General Mills’

Acquisition of
Pillsbury
Nikita Gulgule (B19031)
Snehal Tiwari (B19031)
Anusha Sinha (B19068)
 Case Background
Target – Pillsbury by Diageo PLC Acquirer – General Mills, Inc.
Major Businesses – Major businesses –
• Refrigerated dough and baked goods • Big G cereals
• Green Giant brand - Canned and frozen vegetables • Betty Crocker desserts
• Old El Paso – Mexican foods • Baking and dinner-mix products
• Progresso – soups • Snack products
• Totino – Frozen pizzas • Yoplait and Colombo yogurts
Revenues - $6.1 bn in 2000 Market Capitalization - $11 bn and Revenue - $7.5 bn in 2000
Headquarter – Minneapolis, Minnesota Headquarter – Minneapolis, Minnesota
Earlier inorganic expansion – cereal joint venture with Nestle
Snack joint venture with Pepsico

Deal Conditions: Objective of the Deal:

• Pillsbury would borrow $5 bn and pay a special dividend • Potential growth and value creation identified in smaller
to Diageo & transaction costs amount to $55 mn acquisitions
• Diageo to pay General Mills $642 mn 1 year from the • Diageo wanted to sell in order to focus on beverage
transaction depending on the stock price business
• Transaction was deemed fairly priced by GIS • Pillsbury would complement General Mills’ existing
businesses
 Financial Problems
Risk of Excessive Debt Downgrade Risk for General Mills
 General mills would have to take on the existing debt of Pillsbury of $142  General Mills, increased leverage due to substantial increase in debt level could
million. In addition to this, they would have to take a debt of $5 billion to pay potentially harm the company’s ability to receive credit and also lead to hurting
as dividend to Diageo leading to $5,142 million in increased liabilities. the rating on their investment grade bond.
 General mills already has the second highest debt-to-equity ratio (12.05) as  The acquisition announcement could lead credit rating agencies like Moody’s
opposed to other comparable firms (industry avg. is 2). Since, the company putting ratings of General Mills under review as an addition of a debt over $5
already has a high D/E ratio it would have to raise additional debt at a higher billion in value will significantly affect the company’s debt protection measures.
cost. In addition to that, General Mills debt protection measures were already
 The increase in the liabilities could lead to a lead to increased cost of equity pressurized due to large dividends and share repurchase activity over last
as the shareholders now have to assume higher risks and thus, expect higher few years.
returns.  Therefore, chances of a review going against General Mills seemed high
 The firm also therefore has to weigh if the benefits from the lead are worth provided the situation. It is observed that when threats to a company’s ratings
taking on additional “Debt Load”. seem real, possible synergies emerging out of the acquisition become uncertain.

Limitations of CVR Terms & Conditions

 The Contingent value right (CVR) designed in the deal had a condition based on the minimum number of days the average share price was $42.55 or more. The
number of days finalized in the deal were only 20 in a whole year that is substantially small from both buyer’s perspective as well as seller’s perspective.
 Buyer could inflate the stock prices by using certain mechanisms like Stock splits just to increase stock value even though the company might be doing poorly.

Dilution of Control for General Mills Dilution of Earnings per Share

 Dilution of a company occurs when the value of existing investors’ shares is Earnings per share = Net Income - Dividends on Preferred Stocks
reduced in addition to their decreased ownership in the company. When Average outstanding shares
General Mills will offer 141 million new shares to shareholders of Pillsbury,  Since the company is creating additional number of common stocks, it would
shares of General Mills will become diluted. lead to an increase in the total number of shares and if the earnings are not
 Shareholders might not view dilution of their control in good light as their proportionate to the increase in shares, it would lead to a decrease in EPS.
ownership is being cut down which might arouse doubts regarding the  The EPS of the company is important because it is a key driver of share prices
decrease in the value of their company. and is frequently used as a denominator in the P/E ratio.
 In addition, if the acquisition goes through, Diageo would have a 33% control  A lower EPS ratio would lead to fall in the prices of the General Mills shares.
of shares within General Mills and hence a huge chunk of voting rights that This would adversely affect the company as it expects that the share prices
might provide them with advantage over the smaller shareholders of the would go up in the coming year and this is why the company has taken the
company might feel left out of the firm, route of contingent payment
 Analysis and Alternatives
Acquisition through CVR

As seen from analysis above, the NPV of synergies in terms of cost savings is $3.7 Billion.

 The deal provides opportunities to build

 synergies
 leveraging optimized efficiencies in sales
 marketing activities
 supply chain management
 human resource and administrative costs and production
 The cost that General Mills wants to pay is $10 Billion. However, Diageo wants a price  These synergies would lead to pre-tax savings till perpetuity, as
of $10.5 Billion for Pillsbury. compared to current operations of General Mills.
 General Mills wants to give away no more than 141 Million shares, which constituted  Cost of deal to General Mills after one year:
33% of the total shares outstanding. The shares of General Mills was trading currently
at $34-$37.
 Share price of 141 Mn shares + Transaction Cost ($55
 The value for 1.41 Million shares at this price was about $10 Billion. For the total price Mn) + Debt acquired ($5 Bn) - Clawback
of the deal to be $10.5 Billion, the share price needed to be $44 per share.

GIS Stock price above $42.55 GIS Stock price below $38 GIS Stock price between $38 to $42.55
 General Mills would be able to claim a value of $642
 General Mills would be underpaying for the deal. If  General Mills would be paying a value between $10 Bn
Million from the escrow account. Eventually, general mills
the price falls below $36 per share, they would be and $ 10.5 Bn.
would be paying a value of more than 10.4 Billion.
paying less than $10 Billion for the acquisition.  The deal would be priced between the price gap. Both
 This value is significantly higher than $10 Billion that they
 However, they would also be losing out on the $642 the parties would be satisfied.
wanted to pay. If the share price crosses $44, they would
Mn clawback amount. than $10.5 Billion, which was  General Mills would also be getting a clawback as per
be paying more than $10.5 Billion, which was demanded
demanded by Diageo. the share price.
by Diageo.
 Analysis and Alternatives
Contingent Valuation
Using a collar to enable the contingent value right (CVR). This instrument gives more confidence to the Pillsbury shareholders on General Mills
shareholders the downside is protected when prices fall.
This can be archived by creating a portfolio of options that would create a cap and a floor to the derivative. This can imitate the contingent
between Daigeo and General Mills. The underlying would be General Mills shares.
Implementing the following strategy can help the shareholders achieve a similar result to contingent
 The shareholders already sit on 141 million shares and hence are long on the GIS shares.
 They can write 141 million calls at the strike price of $42.55 per share.
 They can buy 141 million puts at the strike price of $38 per share.

The above table shows the way to find the value of put we
use the put call parity formulae

We have used the Black Scholes model to valuate these prices for the two call Thus the value of this contingent plan using derivatives
options at $42.55 and $38 as strike price respectively. would be close to $318 mn.
We have used historical volatility of 0.248 for calculations. The tables above show
the value of call prices at the two specified prices and 1-year maturity.
 Recommendations

For an investor who owns 141

mn shares of General Mills, this
Since General mills does not The firm should still consider
plan would cost around $318
want to issue more than 33% of making this move as the
mn. The escrow would cost
its shares, it should not allow stock prices of general mill
around $642 mn. Thus it
more stock repurchase increases, the value for General
makes more sense for General
since it can give the control to Mills out of this fund would
Mills investors to invest in the
DIagio shareholders. increase.
contingency value right
collar.
Thank
You!