Table of Content
2. The decisions to sell Pillsbury and list Burger King
2.1 Volatility of cash flows
2.2 Probability of financial distress
2.3 Increased valuation of Diageo
2.3.2 Cash flow
2.3.3 Increased leverage
3. Implicit assumptions of the Monte Carlo simulation
3.1 Capital expenditure
3.2 Investment in intangibles
3.3. Working Capital
3.4 Consistency between implicit and explicit assumptions
4. Description of the working of the simulation
5. The results of the simulation in comparison with Diageo's stated capital structure policy
6 5.1 Diageo's stated capital structure policy
5.2 The results of the Monte Carlo simulation
5.3 Increase in gearing for Diageo
When Grand Metropolitan plc and Guiness plc merged in 1997, they created Diageo plc, the seventh largest food and drink company in the world. With annual sales toping £13 billion and a market capitalization of almost £24 billion, Diageo was primed to become even more profitable, as the merger should help Diageo top the industry while also saving an estimated £290 million per year on overhead expenses and production and purchasing. Diageo was split into four business segments, the largest its Spirits and Wine business, holding the leading market share in the US and UK with revenues of £5 billion. With brand names like Smirnoff, Johnnie Walker, and Tanqueray the Spirits and Wine business had 15% operating margins and 15% growth of total operating profits. Guinness Brewing was Diageo’s second largest division, producing and selling beer around the globe. Diageo was merging Guinness Brewing with the Spirits and Wine business to save an estimated £130 million per year by integrating the distribution channels globally (Chacko and Tufano 2003, p. 1). Pillsbury, a leader in packaged foods, and Burger King, a fast-food restaurant chain, made up Diageo’s third and fourth business segments respectively, in terms of size. By 2000, Diageo was an underperforming stock relative to the broad market indices, and the new Group Chief Executive of Diageo declared a new strategy for Diageo moving forward. 2. The decisions to sell Pillsbury and list Burger King
There are several reasons why Diageo announced the divestitures of Pillsbury and Burger King. The main reason Diageo chose to sell Pillsbury and list Burger King was a change in business strategy, which would allow it to concentrate on its most important and profitable beverage alcohol business. The two divisions of Spirits and Wine and Guinness Brewing were the largest business segments of Diageo. Paul Walsh, the Group Chief Executive of Diageo, stated that he wanted to focus on “beverage alcohol, driving growth through innovation around our unrivalled portfolio of brands and providing an improved base for sustained profitable top line growth” (Chacko and Tufano 2003, p. 2). By eliminating the food segment from the portfolio, and focusing solely on beverage spirits, the company sought to achieve sustainable growth in the future, at higher rates than the 8% currently brought in by the Spirits and Wine business. Diageo’s strategy to focus on premium brands and pricing boosted their operating profit growth rate. With the sale of Pillsbury to General Mills, Diageo would bring in $5.1 billion in cash, plus an additional 141 million shares of newly issued General Mills stock; the approximate value of the additional shares was $5.4 billion (Chacko and Tufano 2003, p. 2). This situation benefited both General Mills and Diageo, as Diageo would now own 33% of the new General Mills/Pillsbury business and could still benefit from potential synergy effects from Pillsbury’s distribution networks. General Mills itself was valuated quite low, with a market to book ratio of -39.9 times (Chacko and Tufano 2003, p. 11). Assuming a higher valuation in future due to synergy...
References: Brealey, Richard, and Myers, Stewart, and Allen, Franklin. 2014. Principles of Corporate Finance (McGraw-Hill Education, UK).
Chacko, George, and Tufano, Peter. 2003. “Diageo plc” Harvard Business School.
Volkart, Rudolf, and Alexander F. Wagner. 2008. Corporate Finance: Grundlagen von Finanzierung und Investition (Versus Verlag, Zürich).
Please join StudyMode to read the full document