MERGER & RESTRUCTURING

Merger & Restructuring

Merger & Restructuring

Introduction

The purpose of this essay is to address three distinct questions using Diageo (DGE.L) as an example. I will discuss why and how companies raise finance and what are the advantages and disadvantages of that. I will then move to question two, and as Diageo raised finance via issuance of debt, I will try to identify how this impacted on the prices of Diageo's shares. Finally, I will discuss the theory of Capital Assets Pricing Model and use it to calculate Diageo's beta.

Discussion

Diageo was formed in 1997 by a merger of Guinness and GrandMet. Diageo produces and distributes some of the world most famous brands of spirits, beers and wines (www.diageo.com). Some of the brands under Diageo's umbrella include Guinness, Johnnie Walker whiskies, Smirnoff vodka and Baileys Original Irish Cream just to mention the few. The company operates in more than 180 countries and employees over 22,000 staff (www.diageo.com). Diageo is involved in every stage of their products' live cycle starting from production, distillation and brewing, through bottling and packaging finished beverages, up to distribution, sales and marketing (www.diageo.com).

Over the course of last ten years, Diageo issued number of bonds to raise capital. Due to the length constraints I will briefly mention only two of those. It is however vital to firstly look at why companies issue bonds or equity. To be able to carry on a business companies need capital. “Working capital is employed in the conduct of day to day operations while longer term finance is needed to undertake fixed capital formation, to finance expansion and to develop new processes or products” (Foley, 1991, p. 7). On a daily bases, a company will need to have sufficient money to pay its suppliers, pay rent for the properties it is using or pay employees salaries. But being able to pay for its immediate expenses is not enough in the long run. Company will also need capital to finance its expansion and future projects as “without a continuous process of regeneration firms will cease to progress and be unable to compete in a dynamic environment” (Arnold, 2008, p. 128).

There are number of ways companies can get funds. One of the most popular method is using internal finance by retaining profits. A company may also look outside its borders for capital by either asking bank for a loan, or raising cash from investors in exchange for financial claims that take the form of bond or equity (Foley, 1991, p. 6).

I will concentrate on these external sources and mainly on debt as Diageo seams to favour this method of raising capital.

According to Diageo's profile on the London Stock Exchange, in 2008 Diageo's debt/equity ratio increased to 2.06 from 1.43 in 2007 (LSE, 2009, p. 12). Therefore, Diageo had to issue substantial number of debt in 2008. As per company's announcement, on the 18th of April 2008 Diageo “reopened its €850 million, fixed rate 5 year bond” and the capital raised will be used to finance “general ...