Diageo Spin off

1. What do you think about the capital structure policies Diageo has pursued in the past. Do they make sense? How does it compare to Diageo's competitors' policies? Which competitors would make for the best comparison?

Both Gand Metropolitan and Guinness plc had little debt prior to the merger, which allowed them to benefit from relatively high ratings on their bonds (AA and A respectively). Straight after the merger, Diageo's management informed that it would maintain similar policies to the ones adopted by the two previous companies. This decision took the form of an implicit promise not to get into a debt level that would lead to a reduction in the credit rating of the company. And another goal was to set a target EBITDA/Total Debt at 34% in year 2000. But having EBITDA at 34% means the company was either reducing its total debt thus not taking full advantage of its tax shield or increasing its EBITDA, which result in paying more taxes. This eased investors and financial markets and as a consequence the company was given an A+ rating by the credit agencies.

Looking at the same ratio, competitors' EBITDA/Total Debt ratios are higher compared to Diageo's (35% and above). This capital structure that Diageo had was considered to be very conservative compared to the same industry competitors.

Other companies that worked in the same line of industry as Diageo were the alcohol industry, Allied Domecq and Pernod Ricard, and the beer industry, Anheuser Busch, Carlsberg and Heineken. But the competitors that made a good comparison were Anheuser Busch, it has roughly similar market capitalization, $32,681 MM, as to Diageo had around $30,720 MM. And if the two companies were to be compared together; Anheuser Busch had 60% of EBITDA/Total Debt, which made this company more solvent compared to Diageo. Anheuser Busch also had higher ROA and ROE, 24% and 34.5% respectively.

2. Why is Diageo selling Pillsbury and spinning off Burger King? How might value be created through these transactions?

Firstly, by selling Pillsbury, Diageo gain a total of $10.5 billion, $5.1 billion in cash and $5.4 billion in 141 million shares of General Mills, worth of value. Secondly, Diageo will also gain cash from spun-off its fast food business – Burger King. Using this newly acquired cash, Diageo was trying to focus and expanding on solely on beverage alcohol business. By doing this, Diageo was creating room to grow. This continuous growth could be from organic growth within the company or from potential acquisitions. From the case, it was already apparent that Diageo was working on a joint bid with Pernod Ricard, Diageo's rival in alcohol business, for Seagrams. Also, Diageo's was projected to spend around GBP 400-500 million over 5 year span on its existing production facilities.

3. Based on the result of the simulation