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In December 2000, the shareholders of General Mills were presented with a merger
prospectus and proxy statement that outlined the terms by which General Mills
would acquire Pillsbury from Diageo plc. Payment was composed of shares of
General Mills stock, assumption of Pillsbury debt, and an unusual contingent
payment. The task for the student is to assess and value the contingent payment in an
effort to judge the attractiveness of the proposal and to recommend how shareholders
should vote on the proposal.
The contingent payment resembles a contingent value right (CVR), which provides
downside protection to the sellers in an acquisition. CVRs can be modeled as two
options:
(1) a long put struck at a low stock price and
(2) a short call struck at a higher stock price.

The combination of a CVR with the underlying stock of the buyer transforms the
payment to the seller from floating stock to a fixed collar. Student analysis can
decompose the contingent payment into its two basic options and value the whole
instrument. The teaching objectives of this case are:
(1) to exercise student skills at identifying and valuing options,
(2) to illustrate how the use of contingent payments can bridge differing views about the
value of a target firm, and
(3) to suggest the important role of synergy expectations in the evaluation of payment
terms.
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R Payment shares

R Assumption of Pillsbury's debt

R > Existing debt = $142m

> New borrowing = $5billion

R Contingent payment by Diageo to General Mills

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R ÿhat is it?

> "Claw-back" or "Contingent Value Right"

>>Claw-back is previously given monies or benefits that are taken back due
to specially arising circumstances. A retraction of stock prices or of the market in
general. Purchasing certain investments provides taxable benefits contingent upon
holding periods. ÿhen you sell these investments before they have maturity,
the benefits must be returned. In Layman's terms, a fall in a stock price right after
an increase is called a clawback of the price.

> Reclaim some value for GM if the stock price more than $42.55 one year after
the acquisition

> Diageo will retain its share price if GM stock price drops in one year after the
acquisition
Contd|
Contd|
R ÿhat are the terms?

> $642m if average daily share price for 20 days is greater than or
equal to $42.55
> $0.45m if average daily share price for 20 days is less than or
equal to $38
> Variable amount: Diageo will retain the amount by which $42.55
exceeds the daily price for 20 days
Contd|
Contd|
R ÿhy?

> GM believes their shares are undervalued and the stock price
will increase within one year
> Diageo believes that the stock price will stay the same or
decrease within one year
> To bridge gap: GM and Diageo incorporate the contingent
payment as described earlier
Contd«
R ÿho benefits?

> GM benefits because GM receives $642m in one year if the

average daily share price is $42.55 or
more
> Diageo benefits because they will not lose value if the price drops
Contd|
Contd|
R %  %45

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Acquisition Cost

R Payment of shares, GM to issue 141m shares of

common stock

R Assumption of $5.142B of Pillsbury's debt

R Transaction cost: $55m

R Contingent payment by Diageo to GM in 1 year

 þ

   
 


  
Strength ÿeakness Opportunity Threat

Recognizable name Difficult times for Pillsbury means a larger Acquiring Pillsbury
brand domestic growth. product portfolio means assuming more
domestically and debt could jeopardize
Investment grade bond Market saturation internationally bond rating
rating
ÿith Pillsbury they could Diageo could control
realize operational 33% of their company
efficiencies in areas such Pillsbury deal means
as supply chain and opportunity costs.
marketing Resources tied up in this
acquisition for some
time. Limits any new
product lines or R&D
opportunities.

Strong competition from

companies like Kraft and
Sara Lee
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Growth and Synergies for GM and
Pillsbury
Consummating this deal would essentially double the size of GM.
Pillsbury revenues in fiscal year 2000 were $6.1 billion and GM's
were $7.5 billion. This would allow GM to gain much needed shelf
space in grocery aisles and give them opportunities to maximize
advertising. By integrating the Pillsbury's product lines with
existing operations, GM could take advantage of synergies in
administrative and production areas such as supply chain costs.
Overlapping functions such as marketing could be combined and
opportunities for staff and resource reduction could save costs while
maintaining high levels of productivity. GM will be handling a
much larger volume of materials and products and cost reduction
opportunities in the supply chain could prove very beneficial. GM
could negotiate lower costs with their partners or threaten to switch
to other low cost vendors.
Recommendation
Cost savings create positive synergies

R Total acquisition cost is somewhere between

$10.555B and $11.196B

R ÿith synergies, Pillsbury's value is estimated to be

$11.3B - $14.2B per Evercore Partners and
$11.836B - $13.489B per Merill Lynch