General Mills CVR Case Study
When the negotiations between General Mills and Diageo reached an impasse, neither company wanted to walk away from the negotiating table. However, both knew that they couldn’t return to their respective boards without a favorable deal. In order to reach an agreement, the companies challenged one another to put their money where their proverbial mouths were. The establishment of the Contingent Value Right allows General Mills and Diageo to disagree on Pillsbury’s value while splitting the difference between the companies’ range of disagreement.
By establishing a share price range in which the upper and lower bounds are equal to the share price values assigned by each company, and setting the payment equal to the value of the company one year from the date of the deal (the share price is calculated as a 20 day average to prevent tampering by either company), each set of managers can return to its respective board and argue that it received the desirable deal. In the circumstance that General Mills’ share price is $38 or above – a price that both companies agreed was fair – both companies are rewarded with a fair deal in which the consideration paid is equal to the share price. If General Mills’ share price falls below $38, Diageo will receive a $4.55 per share bonus as repayment for the fallen value of the shares it acquired. The payout chart of the CVR looks like this:
Payout (per share) GIS < $38 $38 < GIS < $42.55 $42.55 < GIS
General Mills $0 GIS-38 $4.55
Diageo $4.55 42.55-GIS $0
The valuation of the Contingent Value Right is fairly straightforward. It is simply an option spread between strike prices $38 and $42.55 with a minimum payment of $26 million. It is composed of 141MM long call options at strike price $38, 141MM short call options at strike price $42.55, and 26 MM long risk-free bonds. To value this portfolio one can use the Black-Scholes formula, solving with given knowns:
• Risk-free rate: 4.05%