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General Mills acquisition of Pillsbury from Diageo PLC

Prepared By:Rajat Kaul Indrakshi Pulkit Singhal Siddarth Kalra

General MillsHeadquartered in Golden Valley, Minnessota, US y Fortune 500 company, primarily concerned with food products Major brands: y Pillsbury y Green Giant y Old El Paso y Hagen-Dazsy

Case SummeryIn December 2000, the shareholders of General Mills were presented with a merger prospectus and proxy statement that outlined the terms by which General Mills would acquire Pillsbury from Diageo plc. Payment was composed of shares of General Mills stock, assumption of Pillsbury debt, and an unusual contingent payment. The task for the student is to assess and value the contingent payment in an effort to judge the attractiveness of the proposal and to recommend how shareholders should vote on the proposal. The contingent payment resembles a contingent value right (CVR), which provides downside protection to the sellers in an acquisition. CVRs can be modeled as two options: (1) a long put struck at a low stock price and (2) a short call struck at a higher stock price. The combination of a CVR with the underlying stock of the buyer transforms the payment to the seller from floating stock to a fixed collar. Student analysis can decompose the contingent payment into its two basic options and value the whole instrument. The teaching objectives of this case are: (1) to exercise student skills at identifying and valuing options, (2) to illustrate how the use of contingent payments can bridge differing views about the value of a target firm, and (3) to suggest the important role of synergy expectations in the evaluation of payment terms.

Topics that are covered to solve this casey y y y y y y y

Benefit of the acquisition Present value of cost savings Deal structure Contingent payment analysis Acquisition cost SWOT Analysis of General Mills SW Recommendation

Benefits of the Acquisitiony

Accelerate sales and earnings growth by acquiring Pillsbury > > > > Product Innovation International Expansion Channel Expansion Productivity Gains

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Combined product portfolio would be more balanced Combined firm would rank 5th in size among competitors based on food sales Cost savings

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Deal Structurey y y

Payment shares Assumption of Pillsbury's debt > Existing debt = $142m > New borrowing = $5billion Contingent payment by Diageo to General Mills

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Contingent Payment Analysisy

What is it? > "Claw-back" or "Contingent Value Right" >>Claw-back is previously given monies or benefits that are taken back due to specially arising circumstances. A retraction of stock prices or of the market in general. Purchasing certain investments provides taxable benefits contingent upon holding periods. When you sell these investments before they have maturity, the benefits must be returned. In Layman's terms, a fall in a stock price right after an increase is called a clawback of the price. > Reclaim some value for GM if the stock price more than $42.55 one year after the acquisition > Diageo will retain its share price if GM stock price drops in one year after the acquisition

Contd Contdy

What are the terms? > $642m if average daily share price for 20 days is greater than or equal to $42.55 > $0.45m if average daily share price for 20 days is less than or equal to $38 > Variable amount: Diageo will retain the amount by which $42.55 exceeds the daily price for 20 days

Contd Contdy

Why? > GM believes their shares are undervalued and the stock price will increase within one year > Diageo believes that the stock price will stay the same or decrease within one year > To bridge gap: GM and Diageo incorporate the contingent payment as described earlier

Contdy

Who benefits? > GM benefits because GM receives $642m in one year if the average daily share price is $42.55 or more > Diageo benefits because they will not lose value if the price drops

Contd Contdy

How does it work? >Buy and sell a put option at the same time

Acquisition Costy

Payment of shares, GM to issue 141m shares of common stock Assumption of $5.142B of Pillsbury's debt Transaction cost: $55m Contingent payment by Diageo to GM in 1 year

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SWOT Analysis of General MillsStrength Weakness Opportunity ThreatRecognizable name brand Investment grade bond rating Difficult times for domestic growth. Market saturation Pillsbury means a larger product portfolio domestically and internationally With Pillsbury they could realize operational efficiencies in areas such as supply chain and marketing Acquiring Pillsbury means assuming more debt could jeopardize bond rating Diageo could control 33% of their company Pillsbury deal means opportunity costs. Resources tied up in this acquisition for some time. Limits any new product lines or R&D opportunities. Strong competition from companies like Kraft and Sara Lee

SWOT Analysis of Diageo Market leader in beverage industry Strong financial positionStrength Weakness

Burger King and Pillsbury have been a drag on earnings

Pillsbury deal means opportunity costs. Resources tied up in acquisition for some time. Limits new product lines or R&D opportunities. Selling Pillsbury means less diversification and more risk

Opportunity

Threat

Pillsbury deal wipes $5 billion in debt off the books Pillsbury sales means 33% ownership in GM and allows influence of management decisions

Growth and Synergies for GM and PillsburyConsummating this deal would essentially double the size of GM. Pillsbury revenues in fiscal year 2000 were $6.1 billion and GM's were $7.5 billion. This would allow GM to gain much needed shelf space in grocery aisles and give them opportunities to maximize advertising. By integrating the Pillsbury's product lines with existing operations, GM could take advantage of synergies in administrative and production areas such as supply chain costs. Overlapping functions such as marketing could be combined and opportunities for staff and resource reduction could save costs while maintaining high levels of productivity. GM will be handling a much larger volume of materials and products and cost reduction opportunities in the supply chain could prove very beneficial. GM could negotiate lower costs with their partners or threaten to switch to other low cost vendors.

RecommendationCost savings create positive synergiesy

Total acquisition cost is somewhere between $10.555B and $11.196B With synergies, Pillsbury's value is estimated to be $11.3B - $14.2B per Evercore Partners and $11.836B - $13.489B per Merill Lynch

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