General Mills’ Acquisition of Pillsbury from Diageo PLC
1. What are General Mills’ motives for this deal? Estimate the present value of the expected cost savings (synergies). In the spring of 1998 General Mills began studying areas where they could add to the company and advanced a strategy of acquisition-driven growth. General Mills has several motives for pursuing a deal to acquire Pillsbury. Pillsbury was identified as an ideal target due to its ability to complement General Mills’ other existing businesses and Diageo’s readiness to sell. The potential acquisition of Pillsbury would create value for shareholders by “accelerated sales and earnings growth…..through product innovation, channel expansion, international expansion, and productivity gains.” The addition of Pillsbury would lead to a more balanced product portfolio offered by General Mills and its existing businesses, and it the new company would be the fifth largest corporation by measure of global food sales. This diversification and growth allows General Mills to enter new markets and protect itself from losses by stabilizing its markets and adding new customers. The amount of General Mills shelf space will increase in stores, which allows greater flexibility to advertise products and adjust their products to the demands of the consumer. The company will have access to new markets both geographically and in new fast-growing areas of food sales. Supply chain improvements in sales, merchandising, marketing, and administration through the consolidation of Pillsbury and General Mills would create pre-tax savings that are estimated at $645 million through 2003. The acquisition would provide an array of new products that would allow General Mills to reach better economies of scope, which would create greater efficiencies in its COGS and SG&A. In terms of growth, the acquisition of Pillsbury would almost double the size of the company in terms of revenue. In 2000, General Mills had revenue of approximately $7.5 billion and Pillsbury had revenue of approximately $6.1 billion.
Estimate of Cost Savings (See Appendix)
In estimating the present value, we began by estimating the market return by using the 2-year annualized return of the S&P 500. We used the 2-year rate yield because the 1-year yield for the S&P was negative and the 5 and 10-year rate yields were exaggerated by the tech boom. We used a 10-year treasury yield for the risk free rate. For the cost of debt we used the prime rate of lending, the interest rate that banks would charge the most creditworthy, which was 9.50 percent on December 8, 2000 because General Mills had an investment grade credit rating. Next, we calculated the weight of debt and equity. Because we know that after the acquisition Diageo will own ⅓ of the General Mills we can multiply that by 3 to determine the total shares outstanding after the merger, which is 423 million shares. To find the market capitalization before the acquisition we subtract 141 million from 423 million and multiply by the stock value. We determined the stock value by using the 20-day average of GIS from November 10 to December 8, 2000, which was $40.296 per share.
We used General Mills’ market cap and long-term Debt-to-Equity ratio, which is 6.719 percent to calculate General Mills’ long-term debt. The weight of debt is, then,
Therefore, the weight of equity is
After the acquisition, General Mills will assume $5.142 billion in debt, which changes the weight of debt to 33.67 percent and weight of equity to 66.33 percent. Now that we have our discount rate of 8.27326% we can use excel to NPV the expected saving which are $25 million in 2001, $220 million in 2002, and $400 million in 2003 pretax. The after tax saving is $16.25 million, $143 million, and $260 million respectively. The pretax NPV of synergies is $525.89 million and after tax NPV of synergies is $341.83 million.
2. Why was the contingent value right (CVR) included...
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