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Gillette to Buy Duracell for $7 Billion

News

Gillette Co. announced on September 12 that it agreed to acquire Duracell International Inc. in a stock-for-stock transaction valued at more than $7 billion.

Analysis

Cash Flows
Once again the only relevant cash flows in the analysis of mergers, or capital budgeting in general, are incremental cash flows, which can be decomposed into

cash flow = operating cash flow - change in Net Working Capital - investment spending

Which Component Of Cash Flows Would The Following Impact?

Source 1
"Duracell, based in Bethel, Conn., is rolling out new products that could be exploited by the marketing experts at Gillette."

Answer: This would impact operating cash flows through an increase in revenue. Superior marketing tends to increase quantity sold and, with brand-name recognition, a company is able to charge higher prices.

Source 2
"A major plus is the potential for Gillette to use its distribution clout to increase Duracell sales abroad, where the battery maker isn't as strong as in the U.S."

Answer: An increase in sales would increase operating cash flow.

Source 3
"And he said cost-cutting, which will involve a $275 million restructuring charge in the fourth quarter, will reduce costs at the combined companies by between $80 million and $120 million a year by 1999."

 Answer: The $80 million to $120 million reduction in costs represents an incremental cash inflow due to cost savings; an increase in operating cash flows.

Source 4
"Mr. Zeien said the companies also use complementary research and development in such fields as forming metal and plastics and machine engineering. Mr. Zeien said the combined companies will be able to cut some overhead and distribution costs, but he said he doesn't expect reductions in direct sales or marketing."

 Answer: Research & Development costs are typically considered to be investment outlays since their benefits are accrued over more than a one-year period. Thus, this would be a savings, i.e., capital spending is negative. Using the above equation, we have:

- investment spending = - (- investment spending) = cash inflow

Does The Merger Make Sense?
For a merger to be successful, there needs to be some synergy between the two companies. Moreover, history has taught that the companies have to be operating in complementary or related businesses for any potential synergy to be realized. Companies that have diversified in unrelated businesses have not fared well, as evidenced by the increase in the number of corporate spin-offs.

The two companies in question are both technologically driven providers of consumer products that need to be frequently replaced. Thus, they have similar and complementary "competencies," a pre-requisite for a successful merger.

Financing
Holders of Duracell, whose biggest shareholder is New York buyout firm Kohlberg Kravis Roberts & Co., will receive 0.904 shares of Gillette for each share held, or $58.87 a share, based on Gillette's closing price on September 11. This translates to about a 20% premium.

Market Reaction
On the day of the announcement, Duracell's stock soared $9 a share, to $58.125, on the New York Stock Exchange. Gillette stock gained 87.5 cents, to $66 a share, signaling that investors believe that the merger does have the potential of creating value for its shareholders.

Corporate Background

Gillette, with a market value of $30 billion, is one of the nation's leading marketers of household products and includes well-known brands such as Sensor razors, Parker Pens, Oral-B oral products and Braun shavers. Its 1995 sales were $6.8 billion.

Duracell is the biggest producer of alkaline batteries world-wide with annual revenue of $2.3 billion. It has about a 50% share in the U.S. market for alkaline batteries, higher than No. 2 Eveready/Energizer, a unit of Ralston Purina Co., and the biggest maker of alkaline batteries. These batteries, which last longer than traditional zinc carbon ones, have already won the fight for consumers in the US, where they are estimated to account for about 85 per cent of all battery sales.

Sources: WSJ (September 12 and 13, 1996), Financial Times (September 13, 1996)

By Alex Tajirian