MACR Assignment - 4

General Mills’ Acquisition of

Pillsbury from Diageo PLC

Group 5
Arpit Goyal | B19009
Lalit Tiwari | B19026
Ritwick | B19039
Course Faculty: A. Kanagaraj
Case Background
General Mills-US manufacturer
(Acquirer)
 Marketer of consumer foods as Breakfast cereals, Desserts,
Baking and dinner-mix products, snacks products and yoghurt
products.
 In 2000, Revenues : $7.5 billion || Market capitalization : $11
Billion.
 Major international expansions were through JV with Nestle
in cereals and PepsiCo in snacks products.
 Most of the businesses were in mature and low growth stage.
Background of Deal
 Motivation for the transaction for General mills: Fast
growth in business ||Diageo: Focus on its alcoholic-
beverages business.
 First offer of $10 billion was submitted by General Mills
in June 2000, which was countered at $10.5 billion and the
parties could not bridge the gap.
 Final terms of the trade were decided on July 16, 2000.
 GM’s shares fell by 8% but got back on track in August on
the news of positive financial performance of Pillsbury.
PillsBurry (Target)
 Marketer FMCG consumer foods as Dough, Baked goods,
Canned and frozen vegetables, Mexican foods, Progresso
soups, Frozen pizzas.
 In 2000, Revenue: $6.1 billion.
 Structured as independent company and was a part of Diageo
PLC. Diageo Business included alcoholic beverages, with
their major brands being, Smirnoff & Johnnie Walker, Fast
foods like Burger King and Pillsbury.
 Products were in category of high growth region.
Terms of proposed Transactions
Pillsbury Company will become a wholly owned subsidiary of GM. Acquisition was a
LBO with GM accepting $142 million of Pillsbury’s existing debt and take an
additional $5 billion, which Pillsbury would distribute as dividend to Diageo before
closing of transaction.
Valuations set at $10.5 billion with a contingent payout of $642 million to
be kept in an escrow account by Diageo to bridge the gap of $0.5 billion in
their valuations.
Contingent amount depend on average daily share price: If >$42.55, then $642
million || if < $ 38.00, then $0.45 mn || if in between $38 and $42.55, Diaego would
retain the amount by which $42.55 would exceed the share price by the number of
GM shares held by Diaego.
Swap agreed was that GM would issue 141 million shares to
Diageo shareholders, which would give Diageo 33% ownership
of General Mills.
Case Analysis- 1/3
Why are both the parties exploring proposed divesture
transaction?
For GM
As per BCG matrix, for sustainable growth companies
should have products in more than one category.
Currently GM has products which can generated stable
cash flows, but not growth rate is low. It might have
realized that its growth rate would dwindle further due
to saturated and mature market conditions.
Company has great logistical & distribution network,
which can be directly used for any existing product and
henceBackground of much
inorganic growth was Dealbetter to pursue than
greenfield expansion or cash repatriation
For Diageo
For Diageo, Pillsbury is a non-strategic asset and
divesting it could generate cash required for
investment while increasing focus on core
operations.
Why did GM opt for share swap transaction?
 Other options which could have explored include: -
1. Funding through Debt : GM already has high long-term debt
to equity ratio (in terms of book value) of 6.719. Further
increase could decrease the credit rating of the bonds. Further,
undervalued shares could also be due to market concern about
high D/E ratio and further worsening of the same could result in
higher discount being placed on company vis‑à‑vis its peers.
2. Funding through Equity: Issue of shares to existing
shareholders through right issue would be a way to fund the
transaction but shareholder’s willingness to do so need to be
tested. This approach carries high risk of failure & potential
delays and thus, should be avoided.
 This leaves GM with option of entering into stock merger
deal. Since deal size is as big as company itself and synergies
are contingent on various factors company could always put
part of consideration dependent on various considerations
and thus, realise better share swap deal based on agreed
milestones.
 Acquiring business of size of Pillsbury through debt funded
cash pay-out could be difficult to pull off.
Case Analysis- 2/3
Why did GM allow Pillsbury to pay one-off dividend to
Diageo before M&A deal, rather than paying themselves?
 Given that GM intends to keep Pillsbury as separate
corporate entity, they will maintain separate accounting
books and tax records. By ensuring that Debt sits on
books of Pillsbury, GM has ensured that tax liability
of Group is substantially reduced
 Tax arbitrage arising due to differential treatment of
capital gains vis-à-vis dividend income.
 Tax exemption on capital gains. In certain countries,
stock mergers are tax exempt events while paying even
single penny along with stock issue could lead to capital
gains accrual. By ensuring that no cash is paid directly
by GM, capital gains tax could be deferred till actual
sale of shares by GM.
 Reduced debt on GM’s books would also increase
confidence of current lenders and help it in maintaining
its credit rating intact.
Why were contingent claw-back provision inserted in
proposed transaction?
 Since, Diageo’s management was not willing to value shares of GM at
higher than market trade prices (42.55 Vs 38) and thus, there was
deadlock in the negotiations. Further, difference of around $0.5Bn in
Pillsbury valuation was another major of difference that couldn’t be
reconciled.
 Given that GM faced fund raising constraints and thus had to go for
either share swap deal or external equity issue, putting a clause in deal
whereby it could recover back the gain Diageo could realise if
undervaluation of GM shares is reduced and prices go up.
 Contingent claw-back clause would ensure that GM shareholders
gain from the appreciation of market prices towards intrinsic value
and not the other parties. It would also resolve Diageo’s concerns as
pay-out would need to be made only if they realise surplus price.
 It thus benefits existing GM shareholders the most as they would gain
around 2/3rd of money which would flow into GM in case of price
appreciation.
Case Analysis- 3/3

How Contingent Payout will help bridge gap in How are merger synergies and how much margin of
business valuation? safety is built in valuations of this transaction?
With Scholes Model, PV of contingent factor, came out to Fair Value of GM share 34.69 36.31 38 39.6 41.24 42.55 44.51 46.15
Shares issued (In Mn) 141 141 141 141 141 141 141 141
be $446 Mn, which is nearly equal to $500 Mn. Value delivered via share swap4891.29
(in Mn) 5119.71 5358 5583.6 5814.84 5999.55 6275.91 6507.15
Debt taken 5142 5142 5142 5142 5142 5142 5142 5142
Particulars Call_July Put_July Call_Oct Put_Oct Call_Jan Total consideration 10033.29 10261.71 10500 10725.6 10956.84 11141.55 11417.91 11649.15

14th Dec
Premium paid for acquisition at fair value (without considering synergies)
Date of option 19th July 2000 2000
DCF value of Pillsbury Fair value of GM Shares
Exercise price 35 35 40 40 45 34.69 36.31 38 39.6 41.24 42.55 44.51 46.15
Spot Price 35 35 35 35 39.9375 8400.00 19.44% 22.16% 25.00% 27.69% 30.44% 32.64% 35.93% 38.68%
Time period to 8800.57 14.01% 16.60% 19.31% 21.87% 24.50% 26.60% 29.74% 32.37%
expiry 3 3 94 94 37 9201.14 9.04% 11.53% 14.12% 16.57% 19.08% 21.09% 24.09% 26.61%
Value of option 0.25 0.375 0.5 5.375 0.5 9601.71 4.49% 6.87% 9.36% 11.71% 14.11% 16.04% 18.92% 21.32%
10002.29 0.31% 2.59% 4.98% 7.23% 9.54% 11.39% 14.15% 16.46%
Riskfree interest 10402.86 -3.55% -1.36% 0.93% 3.10% 5.33% 7.10% 9.76% 11.98%
rate 6.14% 6.14% 6.14% 6.14% 5.92%
10803.43 -7.13% -5.01% -2.81% -0.72% 1.42% 3.13% 5.69% 7.83%
Implied Volatility 0.1905 0.3032 0.2604 0.3503 0.387 11204.00 -10.45% -8.41% -6.28% -4.27% -2.21% -0.56% 1.91% 3.97%
Value of contigent payout per share (given computed SD of
0.25) 3.17 Premium paid for acquisition at fair value if we assign entire syngergies to Pillsbury business
DCF value of Pillsbury Fair value of GM Shares
34.69 36.31 38 39.6 41.24 42.55 44.51 46.15
PV of contingent pay-out payable 446
11300.00 -11.21% -9.19% -7.08% -5.08% -3.04% -1.40% 1.04% 3.09%
11714.29 -14.35% -12.40% -10.37% -8.44% -6.47% -4.89% -2.53% -0.56%
   
12128.57 -17.28% -15.39% -13.43% -11.57% -9.66% -8.14% -5.86% -3.95%
Value of contigent payout per share (given implied volatility of 12542.86 -20.01% -18.19% -16.29% -14.49% -12.64% -11.17% -8.97% -7.13%
0.26) 3.35 12957.14 -22.57% -20.80% -18.96% -17.22% -15.44% -14.01% -11.88% -10.09%
13371.43 -24.96% -23.26% -21.47% -19.79% -18.06% -16.68% -14.61% -12.88%
13785.71 -27.22% -25.56% -23.83% -22.20% -20.52% -19.18% -17.18% -15.50%
PV of contingent pay-out payable 14200.00 -29.34% -27.73% -26.06% -24.47% -22.84% -21.54% -19.59% -17.96%
  472
Recommendations

 Without considering Synergies: Since at the time of acquisition, GM shares were valued at $38/share and
Pillsbury was being valued at $10.5 Billion, we can see from the transaction that company would end up paying
significant premium if intrinsic value of GM shares are considered and thus, needed to add claw-back clause
whereby gains made by Diageo from price appreciation of GM shares would be paid back to GM.
 Considering Synergies: From previous table, it can be observed that GM has locked in considerable margin of
safety and could afford a decline in business performance , given that margin of safety doesn’t fall below 7% in
worst case and is 26% in best case scenario at current price of $38, transaction would definitely go on to benefit
existing shareholders.
 Given this, we opine that GM shareholders should ratify the transaction as it would go on to add to
shareholder’s wealth and would help company in achieving scale.