Case 3 Report - 1208 2056

ACY 5903A Financial Management Group 3
1 INTRODUCTION
Grand Metropolitan Plc
Grand Metropolitan Plc (GrandMet) is the world’s largest wine and spirits seller. With a
total sales of GBP8.75 billion (in 1991), the company ranked among Britain’s 10 largest
companies.
Company Background
GrandMet was founded in the late 1940s as the Washington Group, a chain of hotels
established by Sir Maxwell Joseph. In 1957, with the acquisition of the Mount Royal Hotel,
the company changed its name to Mount Royal Ltd. In 1962, the company renamed again to
Grand Metropolitan Hotels.
As the name told us, the company was concentrated on hotel businesses at its early time.
However, by a series of acquisitions of different companies, GrandMet started to diversify into
non-hotel businesses since 1966.
Learnt from GrandMet’s historical information, acquisition and divestiture seemed to be the
company’s major activities during 1960s to 1980s. Especially in 1980s, the company was
highly involved in buying and selling with huge capital gains (e.g. GrandMet bought
Intercontinental Hotels for $500 million and sold for $2 billion later).
Development of Core Businesses
Some companies, e.g. Watney (the owner of International Distillers & Vintners), Pillsbury (the
owner of Burger King & Haagen-Dazs), etc. acquired by GrandMet have been eventually
developed as the group’s core businesses.
In 1991-92, GrandMet had even divested all of its hotels, breweries, gaming establishments,
soft-drink bottling plants, fitness products, and all food brands that were judged not to have
international branding potential. As a result, the company sold off close to GBP800 million in
Case: Grand Metropolitan Plc P. 1 of 10

businesses in order to focus on core activities: food, drinks, and retailing.
Strategic Core Competence
With the strategy of focusing on the company’s core competence - management of
international brands in food, drinks, and retailing, GrandMet founded itself successfully beat
the market forecasts in 1991 with a 4.8% increase in pretax profits (GBP963 million) despite
during world recession time.
Three Strategic Business Units (SBU)
Currently, GrandMet acted as a pure holding company for a group of SBUs that were widely
diversified both geographically and in terms of products. The three major operating divisions
are foods, drinks, and retailing. Please refer to Appendix 1 for their distribution of the
group’s trading profit. The major markets of the group are US, UK, and Europe. Please refer
to Appendix 2 for the percentage of turnover contributed by the group’s different market
regions.
GrandMet Stock Exchange
GrandMet’s shares were listed on the London stock exchange and New York stock exchange
(NYSE). However, NYSE was not trading actual shares, instead, the trading was in the form
of “rights” to shares held in trust, called American Depositary Receipts (ADRs). The majority
of shareholders for the group were still in UK.
Financial Strategy
In December 1991, the CEO of the group set the objectives: build brands, cut costs, develop
products, all within the framework of total quality. From the financial point of view, there
were three financial strategies include 1) capitalize brand value, 2) increase interest coverage,

and 3) dispose of products that do not provide an adequate return to support the group’s
operational principles.
Therefore, the group’s financial objectives would be reducing financial leverage (e.g. the
group had successfully fallen its ratio of debt / capital by 9% so that the interest-coverage ratio
had risen from 4.8 times to 6.6 times in 1991); and only investing in projects meeting growth
criteria, which also means that the group would continue to exit businesses if its future
potential earnings do not meet the growth (a 20.5% per year compound growth rate in pretax
profits has been generated during 1987-91 fiscal years).
2 PROBLEMS FACED BY THE GROUP
The group was faced two problems, they were 1) the PE ratio of GrandMet shares in New
York is 10% below the average ratio of the Standard & Poor’s company; 2) there was a
circulation of rumor that GrandMet may be a takeover target.
To address the problems, the group had to evaluate its performance. Had the entire group as
well as all their SBUs performed badly? Were the group’s financial objectives consistent with
the creation of value? Were all segments of the group’s business portfolio performing equally
well? Might one or two of them be targeted for aggressive restructuring?
3 FOUR ANALYZING APPROACHES
In order to find out the underlying cause(s) of the problems and provide recommendations, we
will go through the following analysis:
1) Financial Analysis: with the given financial statements, we will evaluate the group’s
financial performance in view of its position in profitability, liquidity, efficiency and
leverage.
2) Valuation Analysis (DDM): to explain why the group has a low PE ratio, we calculate

the intrinsic value of the group’s share according to the Dividend Discount Model (DDM)
model and then compare it with the market value.
3) Corporate and Segment Analysis (WACC): to evaluate the performance of the group, we
calculate the weighted-average cost of capital for the group as a whole, and also
according to the group’s segments.
4) Geographic Market Analysis: besides analyzing the SBU’s performance at approach
above, we have also done a brief analysis based on the information provided for the
geographic markets.
4 FINDINGS AND RECOMMENDATIONS
1) Financial Analysis
From the financial analysis, we have the following findings:
a. Profitability
The turnover was slightly decreased by 7% from 9,394m/FY90 to 8,748m/FY91, however, the
gross profit margin (GPM) and net profit margin (NPM) were significantly improved from
13.6%/FY90 to 14.6%/FY91 and 6.8%/FY90 to 7.6%/FY91 respectively (Appendix 3). It
was mainly attributed to the lower cost of purchase and lower debt policy, which GrandMet
could enjoy lower interest expenses. Increasing NPM was also a result of sharp increase in the
profit margin from the drink’s segment (form 15.8%/FY90 to 18.7%).
There were a slightly increased in ROA (from 6.8%/FY90 to 7.6%/FY91) and ROE
(7.0%/FY90 to 7.7%/FY91), referring to Appendix 4,which was not only due to the
increased in retained profit but also lower total asset after disposing ~ GBP800m business
segments. (Those were mainly related to the retailing business). Better ROA also was a result
of out-performance in GrandMet’s drinks segment, especially after acquiring two drink-related
companies: Remy Martin-Cointreau and Anglo Espanola de Distribution. The performance of
drinks segment was also outperforming comparing to Food and Retails segments. (In FY91,

RONA of Drinks/Food/Retails: 19.2%/9.8%/6.6%).
b. Liquidity: Stable
No significant change in the current and quick ratios was shown between FY90 and FY91.
(Appendix 5)
c. Efficiency: deteriorating
A sharp decline in the inventory turnover was found. (fr 38 times/FY90 to 9 times/FY91).
d. Leverage: improving
A jump in D/A ratio from 0.41x/ FY88 to 0.69 FY89 was shown after acquisition of Pillsbury
Co (i.e. A Minneapolis-based corporation incorporated in US). (Appendix 6 & 7)
To sum up, We found that the existing asset-allocation in the three segments (Drink, Food and
Retails) and also the debt-policy did not maximize GrandMet’s profitability and return on
asset, provided that:
- Misallocation of assets to the three segments appeared which distorted GrandMet’s
optimal profitability. Since the Drinks segment was out-performed in operating profit
margin and RONA comparing to the Food and Retails segments.
- The increase proportion of ROE was restricted by having high interest coverage ratio
supporting by the principal of Dupont analysis. In which, Dupont System suggests there is
an inverse relationship between ROE and debt leverage.
2) DDM Calculation
Appendix 8 shows the calculation of GrandMet’s intrinsic value which is equal to ₤9.81, in
which constant dividend growth and dividend policy are assumed. Compare to the market
value (₤9.48), the stock is obviously undervalued. Historically, the group had involved highly
in acquisition activities in 1980s. It is a common phenomenon for the stock price to fall on the

bidder side and this resulted in a low P/E ratio.
3) WACC Calculation
WACC analysis is used as the assessment tool to accept or rejecting company projects/
business segment. In our analysis, company level WACC is calculated to determine the
company overall’s cost of capital. After that, we find that the company level WACC is not
enough to assess the performance of the business segment in Grand Metro but only to the
overall company performance (company overall RONA). After that we also calculate the
segment level WACC (to compare with the individual RONA) so as to find out the
underperformed sectors.
Before the calculation, we have made some assumptions on the model:
a. They are similar in financial & operating leverage among the competitors in the same
industry.
b. There is no segmentation between US & UK market with the assumption of correlation
between return in US & UK market equals to 1.
Beta in ₤ = Beta in $ x 1.4
c. There are no currency risk and interest risk as they are assumed to be perfectly eliminated
by hedging.
Company level WACC
The calculated company level WACC (in accordance to the cost of the financing component –
debt, preferred stock, convertible bond, equity) is 12.99%.
The weighted average debt component is calculated in accordance to the existing debt
financing situation in the company. On the other hand, the weighted average equity component
is computed by the CAPM model Please refer to Appendix 9 for the detailed calculation
The company level WACC is not appropriate to compare different segments’ performance with
the assumption of similar operational risk in each segment component. Hence, segment WACC

is formed out.
Segment WACC
To find out the segment WACC, some industry information (i.e. cost of equity: average beta,
risk free rate, market premium; cost of debt: average credit rating & respective cost of fund;
average D/A ratio in Appendix 10-12) are gathered to formulate the result as follows:
It is formed that only the drinks industry is outperformed and the other 2 industries (Retails &
Food). Further investigation should be taken to improve the situation. Please refer to
Appendix 13 for detailed calculation.
4) Geographic Market Analysis
By cost and benefit analysis, we can find out the outperformed region to be the core
developing business.
To assess the benefit, we have to select RONA & profit margin as our assessment tools
(Appendix 14):
It is found that UK should be the best efficient of asset utilization in terms of RONA among
UK, US & Europe markets. Meanwhile the profit margins among these 3 regions are similar,
while both UK and Europe show a higher RONA from 1989 to 1991 comparing with US.
The expectation of borrowing cost will be the benchmark to determine whether the region is
profitable or not. The larger the positive difference between RONA & cost of borrowing, the
more profitable the region is. According to the yield curve trend of UK and US, we find out
that UK yield curve has a downward sloping while the US is the opposite. This shows a lower
borrowing cost in terms of debts is in UK in coming 10 years, in contrast with a high RONA in
UK. This large positive difference between RONA & cost of borrowing in UK and a relatively
high RONA in Europe are signals for us to focus and develop business in UK and Europe.
5 CONCLUSION

GrandMet is facing a query about the company’s value (low PE ration). Besides rumors
surface that it becomes a takeover target. So, what is going wrong?
According to our analysis, we should be able to conclude as follows. In the financial analysis,
as GrandMet is a conglomerate and it is difficult to look for a similar corporate which has
similar business composition as that of GrandMet. As a result, we can only compare the
figures with the company’s own historical values.
In the valuation analysis, we use DDM to calculate the intrinsic value of GrandMet. Although
we find out the stock is undervalued, DDM is a theory which requires a lot of assumption such
as constant dividend growth. It may not be realistic to stick on this finding as well.
WACC would be a right approach to analysis the problem but a single hurdle rate does not fit
as well. With the use of segment WACC analysis, we find out that the Drinks segment
outperformed the Retails and Food segments.
6 RECOMMENDATIONS
As Drinks segment is the only segment having good performance, should GrandMet sell off
and cut the other segments? Here , we have to consider that GrandMet is a huge conglomerate
and there is a very good synergistic effect and diversification. Also, the company could enjoy
the benefit from the economic of scope and scale. By simply withdrawing from the food and
retailing industries would be risky to GrandMet as the competitor will take up the market
share. Besides, synergistic effect will be sacrificed. As a result, it is not wise to sell off or cut
the under-performed segments immediately.
We recommend GrandMet to develop a long term strategic planning divided into 2 phases to
tackle the problems.
Phase I) Restructuring & reengineering of food and retail segments

Existing management structure should be reviewed and business processes need to be
reengineered. This is what the company should focus on immediately with constant
evaluation. If they are still underperformed, we move on to Phase II.
Phase II) Selling out underperformed business sectors in Food and Retails segments
Underperformed segments in Food and Retails markets should be sold out gradually. Focus
will be back to the Drinks segment. Further merger and acquisition should take place on
potential outperformed market players.
In the long run, the most important is, the company should keep working on better corporate
governance and increase its transparency to the public. Only have the outsiders realized that
the company is moving on the right track, the company’s “adding value” goal can be achieved
and this will be reflected in the stock price eventually.
Geographically, there are good operating margins in UK, the highest RONA (efficiency on
asset) in UK and satisfactory RONA in Europe. We would suggest further development in the
UK and European markets. From the downward sloping of the UK yield curve which
represents a lower interest rate and lower cost in coming years, this is also a beneficial
opportunity to move the business to Europe compared with the upward yield curve in US. As
both trends in cost and return are comparatively better in UK, UK and Europe will be our
target market in the coming ten years.
6 POSTSCRIPT
On 1996, GrandMet acquired William Hill Organization Limited. European food business was
revamped by selling out Erasco Group and refocusing on brands like Pillsbury, Green Giant
and Haagen-Dazs again. Its headquarters also moved from Britain to Paris in the same year.
In the Food and Retails segment, there was a dramatic change. First of all, senior management

of Burger King was re-assigned on 1997. Afterwards, GrandMet further merged with
Guinness to form the Diageo. Further restructuring then took place and Burger King and
Pillsbury were sold out. The company sold out most food businesses and refocused on
premium Drinks market in 2002. All these movements were in line with our conclusion in the
previous section.
Therefore, we do believe our 2 phases’ recommendations could constructively tackle the
problems of GrandMet.

Appendix 1: GrandMet’s trading profit
Retailing
25%
Drinks
45% Drinks
Foods
Retailing
Foods
30%

Appendix 2: GrandMet’s market distribution
UK
US
Europe
51% US
10%
Rest of America
2%
Europe
Rest of World
3% Rest of America
UK Rest of World
34%

Appendix 3: Gross profit and net profit margin in the period of 1987 – 1991
1991 1990 1989

Net income/ Sales (%) 7.6% 6.8% 5.5%
Gross Profit / Sales (%) 14.6% 13.6% 12.2%
Return on Assets (ROA) 7.7% 7.0% 5.6%
Reurn on Equity (ROE) 19.1% 18.5% 17.9%
16%
14%
12%
10%
%
8% GPM
6% NPM
4%
2%
0%
1991 1990 1989
Year

Appendix 4: ROA and ROE in the period of 1987~1991
25.0%
20.0%
15.0%
ROA
%
ROE
10.0%
5.0%
0.0%
1991 1990 1989 1988 1987
Year

Appendix 5: Current ratio and interest coverage ratio between 1987 and 1991
8.00
7.00
6.00
5.00
4.00
3.00
2.00
1.00
-
1991 1990 1989 1988 1987
Year Current ratio
Interest coverage

Appendix 6: Proportion of Debt and Equity between 1987 and 1991
1987
1988
1989
1990
1991
0% 20% 40% 60% 80% 100%

Debt %
%
Equity %

Appendix 7: Debt to Asset ratio between 1987 and 1991
Debt/Asset Debt/Asset
1987
1988
1989
1990
1991
- 0.20 0.40 0.60 0.80
D/A

Appendix 8: Dividend Discount Model

Dividend payable on year 1991 218000000
Share outstanding 1,005,896,041
Dividend per share 0.22
Expected dividend per share for 1992, D1 0.24
Dividend growth rate, g 12.00%
Required rate of return, r
(=UK 10 years risk free rate + 1.14*UK market risk premium) 14.47%
GrandMet's intrinsic value
(=D1/(r-g) £9.81

Appendix 9: Calculation of group level WACC

Appendix 10: Segment WACC-Cost of Debt Calculation through Credit Rating

Interpolation

Appendix 11: Segment WACC-Cost of Equity Calculation through Adjusted Average Beta

Appendix 12: Standard and Poor's credit rating definition
Rating Score Pound yield

AAA 　 10.38%
AA+ 　 10.47%
AA 1 10.56%
AA- 2 10.73%
A+ 3 10.91%
A 4 11.08%
A- 5 11.11%
BBB+ 6 11.13%
BBB 7 11.16%
BBB- 　　

Appendix 13: Calculation of segment WACC

Appendix 14: GrandMet’s RONA & profit margin

RONA
1 1 1
Year
991 990 989
U.K. and Ireland 21% 18% 16%
Continental Europe 19% 19% 20%
United state 15% 15% 12%
Rest of America 16% 14% 14%
Rest of World 52% 59% 91%
Operat in g prof it
mar gi n
1 1 1
Year
991 990 989
U.K. and Ireland 13% 12% 9%
Continental Europe 12% 12% 14%
United state 12% 10% 11%
Rest of America 9% 10% 11%
Rest of World 15% 18% 23%

Appendix 15: U.K. Gilt and U.S. Treasury bond Yields (April 8, 1992)
U.K. Gilts, Yield to U.S. Treasuries,

Term 　 Maturity 　Yield to Maturity
1 　 10.50% 　4.45%
2 　 10.40% 　5.29%
3 　 10.30% 　5.95%
5 　 10.00% 　6.82%
10 　 9.80% 　7.45%
15 　 9.60% 　7.59%
20 　 9.60% 　7.83%

Reference
The writing is based on the following materials:

1. The Investopedia - http://www.investopedia.com/articles/fundamental/04/041404.asp
2. Keown, Martin, Petty, & Scott, Jr., Financial Management: Principles and Applications
(Pearson Education International, 10th ed, 2005)
3. Philippe Demigne, Jean-Christophe Donck, Bertrand George and Michael Lev with
Professor Robert F. Bruner, Case of Grand Metropolitan PLC (Darden Business
Publishing, University of Virginia)

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ACY 5903A Financial Management Group 3

Grand Metropolitan Plc

Grand Metropolitan Hotels.

However, by a series of acquisitions of different companies, GrandMet started to diversify into

non-hotel businesses since 1966.

Development of Core Businesses

developed as the group’s core businesses.

Case: Grand Metropolitan Plc P. 1 of 10

businesses in order to focus on core activities: food, drinks, and retailing.

Strategic Core Competence

With the strategy of focusing on the company’s core competence - management of

during world recession time.

Three Strategic Business Units (SBU)

GrandMet Stock Exchange

of shareholders for the group were still in UK.

Case: Grand Metropolitan Plc P. 2 of 10

profits has been generated during 1987-91 fiscal years).

2 PROBLEMS FACED BY THE GROUP

circulation of rumor that GrandMet may be a takeover target.

well? Might one or two of them be targeted for aggressive restructuring?

3 FOUR ANALYZING APPROACHES

will go through the following analysis:

financial performance in view of its position in profitability, liquidity, efficiency and

Case: Grand Metropolitan Plc P. 3 of 10

model and then compare it with the market value.

according to the group’s segments.

4) Geographic Market Analysis: besides analyzing the SBU’s performance at approach

4 FINDINGS AND RECOMMENDATIONS

From the financial analysis, we have the following findings:

13.6%/FY90 to 14.6%/FY91 and 6.8%/FY90 to 7.6%/FY91 respectively (Appendix 3). It

profit margin from the drink’s segment (form 15.8%/FY90 to 18.7%).

of out-performance in GrandMet’s drinks segment, especially after acquiring two drink-related

companies: Remy Martin-Cointreau and Anglo Espanola de Distribution. The performance of

Case: Grand Metropolitan Plc P. 4 of 10

RONA of Drinks/Food/Retails: 19.2%/9.8%/6.6%).

Co (i.e. A Minneapolis-based corporation incorporated in US). (Appendix 6 & 7)

asset, provided that:

- Misallocation of assets to the three segments appeared which distorted GrandMet’s

margin and RONA comparing to the Food and Retails segments.

an inverse relationship between ROE and debt leverage.

Case: Grand Metropolitan Plc P. 5 of 10

bidder side and this resulted in a low P/E ratio.

Before the calculation, we have made some assumptions on the model:

b. There is no segmentation between US & UK market with the assumption of correlation

between return in US & UK market equals to 1.

Beta in ₤ = Beta in $ x 1.4

Company level WACC

debt, preferred stock, convertible bond, equity) is 12.99%.

Case: Grand Metropolitan Plc P. 6 of 10

Appendix 13 for detailed calculation.

4) Geographic Market Analysis

Case: Grand Metropolitan Plc P. 7 of 10

surface that it becomes a takeover target. So, what is going wrong?

figures with the company’s own historical values.

outperformed the Retails and Food segments.

the under-performed segments immediately.

tackle the problems.

Phase I) Restructuring & reengineering of food and retail segments

Case: Grand Metropolitan Plc P. 8 of 10