P&G's $57 Billion Bargain

At $57 billion, Procter & Gamble's (PG ) deal for Gillette (G ) is likely to stand as this year's biggest. Still, it comes with some big, big, freakingly big numbers: $460.4 million set to go to Gillette execs, $164.5 million for CEO Jim Kilts alone. Then, the banks: Goldman Sachs (GS ), Merrill Lynch (MER ), and UBS (UBS ) each will get $30 million -- plus expenses.

All of this assumes that the merger actually closes. Despite the strong possibility that regulators will impose some conditions -- divestment, perhaps, of overlapping toothbrush or dental floss lines -- a closing this fall is looking likely. On July 12, shareholders of each company approved the merger. So the issue for investors is rapidly turning from Gillette's diamond-studded golden parachutes to the value P&G is getting in return for the nearly 1.05 billion common shares it is set to pay Gillette shareholders. With that in mind, I've been focusing on three different sets of numbers, all of which to me add up to this: P&G stock looks like a bargain.

"As if" results. Suppose this deal instead had been done last year. What would sales and profit have been for the fiscal year P&G just ended on June 30? Its latest pro forma results, depicting how it would have fared had it already owned Gillette, stop at the nine months ended Mar. 31. Extrapolating, I figure the full fiscal 2005 would have produced pro forma sales of $66 billion and perhaps $9 billion in earnings. With 3.6 billion shares outstanding -- the number P&G expects when the deal closes -- and a recent share price of $54, that would give the merged company an equity value of $194 billion, or 21.6 times earnings.

How does that compare? Since 2000, P&G's price-earnings multiples have ranged from 20 to 41, according to Capital IQ, a unit of Standard & Poor's (MHP ). Competitor Colgate-Palmolive (L ) today gets 22 times earnings. Walk into Wal-Mart (WMT ), as I did the other day, and you'll see 14.75 ounces of Colgate Regular Shave Cream go for 94 cents, vs. $1.42 for just 11 ounces of Gillette Foamy Regular. For my wallet's sake, I'd take Colgate; for my portfolio, I'd get more for less with Gillette's future parent.

Synergies. The pro forma results don't include any benefit from potential cost savings or increases in revenue that P&G expects will come with the merger. The annual cost savings alone will run $1 billion to $1.2 billion before taxes three years after the merger, P&G estimates. That, plus fresh revenue by pushing Gillette products through P&G's better distribution channels in developing markets overseas, add up to a present value of $14 billion to $16 billion, according to P&G.

Second opinion. Synergies promised in mergers are often derided as so much pie in the sky. Yet some people think P&G's estimate of merger benefits is way low. Rajesh Aggarwal is a professor at the University of Minnesota's Carlson School of Management. He reviewed the deal for Massachusetts regulators, who are attacking it as unfair to investors in Boston-based Gillette. Using documents released by Gillette, Aggarwal calculated that the synergies are worth, in round figures, $19 billion to $29 billion.

As Aggarwal explained to me, "There's a huge amount of uncertainty in valuing any transaction. This is not an exact science" -- note the wide range in estimates. He added: "If P&G is able to successfully complete this transaction, they've gotten a great deal." And if Aggarwal is wrong? P&G still stands to benefit, only less so.

Finally, one more set of numbers in the proxy statement is worth noting. On unveiling the merger in January, P&G committed to repurchasing $18 billion to $22 billion worth of stock to offset some of what it will issue to close the deal. It's not waiting. Through mid-May, when the proxy was filed, P&G already had bought 51.4 million shares at an average cost I estimate at $53.75 a share. In other words, when P&G sees a bargain, it goes right ahead and grabs it.

By Robert Barker

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