Diageo Plc

Case: Diageo Plc Analysis
Fact Pattern
This is a strategic options case regarding Diageo PLC. Diageo is a conglomerate focusing on premium alcoholic beverages. Diageo is a United Kingdom based consumer product company. 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 company began with the mission to be the strongest premium alcoholic beverage producer worldwide. Diageo Plc. is 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. Although the largest and the fastest growing business was the Spirits and wine business, with sales growth of 8% for the year and 15% operating margins and growth in total operating profits of 15%. And the second largest division was Guinness Brewing, which produced and sold beer to markets around the world. And the Diageo was in the process of integrating the two business, which may result in cost reductions of ￡130 million annually. To that end, they have acquired a majority of premium brands in the spirits industry and a large portfolio of premium wines, while at the same time divesting itself of those companies not in line with its new goals.
Diageo’s two remaining business were in packaged and fast foods. As a matter of fact, the stock price of the company was far low from the average stock price after 7/1/99. In 2000, Diageo announced to sell its packaged food subsidiary to General Mills, and sell 20% of its burger king subsidiary through an initial public offering during 2001, and be followed by a spin-off of the remainder after 2002. With these actions, Diageo would concentrate solely on the beverage alcohol business. Meanwhile, Diageo needs to maintain its EBITDA/total debt at about 30% to 35%.Continued growth could come from organic growth, which might involve increase sales of existing products or product extensions. This process required 400-500 millions in the next five years. Growth could also come from acquisitions, but the amount that Diageo might need was virtually impossible to estimate with much certainty. This process required 6-8 billion in the next three years. What’s more, both Guinness and Grand Metropolitan used reasonably little debt to finance themselves prior to the creation of Diageo. When the companies merged, management chose to retain the policies of the merged companies. While Diageo could have increased its debt to A, because the strong debt rating afforded considerable benefits for Diageo in the capital markets, such as raising financing rate more readily and paid lower promised yields, and was able to access short-term commercial paper borrowings at attractive rates. All about these above make Diageo rethinking its financial policies, quantify the characterization of the tradeoff between the costs and benefits of different gearing, or leverage policies to make sure the firm’s financial policies provided enough flexibility to carry out Diageo’s core strategy, meanwhile, simulating the costs of financial distress.
 Diagnostics
At the very beginning let’s focus on the volatility of the different subsidiaries of Diageo. According to the Exhibit 7A volatility of Diageo’s spirits division was 2.3%, volatility of Diageo’s beer division was 3.0%, volatility of Diageo’s food division was 3.1%, and volatility of Diageo’s fast food division was 3.6%. And the both weighted average volatility of industry ROA was 1.9%. Comparing between these 4 divisions, spirits and beer divisions were more stable and profitable. According to the case spirits business was not only the largest segment of Diageo, but also the most profitable business with highest rate of growth. Beer business was the second largest with very close profitability and rate of growth. Diageo need to overcome financial distress through maintaining EBIT/interest higher than 1. Few things could be done to support the growth of the company.
First of all Diageo could think about getting rid of two of its subsidiaries, those who are gaining less profit although having higher volatility. As per the case action of selling food and fast food divisions would help Diageo restructure its capital structure and get some cash. By selling Pillsbury & Burger King, Diageo would get a big amount of money and throw away part of its debt.
Second, find ways to lift the stock price of the company. There were a couple of ways to lift the stock price. For example, Diageo could get rid of its divisions, like Pillsbury and Burger King, which were not performing well, or repurchase its outstanding stocks of the company. General Mills already offered a certain price to acquire Pillsbury. However, Burger King’ spin-off would gain Diageo an uncertain income in two years.
Finally through “Organic Growth” and “Potential Acquisition Diageo could increase growth of the company. To implement “Organic Growth”, Diageo should focus on its most profitable division, beverage, and invest more to develop it. To implement “Potential Acquisition”, Diageo could continue the joint bid for Seagrams, which was a very good deal, with Pernod Recard. Furthermore, there were still some other good deals available to make with the cost of huge amount of capital.
 Options
Option 1: As per analysis one option for Diageo Plc. is to sell its packaged food subsidiary called Pillsbury to General Mills and float the IPO for its Burger King subsidiary these will bring in $10.5 plus billion that can be spent for future acquisition of other firms and competitors.
Option 2: The other thing that Diageo Plc. can do is Retain all its business the alcohol business , packaged food and Burger King subsidiary and manage all the accounts and finance separately this will help Diageo’s Plc. look good in stock market just in case one of its subsidiary isn’t doing well that won’t necessarily affect Diageo Plc.’s financial health.
Option 3: This option suggest Diageo Plc. retain all its business just like option 2 but with a slight variation that. Now we know that Diageo has a good rating of AA it can retain its existing subsidiaries and at the same time raise fund easily for new acquisitions in future. According to the case Diageo could probably borrow 8 billion in 12 months, and this part of loan would not be taxed. If Diageo did so, the loan could be used to invest in beverage division or acquire other companies or do both. This investment required 400-500 million per year in five years, which meant that up to 2.5 billion would be required. Acquisition of Seagrams would spend 3-5 billion, which meant that up to 5 billion would be required, and then we still had about 500 million flexible to use. As a result, food and fast food divisions were still owned by Diageo and help the company gain some cash.
Option 4: Follow the stream and let the company run as it is. If Diageo remained the same situation so far and neither sold Pillsbury nor Burger King and also not integrated largest division, the spirits and wine business with the second largest division, Guinnes Brewing, Diageo’s stock price performance will have been lowering than scaled FTSE index. However, Paul Walsh’s new strategy is to drive the stock price growth. Therefore, this option is against the Paul Walsh’s strategy. Finally, this option cannot help the Diageo restructure. As far as I am concerned, this option should be abandoned.
 Recommendations
As per our detailed analysis of the case of Diageo Plc., the best thing to do for Diageo Plc. is to sell its packaged food subsidiary , Pillsbury, to General Mills and also sell the 20% share of Burger King subsidiary through IPO and sell the rest 80% after 2002 , Before we go further lets discuss what monetary value the above mentioned transaction will bring to Diageo Plc. , as per the case if Diageo Plc. sells Pillsbury to General Mills, Diageo Plc. will receive $5.1 billion in cash plus 141 million newly issued shares of General Mills stock which is currently valued at $5.4 billion which means Diageo Plc. will end up owning 33% of General Mills .
If transaction are done Diageo Plc. will be focused exclusively on the beverage alcohol industry, which is the firm’s core competency and it also means Diageo Plc. will have $10.5 billion from its Pillsbury sale and the fund raised from Burger King IPO at hand. Since Diageo Plc. is now solely concentrating on the alcohol and spirit business and has a large market share in this segment of the market can continue to grow and be the market leader , it can grow by either introducing new lines of product in the alcohol industry and it will be easy for Diageo Plc. as it will use its existing chain of distribution or with $10.5 billion at disposal it can go ahead and bid for acquisitions , we must remember here that bidding for acquisitions is possible now because Diageo Plc. decided to sell its food subsidiary , had it not sold them Diageo Plc. may have been in bad financial position to bid for acquisitions as it doesn’t have any liquid money to facilitate that kind of transactions. As we assume, this firm must keep the interest coverage ratio in 5-8. Then, from figure 2, we can see that cost of financial distress and tax paid ranges from 1800 million to 2100 million, if the coverage ratio is from 5 to 8. Therefore, we will have enough money to deal with the cost of financial distress and keep company’s flexibility in capital.
So as per our detailed analysis of the case we have come to the conclusion that Diageo Plc. should sell off its packaged food subsidiary and Burger King subsidiary and concentrate on its core business which is selling Alcohol beverage where the firms holds the biggest market share.