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The Cross-Border Acquisition of Pillsbury by Grand Metropolitan K. G. Viswanathan* Corporate Finance Review, Volume 1 Number 2, 1997 The 1989 acquisition of Pillsbury Company, a Minneapolis based corporation, by Grand Metropolitan PLC, based in London, is one of the largest cross-border acquisitions. The $5.76 billion deal was completed over a period of three months, beginning in October of 1988, during which the price of Pillsbury common stock shot up by about 70%. The initial bid was opposed by the management of Pillsbury Co., but the final revised bid was accepted by an overwhelming majority of the shareholders of the troubled target. Despite its efforts to find a white knight, Pillsbury was unable to find any other suitors, and its poison pill anti-takeover defense was struck down by a Delaware court, leading to the consummation of the deal. Grand Metropolitan PLC is a leading food and retailing company based in London. Its primary business operations are in food production and retailing, alcoholic and non-alcoholic beverages, pet foods, distribution, hotels and restaurants, and gaming clubs. At the time of the acquisition of Pillsbury Co., Grand met had total assets of $9.89 billion and annual sales of $10.23 billion. The target, Pillsbury Co., was engaged in three major areas -- consumer foods (including brand names such as Green Giant and Haagen-Dazs), restaurants (Burger King, Bennigans and Steak & Ale), and commodity marketing.. In 1988, Pillsbury had total assets of $3.84 billion and annual sales of $6.19 billion. Prior to the acquisition of Pillsbury in 1989, Grand Met had been acquiring companies in U.K. and continental Europe. The Pillsbury acquisition was the first major venture in the U.S. by Grand Met. All of the above and subsequent acquisitions by Grand Met were consistent with its strategy of building a global food and retailing empire. Its attractive offer to buy Pillsbury was motivated by the brands and brand names it was instantly acquiring. Grand Met preferred to buy these at a premium, instead of building its own, which would involve a long process and a high cost. The initial bid to buy Pillsbury Co., was made on October 3, 1988. The offer was for $5.17 billion or $60 per share of Pillsbury stock. Four days prior to that, Grand Met had sold its Inter-Continental Hotel chain for $2.3 billion. Immediately after the offer, Pillsburys management was exploring for alternatives to the Grand Met bid. It was considering selling its Burger King unit, going private in a leveraged buy-out, and acquiring shares of Grand Met with the help of another party. It also started legal action, which temporarily restrained Grand Met from acquiring shares of Pillsbury. During the following months, Grand Met sweetened its offers and extended them several times. On December 19, 1988, a Delaware court struck down Pillsburys poison pill anti-takeover defense, leading to Pillsbury Co. agreeing to be acquired by Grand Met for about $5.76 billion or $66 per share. The final price paid by Grand Met represented an earnings multiple of 31 based on Pillsburys earnings for the twelve months ending in May, 1988. While the primary motivation for the acquisition was its strategy to build a global food and retailing empire and the worldwide recognition of Pillsburys products, other factors motivated and facilitated Grand Met in its actions. One of the first things Grand Met did following the acquisition was to replace the senior management of the Burger King unit and overhaul its marketing strategy. The unit had been facing problems, and Grand Met felt that its value could be increased by installing new management. Another factor that facilitated the acquisition, and which made it difficult for Pillsbury to find a white knight, was the differential accounting treatment of goodwill in the U.S. and Britain, which favored acquisitions by British firms. The $5.76 billion acquisition by Grand Met amounted to a premium of about $4 billion over Pillsburys book value. U.S. accounting rules require firms to amortize goodwill (the premium paid ) over the next 40 years, resulting in a reduction in earnings each year. This would negatively impact the reported earnings per share, which is tied to management compensation and is closely watched by investors. The British accounting rules do not require that the goodwill reported from acquisitions be amortized. Instead, it can be charged against shareholder equity, which would reduce the equity and improve the return on equity. Firms also have the option of charging the goodwill over the various brand names acquired, without having to amortize them or deduct the shareholder equity. This accounting flexibility made it easier for Grand Met to pay a large premium for Pillsbury, and no U.S. bidders could compete with Grand Met. Selected Performance Measures of Grand Metropolitan 1987 1988 1989 1990 1991 1992 Operating Cash Flows / Sales (%) 12.1 12.7 12.6 14.0 14.9 14.9 Net Income / Sales (%) 5.84 6.82 5.63 6.95 7.70 8.09 Return on Equity (%) 18.9 16.3 16.0 21.9 18.7 17.6 Debt / Equity (%) 67.5 21.4 125.9 87.2 80.0 67.0 Earnings per share ($) 3.50 2.76 3.72 4.05 1.52 2.18 The above table shows selected performance measures of Grand Met prior to and after the acquisition of Pillsbury Co. The operating cash flows as a percentage of sales improved significantly in 1990, 1991 and 1992 compared to 1987, 1988 and 1989. The net profit margin also improved significantly after the acquisition, and has been rising since 1989. The return on equity improved considerably after the acquisition, but had deteriorated a little in 1991 and 1992. The same is true for its reported earnings per share. The debt-to-equity ratio was quite low in 1988, when the offer to buy Pillsbury was initiated. The high value in 1989 reflects the acquisition of Pillsbury in 1989. Subsequently, Grand Met reduced its debt-to-equity ratio to more acceptable levels. The higher debt capacity and improved performance measures are factors that Grand Met would have hoped for prior to the acquisition. On October 3 1988, prior to the acquisition announcement, Pillsburys common stock closed at $39 per share. The prices during the previous nine months ranged between $35 and $45. On October 4, the closing price was $57 per share. Subsequently, the price drifted upwards as Grand Met sweetened its offer and it became apparent that the acquisition would go through. On January 10 1989, when the acquisition was completed, Pillsbury stock closed at $66 per share. This represents an increase of 69.2% from the announcement of the initial bid to the completion of the acquisition. The $27 increase in price per share also represents an increase in value of $2.306 billion ($27 times the number of shares outstanding of 85,388,000). During that period, the S&P 500 index increased from 271.38 to 280.38, an increase of 3.32%. After adjusting for the changes in the market index, Pillsbury stock increased in price by an impressive 63.8%, and increased in value by about $2.15 billion. On October 3 1988, Grand Met shares closed at 486p per share or about $8.22 per share. On January 10 1989, it closed at 448p per share or about $7.85 per share, representing a decline of about 4.5% in dollar terms. This represents a loss in market value of about $318 million. This loss was accentuated by the increase in the FTSE 100 index from 1803 to 1836, an increase of 1.9%, during the acquisition completion period. Adjusting for the rise in the market index, the decline in the share price in dollar terms was about 6.3%, and the loss in market value was about $449 million. Consistent with the empirical literature on mergers, the acquisition of Pillsbury by Grand Met resulted in a net increase in market value of about $1.7 billion during the acquisition process. The shareholders of the target firm experienced increase in value, while the shareholders of the bidder experienced losses. However, in the long run, the performance of the bidder, Grand Met, appears to have improved considerably. * Dr. K. G. Viswanathan is an Associate Professor in the Department of Banking and Finance, Frank G. Zarb School of Business, Hofstra University. Dr. Viswanathan teaches courses in international finance, corporate finance and financial markets. His research interests include issues pertaining to firms listing on stock exchanges, cross-border bank mergers, and joint ventures.
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