On December eight, 2000, administration at General Mills proposed a plan to acquire Pillsbury, a baked-goods producer. Pillsbury is currently controlled by Diageo PLC, one of many world’s main shopper items firms. The deal specifies that General Mills is to create and thus concern further shares of frequent inventory to Diageo in trade for complete ownership of the Pillsbury subsidiary. If the deal is executed, Diageo will turn into General Mills’ largest shareholder. The consideration to Diageo would come with 141 million shares of the company’s widespread inventory and the belief of .
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142 billion of Pillsbury debt, making the deal worth over $10 billion. In addition, the settlement will contain a contingency fee, as as a lot as $642 million of the total transaction value may be repaid to General Mills on the first anniversary of the closing, relying on its average stock price at the moment. In this report, we are going to calculate and analyze numerous costs and benefits associated with the transaction to determine whether or not or not General Mills’ shareholders ought to vote for the proposed acquisition.
If approved, General Mills will turn out to be the fifth largest meals company on the earth.
OVERVIEW OF GENERAL MILLS, INC
General Mills manufactures and markets branded client meals worldwide. It has a powerful presence in the United States, as it is the nation’s largest producer of yogurt and the second largest producer of ready-to-eat breakfast cereals. The company owns many product segments which are marketed beneath high-profile model names, similar to Betty Crocker, Yoplait, Cheerios, and Big G. Each of those businesses within the United States was mature and provided comparatively low organic development.
Because of this cause, the agency has pursued quite a few growth opportunities which have efficiently positioned General Mills as a market chief.
Its expansion efforts have proved profitable, as General Mills had annual revenues of about $7. 5 billion within the fiscal-year 2000. Although highly worthwhile, General Mills is facing elevated competitors in the food business, as rivals are consolidating and becoming harder to compete against. Therefore, General Mills should have the power to recognize and thus act on probably high-yielding investments that may permit the corporate to expand regardless of the slow-growth meals trade. Through a program of aggressive share repurchases within the 1990s, General Mills had increased its e-book value debt-to-equity ratio dramatically compared with its friends.
Despite this reality, General Mills still maintains an funding grade bond score from the ranking agencies.
OVERVIEW OF DIAGEO PLC AND PILLSBURY COMPANY
Diageo is doubtless one of the world’s leading client goods corporations fashioned in 1997 by way of the merger of GrandMet and Guinness. Its product portfolio consisted of prominent alcoholic-beverage brands corresponding to J;B, Johnnie Walker, Smirnoff, Gordon’s, Tanqueray, and Guinness as nicely as the Burger King fast meals chain and Pillsbury. Pillsbury is a baked goods firm that operates underneath Diageo. Pillsbury is certainly one of America’s best-recognized names within the meals trade.
Marketing its items under the popular Dough Boy character, Pillsbury has efficiently positioned its model and has created a longstanding platform for success in the food industry. The firm also controls several other high-profile manufacturers, similar to Green Giant, Old El Paso, and Progresso. Not too far behind General Mills, in 2000, Pillsbury generated annual revenues of $6. 1 billion.
OVERVIEW OF GENERAL MILLS’ ACQUISITION OF PILLSBURY
On December eight, 2000, administration of General Mills really helpful that its shareholders authorize the creation of more shares of common inventory in order to purchase Pillsbury.
The transaction between Pillsbury and General Mills will contain a stock-for-stock trade that may pay Diageo over $10 billion; 141 million shares of frequent stock along with the assumption of $5. 142 billion in debt. This debt figure contains Pillsbury’s existing debt of $142 million, together with $5 billion in new borrowings that might be distributed to Diageo in the form of a special dividend earlier than the deal is closed. After the transaction is accomplished, Diageo will own about 33% of General Mills’ excellent shares. If accredited, the transaction would result in Pillsbury working as a wholly-owned subsidiary of General Mills.
This essentially implies that Pillsbury is completely controlled by General Mills, as General Mills would personal 100 percent of Pillsbury’s stock. Diageo is primarily divesting its holding in Pillsbury in change for a substantial holding in General Mills. The transaction additionally features a rare contingency fee, which specifies that $642 million of the transaction price might be set aside by Diageo in an escrow account for one yr following the closing of the deal. If General Mills’ average inventory price is above $42. 55, Diageo is to transfer the $642 million again to General Mills.
If General Mills’ common stock price is beneath $38, Diageo will solely pay $450,000. If the stock price is between these two values, the escrow fund will be break up on a pro-rated foundation. It is essential to note that there are two main constraints involved with the transaction. First, General Mills doesn’t want Diageo to personal in extra of 33% of its inventory. Second, General Mills does not want to lose its investment-grade bond ranking.
GENERAL MILLS’ STRATEGIC MOTIVES FOR ACQUIRING PILLSBURY
Acquiring Pillsbury can provide General Mills with two main potential advantages. The first potential profit for acquiring Pillsbury is growth. The acquisition of Pillsbury provides General Mills the chance to double the dimensions of its empire. If the transaction is permitted, General Mills will become the fifth largest meals company in the world. By purchase Pillsbury, General Mills would create value for shareholders by offering opportunities for accelerated sales and earnings growth. These opportunities would be exploited through product innovation, channel expansion, worldwide growth, and productivity gains.
In addition to progress, the transaction would additionally create constructive synergies for General Mills through price savings. General Mills’ management is motivated to shut the deal because they imagine that the 2 firms will grow quicker collectively than both would alone. In different phrases, General Mills hopes to increase the worth of the combined enterprise by way of synergy, which is ready to profit Diageo as well as the other shareholders of General Mills. The acquisition should accelerate earnings extra shortly than if GM remains smaller and continues to focus solely on its core products.
If General Mills acquires Pillsbury, it will be able to mix the capital, assets, and know-how of each firms, leading to higher efficiencies and increased capability for future growth efforts. The transaction would additionally lead to at least $645 million in pretax savings between fiscal yr 2001 and 2003 ($25 million in fiscal 2001, $220 million in 2002, and $400 million in 2003). These financial savings are the results of provide chain enhancements, efficiencies in selling, merchandising, and marketing, as nicely as the streamlining of administrative activities.
The deal would be economically attractive if the benefit is greater than or equal to the value of the acquisition. In other word, the deal can be thought of economically attractive if: Value of Pillsbury + Synergies + Clawback Stock Paid + Debt Assumed If the profit is bigger than or equal to the value of the acquisition, worth shall be created for the shareholders. In different words, General Mills’ shareholders, which will embody Diageo, shall be benefit from the transaction.
VALUATION OF PILLSBURY (WITHOUT SYNERGIES)
Pillsbury was valued by both Evercore Partners and Merrill Lynch using three valuation strategies: comparable firms (LTM EBITDA and LTM EBIT), comparable transactions (LTM EBITDA and LTM EBIT), and discounted cash circulate (With and Without Synergies). Since synergies will be calculated individually in our dialogue, you will need to worth Pillsbury without synergies first (in different words, we need to find the value of Pillsbury by itself). The values that Evercore Partners and Merrill Lynch came up with are between $8. 4 billion and $13. 21.
For our evaluation, we will use these numbers as our estimated standalone value for Pillsbury with $8. 4 billon because the low value and $13. 21 as the excessive worth.
VALUE OF SYNERGIES (COST SYNERGIES)
If the transaction is accredited by shareholders, General Mills’ management staff believes that the deal would create price financial savings of $25 million, $220 million, and $400 million in 2001, 2002, and 2003 respectively. These financial savings are the outcomes of provide chain improvements, efficiencies in selling, merchandising, and marketing, in addition to the streamlining of administrative activities.
However, by way of optimistic synergies between General Mills and Pillsbury, we believe that the cost financial savings will last more than three years. Below is the discounted money move valuation of price synergies given the following assumptions: a. WACC = 9. 3% b. Annual Inflation = 2% c. Free Cash Flow Perpetual Growth Rate = 2. 5% d. Tax Rate = 40% Based on the evaluation above, the web present value of price synergies is about $3. 24 billion. This number could be very important thought of the valuation of Pillsbury itself is simply worth between $8. four billion and $13. 21 billion.
Synergies shall be an important consider our consideration after we provide our recommendations later in the report.
VALUE OF CLAWBACK
As a half of the settlement between General Mills and Diageo, a contingent payment clause is included within the transaction. The terms of this fee specify that up to $642 million of the whole transaction value may be repaid to General Mills at the first anniversary of the closing, relying on its average inventory worth for the 20 buying and selling days prior to that date. If General Mills’ common stock value is above $42. 55, Diageo is to transfer the $642 million again to General Mills.
If General Mills’ common inventory price is beneath $38, Diageo will solely pay $450,000. If the stock value is between these two values, the escrow fund shall be cut up on a pro-rated foundation. Exhibit 1 reveals the payoff diagram for this contingent fee. With the stock value on the x-axis and the payoff quantity on the y-axis, we’re able to present the payoff quantity (according to the phrases within the contingency plan) with respect to the worth of General Mills’ inventory. As shown within the graph, the payoff is flat at $450,000 when the inventory price is in between $0 and $38.
However, the payoff begins increasing when the inventory price is between $38 and $42. 55. The closer the stock worth comes to $42. fifty five, the upper the payoff quantity to General Mills. Once the stock worth reaches $42. 55, the payoff is flat again, as General Mills is to obtain a onerous and fast quantity of $642 million regardless of the worth enhance after it reaches the purpose of $42. 55. Some financial skilled called this contingent fee “claw-back” provision because it would reclaim some value for General Mills if its share value rose. This contingent plan serves an necessary objective on this transaction.
Since General Mills and Diageo had variations in opinions as regards to the worth of General Mills’ stock, the contingency cost serves as a “deal saver”. The whole transaction was about to disintegrate over a price disagreement. General Mills didn’t want to pay more than $10 billion, whereas Diageo didn’t wish to accept something less than $10. 5 billion. Therefore, the contingency cost established the “bridge the gap” in purchase worth. In addition, General Mills believes that its stock is undervalued, whereas Diageo believes the stock price will keep the same or decrease inside a 12 months.
In other words, General Mills thinks the stock is value greater than it’s trading for. It serves as a chance for General Mills to take benefit of its notion of the power of its stock. From General Mills’ viewpoint, the contingent cost is equal to a bull unfold: a long call with exercise worth of $38. 00 and a short call with train price of $42. fifty five. Using Black Scholes possibility pricing model, the evaluation under shows the worth for this combined position. From the analysis above, the present value of the contingent cost (Clawback) is between $195. 43 million and $331. sixty three million.
If the deal is approved by shareholders, Diageo will personal 141 million shares of General Mills’ widespread inventory. To decide the value of General Mills’ stock fee to Diageo, you will need to notice that General Mills’ board of directors permitted the merger in July of 2000 however General Mills’ executives did not ask the shareholders for creation of more shares of its frequent inventory till December of that year. Due to this reason, the typical stock value of July and December will be used to calculate the worth of General Mills’ inventory cost to Diageo. Using the typical price of the July inventory price ($35.50 per share), the worth of General Mills’ stock payment to Diageo is $5. 006 billion (141 million shares x $35. 50/share). Using the typical worth of the December stock value ($41. 00 per share), the worth of General Mills’ inventory cost to Diageo is $5. 781 billion (141 million shares x $41/share).
VALUE OF DEBT ASSUMED
If the deal is approved by shareholders, General Mills will tackle $5. 142 billion in new debt. This debt figure consists of Pillsbury’s existing debt of $142 million, along with $5 billion in new borrowings that will be distributed to Diageo in the form of a particular dividend before the deal is closed.
This is one of the components that shareholders should think about when making the decision as to whether or to not vote for the deal. It is essential to notice that General Mills have already got the next increase in debt to fairness ratio compared with its peers because of aggressive share repurchase back in the Nineties. General Mills could lose its investment grade bond score if it has an extreme quantity of debt on its balance sheet. Now that we’ve all the parts of costs and benefits for the acquisition, let’s put it all together to see if the acquisition of Pillsbury might be economically engaging to shareholder.
In different word, will the acquisition of Pillsbury create worth for shareholders? The desk below summarizes the costs and benefits of Pillsbury Acquisition. Based on the analysis above, the advantages for both low and high end of the acquisition are higher than the costs of the acquisition. Due to this cause, the acquisition of Pillsbury is economically attractive to each General Mills’ managements and shareholders.
RECOMMENDATION FOR GENERAL MILLS’ SHAREHOLDERS
Based on the fee and benefit analysis, the acquisition of Pillsbury is a promising investment. Acquiring Pillsbury can help General Mills create synergies via both income / incomes growth and value savings. One key data that each one shareholders should remember when making determination is synergies. As shown within the calculation above, synergies account for a big a half of the benefit facet of the acquisition. If shareholders vote for this deal, they are making an enormous guess on the creation of synergies between the two companies. If synergies can’t be created between the 2 firms, no worth will be created for the shareholders.