Grand Metropolitan PLC Essay

Company Background and Issues Grand Metropolitan PLC was a multinational holdings company that faced a hostile takeover threat in the late 1980’s and early 1990’s. The company specialized in wine and spirits. The headquarters for operation was in London, England at the time of this case. The major dilemma at hand is avoiding a takeover. The economy was bad at the time, and the company’s stock price was thought to be undervalued, as their low P/E ratio of 13.3 indicated. Management needs to find out why their stock price is so undervalued. A new strategy of Grand Metropolitan’s was to capitalizing brand value on the balance sheet. Another strategy of management was to divest in low growth areas and invest heavier in projects that meet a certain growth criteria. The CEO stated, â€Å"In addition to brewing, we have continued to exit those businesses whose failure potential earnings do not meet our growth criteria†¦ All those decisions were driven by a thorough analysis of income growth prospects†. Senior management is committed to reducing debt. In 1991 alone the debt to capital ratio fell by 9%. Management has shown to be committed to these goals into the future. One of the issues management will have to face is how to tell which business units are outperforming others. Despite the great performance of Grand Metropolitan as a company during the 1980’s, the stock was undervalued in the early 1990’s. This is the immediate issue management must address to avoid a takeover. Financial Analysis Cost of Capital: Our estimate of the pound-based weighted average cost of capital for Grand Metropolitan was 16.433862%. We used the weights from exhibit 6. The tax rate was given as 35%. We used the weighted average costs of debt and preferred stock from exhibit 7. We then discounted the flow of future dividends to find the cost of common equity. We also used the three strategic business units to find the approximate weighted average cost of capital for each unit. We found that WACC for Restaurant-Retailing came to 12.8876%. The WACC for Food Processing came to 12.12%. And the WACC for Drinks came to 11.5513%. We used exhibit 8 to find the average cost of equity and debt for the comparable companies in each business segment and forecasted it on to Grand Metropolitan. We noticed a high cost of equity for Grand Metropolitan. This comes at a time when the company is trying to reduce its debt. The cost of equity was found to be 16% in the U.S. and about 18% in Great Britain. Cost of Debt: To find our cost of debt we took the market value of debt to capital ratios for each segment, found on exhibit 8, for our weights. Our assumptions to find the cost of debt, since it was not explicitly given, were as follows; we used the bond ratings given under each segment, we then used the yields by rating category chart on exhibit 9 to find the appropriate rates and found an average of the ratings assigned for each segment. Now having found our weights and rates we are able to with the tax rate found within each segment find our cost of debt. Currency rate risk: Due to the diversity of markets that Grand Metropolitan operates within, the company is inherently exposed to currency conversation rate risk. The majority of the subsidiaries of Grand Metropolitan operate within the United Kingdom and the United States markets, which utilize the Great Britain Pound and the U.S. Dollar respectively. With Grand Metropolitan’s headquarters in London, England, they have a large number, 77%, of their Debt currency in U.S. dollars. We think this is due to their ability to access a much lower debt rate within the U.S. market, so they can finance their projects with the cheapest debt available. Market Analysis: Grand Metropolitan’s P/E ratio is noticeably lower when compared to the other companies within its segmented segments. We found that these low P/E ratios combined with increased profits made Grand Metropolitan a potential target for corporate raiders, i.e. takeover risk. RONA: During our analysis of individual segments, exhibit 2, we found that the RONAs for the Retailing and Food were lagging behind that of the Drinks segment. Furthermore, the Drinks segment only has 26% of total net assets, yet it provides 46% of operating profits. Comparing this to the Retailing segment, which utilizes 40% of net assets while only contributing 24% of the total profits, shows a great disparity. The Food segment represents 34% of net assets and 30% of the total profits. EVA: When calculating EVA, our early indications that Retailing was a drain on the company’s profits and growth were further confirmed. Retail had a negative EVA of -137.70. Drinks were clearly the main most efficient segment with an EVA of 135.83, and Food had a -44.04 EVA. We calculated these EVA’s using our segment WACC’s and using Net Assets as a measure of Capital. Tax Rates for each segment were given in exhibit 8, which were applied to operating profit for a NOPAT of each segment. These results show how mismanaged and inefficient the Retailing segment, and to a smaller degree the food segment are. Environmental Analysis: Strengths: The strength of Grand Metropolitan is its drink segment. The operating profit in the United States has been grown from $185 to $517. The UK and Ireland are using only 30% of net assets, but contribute 36% of the operating profit. Weaknesses: Retailing appears to be a weakness for Grand Metropolitan. The return on net assets and operating profit has been consistently lower than the other segments. The company’s capital structure is set up with a heavier than average amount of debt. Grand Metropolitan carries 43% debt to capital, while the average for comparable companies is between 28-34% depending on the segment. Opportunities: Grand Metropolitan has an opportunity to increase profits by investing in current successful brands. The brands that fall under drinks have proven to give the highest return on net assets. Recommendation: From our results we can conclude that the Retailing and Food segments are not adding value to the firm and are bringing down the value being added by the Drinks segment. While Food’s EVA of -44.04 isn’t nearly as bad as Retail’s -137.70, both are bringing down the company’s growth opportunities. These segments are either ripe for a selloff or restructuring. The food segment especially seems like it needs just a management change since it’s close to being positive EVA but return on net assets has dipped in the last few years, leading to the low EVA.