financial Statements (1990-2004) Yahoo! Finance finance.yahooo.com Historical quotes used to calculate beta and rate of return Valueline www.valueline.com Source of projected data Gillette www.gillette.com Investors relations and press releases Big Charts www.bigcharts.com Gillette stock charts