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REV. AUGUST 6, 2003
Ian Cray, Diageo plc’s Treasurer, looked out of his office window onto the busy streets of London in October 2000. The London-based consumer goods company Diageo had recently announced its intention to sell its packaged food subsidiary, Pillsbury, to General Mills. Earlier in the year, Diageo also announced its intent to sell 20% of its Burger King subsidiary through an initial public offering during 2001, to be followed by a spin-off of the remainder of Burger King after December 2002. If these transactions took place, the firm would be focused exclusively on the beverage alcohol industry. As Diageo’s business was restructured, it was an opportune time to rethink its financing mix. On Cray’s desk lay a novel report by Ian Simpson, Diageo’s Director of Corporate Finance and Capital Markets, and Adrian Williams, the firm’s Treasury Research Manager. Their analysis sought to quantify the textbook characterization of the tradeoff between the costs and benefits of different gearing, or leverage, policies. Built around a simulation model of the future cash flows of the company, their analysis attempted to understand the tax benefits of higher gearing versus the likelihood and severity of costly financial distress. While the analysis was still rough at points, the concepts and implementation were intriguing. Now that Diageo was rethinking its financial policies, the model could prove useful. Simpson, Williams and Cray would soon meet to discuss its implications.
Diageo was formed in November 1997 from the merger of Grand Metropolitan plc and Guinness plc, two of the world’s leading consumer product companies. The newly-merged firm was the seventh largest food and drink company in the world with a market capitalization of nearly £24 billion and annual sales of over £13 billion to more than 140 countries. The merger was ostensibly motivated by the desire to become the industry leader and expected cost savings of nearly £290 million per year due to marketing synergies, reduction in head office and regional office overhead expenses, and production and purchasing efficiencies.
Some investors had been critical of the merger. One equity analyst, who judged that the firm would underperform the market, wrote “Diageo is creating an entity that fails to learn from all the mergers and acquisitions in other consumer areas that found portfolio strength does not work.”1 Separately, Bernard Arnault, the CEO of LVMH, a French luxury goods and drinks company, tried to scuttle the deal, and replace it with a three way merger that included LVMH while “demerging” Pillsbury and Burger King. Arnault, already the largest shareholder, doubled his stake to 11% of the combined stock, but failed to change the terms of the merger.
1 J. Wakely, A. Gowen, R. Newboult, F. Ramzan, “Diageo,” Lehman Brothers, November 21, 1997.
________________________________________________________________________________________________________________ Professors George Chacko and Peter Tufano and Research Associate Joshua Musher prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2001 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.
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