Chestnut Foods (a)

Abstract

After a period of poor stock-market performance, conglomerate Chestnut Foods (Chestnut) faces the acquisition of its stock by an activist investor. The new investor demands the sale of Chestnut's high-growth division, which contrasts with the CFO's turnaround plan to expand this same division. To disentangle the way forward for Chestnut, students are invited to grapple with the risk-adjusted performance of each division and the estimation of division-specific hurdle rates. Students learn to appreciate the importance of using risk-adjusted hurdle rates in establishing appropriate investment policy.This case has been used in Darden's first-year required finance course. It is designed to be used within a module on estimating the cost of capital, but only after students have become familiar with the basic techniques for estimating a weighted average cost of capital.

Excerpt

UVA-F-1736

Rev. Sept. 15, 2017

Chestnut Foods

In early 2014, stock performance at Minneapolis-based Chestnut Foods (Chestnut) had failed to meet expectations for several years running, and senior management was hard-pressed to talk about much else. CFO Brenda Pedersen, eager to reverse the trend, had begun advocating two strategic initiatives: a $ 1billion investment in company growth and the adoption of a more progressive corporate identity. At a restaurant overlooking the Mississippi River, Pedersen hosted an informal meeting of company VPs to build support; exchanges had been highly spirited, but no consensus had materialized. Then, on her drive home from the restaurant, she received a call from Claire Meyer, VP of Food Products, who had attended the dinner. Given the tone of the meeting, Pedersen wasn't surprised to get a call so soon, but what Meyer shared floored the CFO. “It just came up on Twitter. My admin saw it and texted me. I'm not going to say I told you so.”

Meyer read her the tweet. “Van Muur buys 10% of Chestnut, seeks seats on board and a new management direction.” Meyer filled in the details: based on filings earlier in the day with the U.S. Securities and Exchange Commission, Rollo van Muur, a high-profile activist investor, had quietly and unexpectedly purchased 10% of the company and was asserting the right to two seats on the board. In addition, Van Muur was recommending that the Instruments division be sold off “to keep the focus where it belongs.”

Pedersen drove in shocked silence and processed the information while Meyer waited patiently on the line, not sure what to expect. When Pedersen finally responded, she fell back on humor: “Well, that's one way to move the discussion along, but he could have just come to dinner with us.” By the end of the night, she had spoken with CEO Moss Thornton and organized a team of lawyers and finance staff to assess the company's options.

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Keywords: cost of capital, divisional hurdle rates, capital markets, WACC, weighted average cost of capital, CAPM, capital asset pricing model, capital budgeting