In depth analysis of the General Mills Acquisition of Pillsbury from Diageo

1. General Mills’
Acquisition of Pillsbury
from Diageo PLC
Lauren Sherlock
Jason Park
JP Zendman
12/9/2009

2. General Mills’ Acquisition of Pillsbury from Diageo PLC
Situation Analysis:
In December 2000, management at General Mills (GM) proposed a plan to acquire Pillsbury, a baked-
goods producer, in a stock-for-stock exchange. Pillsbury is currently controlled by Diageo PLC, one of the
world’s leading consumer–goods companies. The deal specifies that General Mills is to create and thus
issue additional shares of common stock to Diageo in exchange for complete ownership of the Pillsbury
subsidiary. If the deal is executed, Diageo will become General Mills’ largest shareholder. The
consideration to Diageo would include 141 million shares of the company's common stock and the
assumption of $5.142 billion of Pillsbury debt, making the deal worth over $10 billion. In addition, the
agreement will contain a contingency, as up to $642 million of the total transaction value may be repaid
to General Mills at the first anniversary of the closing, depending on its (20-day) average stock price at
that time. Therefore, we must calculate and thus analyze the various costs and savings associated with
the transaction to determine whether or not General Mills’ shareholders should vote for the proposed
merger. If approved, this will be the biggest takeover in GM’s 136 years of business and General Mills
will become the fifth largest food company in the world (Forster, 2002).
General Mills Company Profile:
General Mills manufactures and markets branded consumer foods worldwide. It has a strong presence
in the United States, as it is the nation’s largest producer of yogurt and the second largest producer of
ready-to-eat cereals (generalmills.com). General Mills has successfully tapped into international
markets, serving more than 100 countries around the globe. The company owns many product
segments that are marketed under high-profile brand names, such as Betty Crocker, Yoplait, Cheerios,
and Big G. The company has mature product lines and has pursued numerous expansion efforts that
have successfully positioned General Mills as a market leader. In fact, on average, US shoppers place at
least one General Mills product into their shopping cart each time they visit the grocery store
(generalmills.com). Its products are manufactured in 15 countries and are available in more than 100,
thus General Mills has capitalized on overseas expansion and has benefited from broad, efficient
distribution channels. Its expansion efforts have proved successful, as GM had annual revenues of about
$7.5 billion in the year 2000. Although highly profitable, GM is facing increased competition in the food
industry, as rivals are consolidating and becoming more difficult to compete against. Therefore, GM
must be able to recognize and thus act on potentially high-yielding investments that will allow the
company to expand despite the slow-growth food industry.
Diageo PLC/Pillsbury Company Profile:
Pillsbury is a baked goods company that operates under the parent organization, Diageo PLC. Diageo is a
London-based consumer-goods conglomerate that specializes in the manufacture of premium alcoholic
brands such as Smirnoff, Johnnie Walker, and Guinness. Its portfolio includes world-famous drink
brands, Burger King, and Pillsbury, a producer of refrigerated dough and baked goods. Pillsbury is one of
2|General Mills’ Acquisition of Pillsbury

3. America’s best-recognized names in the food industry. Marketing its goods under the popular Dough
Boy character, Pillsbury has successfully positioned its brand and has created a longstanding platform
for success in the food industry. The company also controls several other high-profile brands, such as
Green Giant, Old El Paso, and Progresso. Not too far behind General Mills, in 2000, Pillsbury generated
annual revenues of $6.1 billion. Although Pillsbury has shown a high potential for growth in the food
industry, Diageo PLC hopes to divest the company in order to focus more heavily on its core business –
manufacturing premium alcoholic beverages. In recent years, its beer and liquor businesses have been
strong performers, yet its Pillsbury and Burger King divisions have been a drag on earnings. Thus, a deal
with General Mills will allow Diageo to divest some of its unprofitable food assets and will also enable
Diageo to focus more heavily on its thriving alcohol business.
The Transaction:
As mentioned above, the transaction between Pillsbury and General Mills will involve a stock-for-stock
exchange that would pay Diageo over $10 billion; 141 million shares of common stock in addition to the
assumption of $5.142 billion in debt. This debt figure includes Pillsbury’s existing debt of $142 million,
along with $5 billion in new borrowings that will be distributed to Diageo in the form of a special
dividend before the deal is closed. After the transaction is completed, Diageo will own 33% of General
Mills’ outstanding shares. If approved, the merge would result in Pillsbury operating as a wholly-owned
subsidiary of General Mills. This essentially means that Pillsbury is completely controlled by GM, as GM
would own 100% of Pillsbury’s stock. If the transaction is executed, all of Pillsbury’s equity ownership
will be held by General Mills. Diageo is primarily divesting its holding in Pillsbury in exchange for a
substantial holding in General Mills.
The transaction also includes a rare contingency payment, which specifies that $642 million of the
transaction cost will be set aside by Diageo in an escrow account for one year following the closing of
the deal. If GM’s average stock price is above $42.55, Diageo is to transfer the $642 million back to
General Mills. If GM’s average stock price is below $38, Diageo will only pay $450,000. If the stock price
is between these two values, the escrow fund will be split on a pro-rated basis. This transaction clause is
rare because normally in deals involving a stock exchange, an adjustment occurs at the time the deal
closes, not a year later. It is our assumption that General Mills wanted a specific period of time to
achieve success with the transaction. This variable payment will be described in more detail later in the
report.
It is important to note that there are two main constraints involved with the transaction. First, General
Mills does not want Diageo to own in excess of 33% of its stock. Second, GM does not want to lose its
investment-grade bond rating of A-.
General Mills’ Strategic Motives:
Diversification: General Mills is motivated to acquire Pillsbury because it has a desire to grow and
expand. In order to remain a market leader and survive against heavy competitive forces, GM must
diversify its offerings and enlarge its product portfolio to reach new customers and tap into new,
thriving food markets. Powerhouse rivals such as Kellogg, Kraft, and Nestle continue to grow, leaving
3|General Mills’ Acquisition of Pillsbury

4. General Mills no choice but to increase its expansion efforts. By combing two large product portfolios,
GM will be able to stabilize earnings and reach more customers in more markets than ever before. In
essence, it will allow GM to break into new, fast-growing food categories that complement its existing
product portfolio. For example, unlike GM, Pillsbury has a strong presence in the food-service industry,
successfully serving restaurants, school cafeterias, and vending machines (Haeg, 2000). Pillsbury has
perfected its food-service approach and General Mills will be able to benefit from new customer
segments and increased distribution power. Thus, due to Pillsbury’s knowledge and expertise in the
food-service business, if the deal is approved, sales to restaurants will rise and GM will reap the benefits
of related portfolio expansion.
Growth: The acquisition also gives GM the opportunity to double the size of its empire. The larger
General Mills becomes, the more power it will possess in supermarket aisles. As retail giants such as
Target, Wal-Mart, and K-Mart aggressively add supermarkets to their stores, the added power is even
more beneficial. General Mills has the opportunity to gain more shelf space, which provides a platform
for new brands and product line extensions. Since General Mills excels in product development, it can
apply its skills to Pillsbury’s products and focus on creating new lines that reflect changing consumer
preferences. If the acquisition is approved, GM will have more than 30 brands with annual sales
exceeding $100 million (GM Annual Report, 2000). Hence, management is motivated to increase the size
and therefore value of its organization by acquiring more brands and more expertise.
Synergy: Generally, General Mills’ management is motivated to close the deal because they believe that
the two companies will grow faster together than either would alone. In other words, GM hopes to
increase the value of the combined enterprise through synergy, which will benefit Diageo as well as the
other shareholders of General Mills. The acquisition should accelerate earnings more quickly than if GM
remains smaller and continues to focus solely on its core products. This synergy is achieved through
newfound economies of scope and a reduction in competitive forces. If GM acquires Pillsbury, it will be
able to combine the capital, resources, and technology of both firms, resulting in greater efficiencies and
increased capacity for future expansion efforts. Since the products that GM and Pillsbury manufacture
are related, GM can allocate similar resources to the production of its own goods as well as the
production of Pillsbury goods. In other words, General Mills can reuse resources for both companies, as
well as buy them in larger quantities at lower rates. Most importantly, the acquisition will allow GM to
eliminate a major competitor in the industry. GM and Pillsbury have been longtime rivals; therefore
eliminating a main opponent will give GM more price flexibility and will also enable management to take
more risks with regards to product development and promotion. It will also give GM a heavier portion of
market share.
Stronger Global Presence: If General Mills acquires Pillsbury, a greater international presence will be
achieved. Pillsbury has a global focus and has mastered overseas expansion. By combining the two
companies, sales of General Mills’ brands in international markets will more than double and add almost
$1 billion in revenues from Pillsbury operations in Asia, Europe, and Latin America (Haeg, 2000). The
merger would also bring significant supply-chain improvements, as the consolidation of worldwide
activities will provide efficiencies in selling and marketing. By streamlining global production and
4|General Mills’ Acquisition of Pillsbury

5. administrative activities, General Mills is able to benefit from the efficiencies that the combined
enterprises create.
Industry Forces: Recently, the food industry has shown a consolidation trend which has resulted in
larger, more influential competitive forces. In order to keep pace with industry rivals, GM must also
expand in order to give itself more power over shelf space and pricing decisions. It is important to note
that the food industry is historically a low-growth sector. Thus, any opportunity to grow must be
initiated internally. Moreover, based on past financial statements, GM’s cereal division (its core
business) has shown declining sales. Since this is General Mills’ most profitable, promising division,
falling sales signal trouble in upcoming years. Therefore, if General Mills acquires Pillsbury, it is able to
drastically reduce its dependence on cereal sales and focus on more profitable divisions.
Cost Savings: To numerically illustrate the benefits associated with the acquisition, we calculated the
present value of the cost savings that would result from the acquisition. In order to compute this
number, we first had to determine the applicable interest rate to use. We agreed that WACC is the best
rate to use, as it is a reliable benchmark indicator.
Cost of Debt: We used the prime rate of 9.5% for the cost of debt, as this is the interest rate that banks
charge its most creditworthy customers. GM is considered a creditworthy company because it is
classified as a large cap organization.
Cost of Equity: To formulate the cost of equity, we used the CAPM model. We decided to use the
expected market rate of the S&P 500, as GM is a large cap company and the S&P 500 shows the average
performance of the top 500 large cap companies. We decided to use the 2-year annual return of 1999 &
2000. If we had used the 1, 5, or 10-year yields, we would have arrived at ludicrous expected returns.
For example, the 1-year rate yielded negative results, whereas the 5 and 10-year rates yielded results
that were too high to incorporate into our calculation. This is because the S&P Index experienced
significant growth between 1990 and 2000, which can formally be attributed to the dot-com bubble (see
chart below).
������������ = ������������ + ������ ������������ − ������������ = 5.74 + .65 11.94 − 5.74 = 9.735%
S&P 500
Weight of Debt & Equity: To determine the appropriate debt and equity weights, we used GM’s 20 day
average stock price on November 27, 2000, which was $40.43. We also know that General Mills is
offering Diageo 141 million shares for Pillsbury, which would make Diageo one of General Mills’ major
5|General Mills’ Acquisition of Pillsbury

6. shareholders. In fact, Diageo will own 1/3 of the total company. Therefore, we can calculate the total
number of shares that GM has outstanding.
141 ∗ 3 = 423 ������������������������������������������ ������������������������������������ ������������ .423 ������������������������������������������ ������������������������������������
423 – 141 = 282 million shares or .282 billion shares before issuing new shares
40.43 ∗ .282 = $11.4 ������������������������������������������
* $40.43 is the 20 day average price on November 27, 2000
As of November 27, 2000, General Mills’ estimated market capitalization is $11.4 billion.
GM’s long-term debt-to-equity ratio is estimated to be about 6.719%. Since we know both its long-term
debt-to-equity ratio as well as its estimated market capitalization, we can now determine how much
long-term debt General Mills has.
������ ������
. 06719 = =
������ 11.4
������ = .766 = 0.766 ������������������������������������������
By using its current market capitalization of $11.4 billion and its long term debt of $0.766 billion, the
weight of debt comes out to be 6.72%.
������ . 766
������������������������������������ ������������ ������������������������ = = = ������. ������%
������ 11.4 + .766
������ 11.4 − .766
������������������������������������ ������������ ������������������������������������ = = = ������������. ������%
������ 11.4 + .766
������ ������
������������������������ = ∗ ������������ + ∗ ������������ ∗ 1 − ������
������ ������
������������������������ = . 937 9.735 + . 63 ∗ 9.5 1 − .35
������������������������ = ������������. ������������%
With the additional $5.142 billion in debt, the WACC changes as follows:
������ . 766 + 5.142
������������������������������������ ������������ ������������������������ = = = ������������. ������������%
������ 12.17 + 5.142
������ 16.542 − 5.908
������������������������������������ ������������ ������������������������������������ = = = ������������. ������������%
������ 17.31
Modigliani & Miller Proposition II:
������
������������′ = ������������ + ������������ − ������������ 1 − ������
������
5.908
������������ ′ = 9.735 + 9.735 − 9.5 1 − .35 = ������. ������������%
10.634
6|General Mills’ Acquisition of Pillsbury

7. The cost of equity increased because General Mills is taking on more debt, thus its exposure to
bankruptcy subsequently increases. Due to this increased risk, investors will require a higher rate of
return (which can be seen in the new calculation for the cost of equity).
������ ������
������������������������ = ∗ ������������ + ∗ ������������ ∗ 1 − ������
������ ������
������������������������ = . 6143 9.82 + . 3413 ∗ 9.5 1 − .35
������������������������ = ������. ������������%
General Mills’ management team believes that if Pillsbury is acquired, it will attain pretax savings of $25
million, $220 million, and $400 million in 2000, 2001, and 2003 respectively. These savings will result
from supply chain improvements and greater efficiencies in selling, merchandising, and marketing its
goods. If we calculate the present value of these pretax savings, we will be able to give General Mills an
estimate of the cost savings it will likely incur.
Present Value of Pretax Savings:
Pretax Savings – Present Value Calculations
2001 $25 million
2002 $220 million
2003 $400 million
Total Pre-Tax cost savings
NPV(8.14,0,{25,220,400})= $527.55 million
Present Value of After-Tax Savings:
2001: $16.25 million
2002: $143 million
2003: $260 million
Total After-Tax Savings: NPV (8.14, 0,{16.25, 143, 260})= $342.90 million
Therefore, GM will have pretax cost savings of about $527.55 million or after tax cost savings of $342.9
million (using its 35% tax bracket).
However, through the synergies of General Mills and Pillsbury, we believe that the cost savings will last
longer than three years. For instance, through the acquisition, General Mills may cut down part of its
work force today to add to the cost savings. However, next year, General Mills is utilizing the savings
again, as they will not be hiring the work force it cut down last year. We believe that the cost savings will
last up to six years with savings of $400 million in 2004, 2005, and 2006. The calculations for the
terminal value are as follows:
Total Pre-Tax Cost Savings:
NPV (8.14,0,{25,220,400,400,400,400})= $1.341 billion
7|General Mills’ Acquisition of Pillsbury

8. Total After-Tax Cost Savings:
2001: $16.25 million
2002: $143 million
2003: $260 million
2004: $260 million
2005: $260 million
2006: $260 million
NPV (8.14,0,{16.25, 143, 260, 260, 260, 260})= $871.41 million
Terminal Value = $1.398 billion
N=6, I=8.44, PV=$859.58 million, FV= $1.398 billion
This is an estimate of our cost savings. Therefore, it is safe to say that our estimated after-tax cost
savings will fall between $342.9 million – $871.41 million.
Due to these figures, management at GM is extremely motivated to close the transaction.
Contingent Payment:
As part of the agreement between General Mills and Diageo, a contingent payment clause is included in
the transaction. The terms of this payment specify that up to $642 million of the total transaction value
may be repaid to General Mills at the first anniversary of the closing, depending on its average stock
price for the 20 trading days prior to that date. If the average price is $42.55 or above, General Mills will
receive the full $642 million disbursement. This is because Diageo has already earned a large enough
return on its GM stock holdings. Thus, it would have to pay back GM the full amount in the escrow fund.
The amount in the escrow fund is essentially the amount Diageo must earn on GM’s stock in order for
Diageo to be required to pay the full amount back to GM. The amount of the return is $4.55 per share,
which means GM’s stock price must rise to $42.55 in order for GM to get Diageo’s entire escrow fund
back. In this case, GM’s acquisition cost will only total $9.91 billion (see above).
However, from Diageo’s perspective, it will actually be receiving $10.5 billion (as GM’s stock appreciated
in value to $42.55/share). If General Mills’ stock price exceeds $42.55, Diageo will technically receive
more than $10.5 billion (as Diageo is a large owner of GM’s stock), depending on the actual value of the
stock. Diageo would not be affected by paying the escrow fund back to GM because it has earned at
least that amount in returns on GM’s stock.
If the stock price is $38.00 or less, General Mills will only receive $450,000 of the escrow fund and both
companies would incur a loss from the depreciating stock value. In other words, Diageo is agreeing to
this deal because it believes that GM’s stock price will fall post-acquisition. On the contrary, General
Mills believes that Pillsbury is undervalued if it could acquire it for less than $10 billion. By acquiring
Pillsbury, GM believes its stock price will increase over time through synergy.
8|General Mills’ Acquisition of Pillsbury

9. Purpose of Clawback Approach:
The last part of the contingent payment includes a clawback provision, which states that if the stock
price falls between $38.00 and $42.55, Diageo would keep the amount by which the stock price is below
$42.55 times the number of GM shares that Diageo has (141 million). According to this plan, if the stock
prices rises, the return that Diageo earns over $38 per share (multiplied by the number of shares), would
be equal to the partial amount of the escrow fund that Diageo must pay back to General Mills.
This contingent plan serves an important purpose. Since GM and Diageo had differences in opinions with
regards to the value of GM stock, the contingency payment serves as a “deal saver”. The entire
transaction was about to fall apart over a price disagreement. GM didn’t want to pay more than $10
billion, whereas Diageo didn’t want to accept anything less than $10.5 billion. Therefore, the
contingency was established the bridge the gap in purchase price. In addition, General Mills believes
that its stock is undervalued, whereas Diageo believes the stock price will stay the same or decrease
within a year. In other words, GM thinks the stock is worth more than it is trading for. It serves as an
opportunity for General Mills to take advantage of its perception of the strength of its stock.
In sum, the payment provides a guarantee that one party will benefit based on the movement of GM’s
stock price and allows both sides of the deal to value the stock differently. It essentially gives both sides
risk protection over the difference in stock price.
A Different Approach to the Contingent Payment:
While trying to determine the reasoning behind the $450,000 contingency payment, we discovered that
the 642 million dollar escrow fund is actually a rounded figure. To find the maximum amount that
Diageo is willing to pay General Mills in the event of a stock increase, we took the difference between
the high stock price ($42.55) and the low stock price ($38.00) to determine the cap amount that Diageo
is willing to give GM back ($4.55/share x 141 million shares = $641,550 million). In other words, if the
average 20-day stock price is above $42.55 per share, then Diageo would need to credit the $641.55
million back to GM. If the stock price dips below $38, Diageo will not have to pay General Mills anything,
as the difference between the two numbers is $450,000 ($642 million – $641,550 million). If the stock
price is between $38 and $42.55 per share, then Diageo would give the difference in amount back to
GM while keeping the rest of the original $641.55 million. Therefore, in reality, the amount in the
escrow fund is actually $641,550. In this case, the total acquisition cost would be the same (see below).
For the purpose of this paper, in the future, we will refer to the two accounts in the original way: $642
million and $450,000.
$42.55 − $38 = $4.55 ∗ 141,000,000 = $������������������. ������������ ������������������������������������������
$10.5 + $. 055 = $������������. ������������������ ������������������������������������������
$10.5 + $. 055 − $. 64155 = $������. ������������������������������ ������������������������������������������
The Clawback Feature:
9|General Mills’ Acquisition of Pillsbury

10. The attractiveness of the clawback feature is dependent on the actual outcome. If the stock price rises
(as GM believes it will), GM benefits because it is able to reclaim some of its value. In other words, the
closer the average stock price (over a 20 day period) is to $42.55, the more value GM can “clawback”
from Diageo. For example, if the average stock price amounts to $41, GM can reclaim about $423 million
of the escrow fund ($1.55x141 million shares – $642 million). However, if the average stock price is $39,
GM can only reclaim about $141 million. Thus, the more the stock price is above $38, the more value
General Mills can claim. This will increase GM’s value and make the deal much more profitable from
GM’s perspective. Although a stock price increase will force Diageo to pay General Mills more money
from the escrow fund, Diageo will also benefit if the stock price rises because it owns 33% of the
company. Therefore, Diageo has the potential to benefit from the accelerated growth and substantial
cost savings that the merger is expected to produce. However, if the average stock price drops, then
Diego will reap the benefits. The lower the average stock price is, the less Diageo will have to pay
General Mills. Of course, if it falls below $38/share, Diageo can retain $641.55 million. The agreement is
created so each party benefits based on their perception on the stock value. Since Diageo believes the
stock price will fall, it will benefit if it does in fact drop. Since General Mills feels the stock price will rise,
it will benefit if the company gains value. Either way, somebody benefits. The clawback feature is
designed so that if the stock price rises above $42.55, Diageo will earn $10.5 billion (or more) from the
acquisition and GM will only be paying ~$9.8 billion ($10.5 - $.641.55). In essence, both parties are
happy in this scenario.
Value of Contingent Payment in Early December 2000:
While brainstorming ways to determine the value of the contingent payment in early December, we
realized that different people have different thoughts with regards to what is considered “early”.
Therefore, in order to master accuracy and to accommodate people with different viewpoints, we have
formulated six different 20-day stock price scenarios to determine what the contingent payment is
worth in early December 2000 (depending on what the individual considers as “early”).
As of early December 2000, Diageo will retain between $232.16 and $248.02 million. By taking the
average, Diageo would retain about $240.17 million. This figure is most closely represented by the 20-
day average as of December 1, 2000. Diageo would still need to pay GM somewhere between $393.53
and $409.39 million. By taking the average, GM would receive approximately $401.38 million as of early
December. Please refer to Appendix B to see an entire list of the 20-day averages.
Hockey Stick Diagram:
In order to graphically illustrate the payout associated with the contingency plan, we created a hockey
stick diagram (please refer to Appendix A). With the stock price on the x-axis and the payoff amount on
the y-axis, we are able to show the payoff amount (according to the terms in the contingency plan) with
respect to the price of GM’s stock. As shown in the graph, the payoff is flat when the stock price is in
between $0 and $38. This is because the payout amount is fixed at this price level. Thus, if the stock
price is $38 or less, Diageo will pay a fixed amount of $450,000. However, the payoff begins increasing
when the stock price is between $38 and $42.55. This is attributed to the variable contingency payment.
10 | G e n e r a l M i l l s ’ A c q u i s i t i o n o f P i l l s b u r y

11. The closer the stock price comes to $42.55, the higher the payoff amount to General Mills. This is
graphically shown by the steep increase between $38 and $42.55. However, once the stock price
reaches $42.55, the payoff if flat again, as GM is to receive a fixed amount of $642 million regardless of
the price increase after it reaches the point of $42.55. Therefore, the lowest payoff amount is $450,000
(between $0 and $38) and the highest payoff amount is $642 million ($42.55 and above).
Acquisition Cost:
The total cost to acquire Pillsbury is estimated to be $9.91 billion, assuming that GM’s stock price will
reach or exceed $42.55 one year after the transaction date. Please note that there are transaction costs
of $55 million that GM is responsible to pay.
General Mills for Pillsbury: $10.5 + $. 055 − $. 642 = ������. ������������ ������������������������������������������
Diageo: $10.5 − $. 642 + $. 642 = $������������. ������ ������������������������������������������
GM is issuing Diageo 141 million shares of common stock valued at a per share price of $38 (141 million
shares x $38 = $5.358 billion). GM will also be assuming $5.142 billion worth of Pillsbury’s debt.
Together, the net value of the exchange totals about $10.5 billion ($5.358 + $5.142 = $10.5 billion).
However, according to the variable clause, GM has the opportunity to earn back $642 million of the total
transaction value. Hence, if the stock price rises above $42.55, GM will reduce its purchase price by $642
million.
Diageo will be receiving an amount of General Mills’ common stock (141 million shares) that will give it a
33% ownership share of GM. These shares, as stated above, are valued at $38 per share. Diageo will also
have the opportunity to take all of Pillsbury’s debt ($5.142 billion) off of its books. Of the $10.5 billion
exchange, Diageo, according to the contingent payment clause in the acquisition contract, must set
aside about $642 million in an escrow fund for potential repayment back to General Mills.
Benefits of the Transaction: General Mills’ Perspective
Geographic Efficiencies: From General Mills’ perspective, this transaction has the potential to add a
significant amount of value to the organization. Through the acquisition, General Mills has the
opportunity to accelerate sales and earnings growth through product innovation and various
productivity gains. Marketing and distributing the products together will yield huge benefits for General
Mills in both the short and long term. The two companies know each other well and basically “grew up
together”, as they were both headquartered in Minneapolis, Minnesota for many years. They have
strong ties to the local community and served as competitive hometown rivals. Both companies
emerged in the flour milling business and have similar corporate cultures, strategic objectives,
ambitions, and long-term goals. Since Pillsbury has been under Diageo’s control in London for the past
ten years, the merger will bring full control of the company back to the United States and provide
sustainable geographical benefits for GM. Thus, the arrangement will bring Pillsbury’s management back
to its home state of Minnesota, and the close proximities of GM and Pillsbury’s headquarters will
provide geographic efficiencies that will make the integration process much more manageable.
11 | G e n e r a l M i l l s ’ A c q u i s i t i o n o f P i l l s b u r y

12. Related Diversification/Product Compatibility: The acquisition can benefit General Mills because the
two companies offer similar, premium-priced products that are perceived by consumers as premier
brands. It will allow General Mills to sharpen its product focus and build a giant food portfolio after
years of unsuccessful diversification efforts. For example, in previous years, General Mills gained control
over Eddie Bauer and Talbots (clothing retailers), Parker Brothers (board games), and Red Lobster and
Olive Garden (chain restaurants). These business units were not in line with the core competencies and
strategic objectives of General Mills and the random acquisitions lacked a clear, strategic focus.
Therefore, if General Mills desires to expand its offerings through an acquisition, it is most beneficial to
unite with an organization that has similar products, technology, and production systems. The merger
with Pillsbury will provide General Mills with a more balanced product portfolio and will allow the
company to concentrate on what it does best – food manufacturing. For example, General Mills’ Betty
Crocker brand can be marketed and distributed alongside Diageo’s Pillsbury brand. Both brands
complement each other and can provide various efficiency gains such as cost reductions through
economies of scope and economies of scale. On the other end of the deal, the acquisition will also allow
Diageo to sharpen its product focus. As mentioned above, Diageo is in the alcoholic beverage industry.
By selling its Pillsbury division, it can focus on perfecting its core business and can allocate more funds
towards expanding and marketing its higher-margin alcohol sector.
Transaction Benefits: The acquisition also gives General Mills opportunities to save costs. As stated
above, management at General Mills can expect pre-tax cost savings of over $500 million within just a
three-year time period. These are significant savings considering the magnitude of the transaction.
Another benefit of the deal is the fact that the $5 billion “special dividend” paid to Diageo is financed
through debt instead of equity. Debt is a cheaper source of financing than equity is and interest
payments are tax-deductable. Therefore, since the $5 billion dividend was financed through debt rather
than through stock or cash, GM can enjoy a less expensive form of financing. The transaction is also
beneficial because General Mills doesn’t have to lose more than 33% of its ownership through the
issuance of more shares. Lastly, due to the contingency payment, GM can possibly benefit because it has
the chance to earn $642 million of the total transaction value back one year from now.
Benefit from Diageo’s Perspective:
The Pillsbury acquisition is mostly paid for in the form of stock (stock-for-stock exchange), therefore, for
tax purposes, it is treated as an exchange rather than a sale. This means that the transaction is
considered a nontaxable offer, thus Diageo is able to avoid a substantial capital gains tax. In a
nontaxable deal, target shareholders who receive shares of the acquiring company’s stock do not have
to pay any taxes at the time of the merger; they only have to pay taxes when they sell their stock in the
acquiring company. This is beneficial from Diageo’s point of view because it can postpone the payment
of capital gains tax. Furthermore, since Diageo is a large GM shareholder, it will benefit from synergistic
gains produced by the merger.
Costs of the Deal:
12 | G e n e r a l M i l l s ’ A c q u i s i t i o n o f P i l l s b u r y

13. Increased Interest Payments: Although there are many benefits that can be achieved through the
acquisition, there are also significant costs associated with the transaction that General Mills must
address before decisions are finalized. First and foremost, General Mills will experience a substantial
increase in debt. If it acquires Pillsbury, its debt level will double. Currently, GM has $3.7 billion in debt.
If the acquisition is approved by shareholders, its debt level will soar to over $8.5 billion. This increased
leverage has the potential to harm General Mills’ ability to receive credit and will also hurt its
investment-grade bond rating. Fixed costs will soar, as its interest payments (due to the incremental
debt it must take on to finance the acquisition) will double. Moreover, fixed asset spending must
increase to support the additional businesses and its fixed coverage and cash flow to debt ratios will
decline in the short run. In sum, GM’s bottom line will be negatively affected, as the costs associated
with just Pillsbury’s debt is substantial.
Configuration Costs: The Pillsbury acquisition brings uncertainty with regards to regulatory processes,
integration problems, failure to achieve synergies, and inexperience with new business lines. General
Mills must combine selling organizations, merge payrolls, and reconfigure manufacturing facilities. All of
these procedures are expensive and lengthy, thus it must anticipate increased costs and adjust its
processes to accommodate for the organizational changes. In sum, integrating the two companies' sales
and marketing forces is costly, as well as ensuring that Pillsbury’s product lines fit with the rest of GM’s
portfolio.
Inheritance of Declining Product Lines: General Mills must also be concerned with the financial
performance of Pillsbury and the costs associated with its declining business units. While certain
Pillsbury product lines have been profitable in recent years, others have been declining. For example, its
canned vegetables and frozen products have experienced significant sales drops in recent years (Forster,
2001). General Mills must ensure that Pillsbury’s “deadweight” product lines are eliminated in order to
avoid the excessive costs of reconfiguring. Furthermore, the transaction is expected to reduce the
strength in General Mills’ earnings until the fiscal year of 2004. If earnings fall, its stock price is likely to
decline and financial statements will reflect poorly on the company. Also, with double the amount of
product lines, General Mills will become more vulnerable to rising costs, such as labor rates and
commodity prices. Generally, the cost of doing business increases as the size of the organization
increases.
Opportunity Costs: One of the most substantial costs associated with this transaction is not as obvious
and measurable as the preceding costs. In this case, opportunity costs serve as a major drawback to the
deal. As GM performs the lengthy task of synergizing the two companies, it is foregoing other major
opportunities in which its time and resources could be better spent. For example, new product launches
and various line extensions may slow as GM smoothes out the operation. It may not be able to allocate
the necessary resources to marketing and advertising campaigns, and management will be more
focused on synergizing the two companies than improving the top line of the business. Therefore, the
company is foregoing major opportunities in order to accommodate the organizational changes that the
acquisition brings to the table.
13 | G e n e r a l M i l l s ’ A c q u i s i t i o n o f P i l l s b u r y

14. Transaction Costs: General Mills may also have to slow its share repurchase activity to offset higher
costs associated with the higher level of debt. Furthermore, due to the sizable increase in number of
shares outstanding, General Mills will not experience growth in its earnings per share ratio for a
significant amount of time. Finally, the deal has transaction costs of $55 million that General Mills must
pay when acquiring Pillsbury.
Overall, General Mills must ensure that these costs are mitigated and controlled before it enters into the
agreement.
Ethical Issues:
Job Losses: If the deal is approved, General Mills will most likely lay off hundreds – even thousands – of
Pillsbury employees. After most takeovers, some managers of the acquired companies lose their jobs (or
at least their autonomy). Since both companies are headquartered in the Twin Cities, job layoffs are
more probable and the local community is likely to react negatively. After all, General Mills and Pillsbury
have both been headquartered in Minneapolis, Minnesota for many years. Hence, they both have strong
ties to the community and many Pillsbury employees have been there for years. In some situations, one
family in Minnesota works for General Mills, while the other works for Pillsbury. Therefore, layoffs will
directly affect GM’s local community and will possibly taint its reputation through the eyes of local
stakeholders.
Consumer Harm: GM and Pillsbury are both giant food manufacturers. Thus, the market concentration
post-merger will be drastically different. If GM acquires Pillsbury, competition will be severely reduced
and will likely result in higher prices charged to consumers. The transaction creates competitive
problems because the number of competitors in the market is directly reduced. This suggests potential
consumer harm because GM is already one of the largest packaged food companies in the world.
Therefore, by acquiring Pillsbury, GM will become the third largest food company in North America
which will ultimately result in more market power and thus higher prices. Currently, GM and Pillsbury
are direct competitors. If the merger is approved by shareholders, GM must ensure that the competitive
advantages that the combined company gains will not cause unfair advantages within the open market.
Unfair advantages would lead to greater market power, which would ultimately harm consumers in the
form of higher prices.
Our Decision: Is this Deal Economically Attractive to General Mills Shareholders?
This deal is absolutely economically attractive from the viewpoint of General Mills’ shareholders. The
acquisition is expected to produce pre-tax cost savings of $527.55 million. This indicates that there is
positive synergy between General Mills and Pillsbury. Based on the analyses by Meryl Lynch and
Evercore Partners, Pillsbury is worth between $11.836 - $13.489 billion and $11.3 - $14.2 billion
respectively. Thus, acquiring Pillsbury will add a significant amount of value to General Mills.
Furthermore, since General Mills strongly believes that its stock price will rise post-acquisition, the stock
price at GM may rise well above $42.55/share, thus increasing GM’s value further (will gain back
$641.55 million).
14 | G e n e r a l M i l l s ’ A c q u i s i t i o n o f P i l l s b u r y

15. Final Thoughts: Shareholders’ Key Bet
If the deal is approved, General Mills stockholders must bet on the GM stock price rising to $42.55 or
(hopefully) above. If we were stockholders at General Mills, we would closely monitor the post-
acquisition stock price, which represents the markets belief about the value created by the merger. As
shareholders, we would also observe (post-merger) organizational practices to ensure that GM is doing
everything it can to successfully synergize the two companies.
In addition, the shareholders will want to look closely at the 10Q reports to see how General Mills is
performing on a quarterly basis. Shareholders can determine if Pillsbury actually contributed to revenue
increases and if it helped achieve cost savings through economies of scale. The 10Q is a quarterly report
of a company’s performance issued to the SEC. In the 10Q, General Mills is required to disclose any
relevant information that may pertain to their financial position. The 10Q is publicly available to all
shareholders. Shareholders should also look at the 10K, which is a summary of the company’s financial
performance for the fiscal year.
Shareholders should also participate in conference calls post-acquisition. On average, most publicly
traded companies offers about four conference calls per year. In a conference call, shareholders and
others can call in over the phone to hear management’s perspective on the company’s financial results
as well as its overall performance (e.g. earnings and revenue projections). The financial statements give
shareholders an idea as to how the company has performed in the past. However, the projections show
how the company is doing currently and also show managements outlook on future performance.
During the conference call, shareholders have the opportunity to ask questions to management
regarding the company’s financial performance. In the case of General Mills, shareholders can ask about
how the increase in its debt structure is affecting General Mills performance compared to previous
years.
Overall, acquiring Pillsbury is a promising investment from GM’s perspective. Based on our analysis, the
benefits of the transaction outweigh the costs, as GM is likely to enjoy synergistic gains for many years
to come.
15 | G e n e r a l M i l l s ’ A c q u i s i t i o n o f P i l l s b u r y

16. Works Cited:
Forster, Julie. "General Malaise at General Mills." Business Week 01 Jul 2001: 1 Dec 2009.
<http://www.businessweek.com/magazine/content/02_26/b3789081.htm>.
General Mills 2000 Annual Report
General Mills 2001 Annual Report
Haeg, Andrew. "General Mills Acquires Pillsbury." MPR 17 Jul 2000: 1 Dec 2009.
<http://news.minnesota.publicradio.org/features/200007/17_haega_gmills/>.
Group Meeting Times:
Our group has met literally every day since last Wednesday, December 2nd (including Saturday and
Sunday). We typically met for about three hours per day. All group members were present.
16 | G e n e r a l M i l l s ’ A c q u i s i t i o n o f P i l l s b u r y

17. Appendix A
17 | G e n e r a l M i l l s ’ A c q u i s i t i o n o f P i l l s b u r y