Last week, Coty Inc. announced its intent to acquire Avon Products (NASDAQ: AVP) for $23.25 per share. The offer represents a ~20% premium over the closing price on March 30 and is an all cash deal. AVP rejected the offer, citing undervaluation. Coty has shown that it is willing to “consider increasing its price if Avon can demonstrate that there is greater value.” AVP has had its share of financial and operational troubles with deteriorating sales and a bleak growth outlook. However, it remains the leading direct seller of beauty and related products. It has over 6.5 million representatives and operates through three divisions: beauty, fashion, and home. The stock is held by Magnetar Capital, Caxton Associates, Wallace R. Weitz & Co., Highbridge Capital Management and D.E. Shaw. Coty is a privately-held French fragrance company that has grown to approximately $4.5 billion in revenues and 12,000 employees. Fragrance remains its core division, followed by cosmetics, and skin and body.
Coty has indicated that it can enhance innovation and service levels at AVP. It would also bring a management with a strong track record of organic growth to the table. Coty is strong in nail products and fragrances, which will complement AVP’s strength in color and skin products. AVP is strong in emerging markets, accounting for 68% of revenues versus 26% at Coty. We see a great opportunity for Coty to leverage AVP’s emerging markets exposure. The combined entity would generate about $15.8 billion in revenue, excluding revenue synergies, and would have an improved geographic diversification profile with over half of revenue from emerging markets. And even though Coty is heavily weighted to the slower growing developed markets, it has reported 7% growth y-o-y for that past 2 years, a type of growth trajectory it is confident it can bring to AVP. Bottom line improvements will be helped by potential cost synergies, most clearly in system upgrades and representative compensation. It is clear that the AVP turnaround will require significant amounts of reinvestment, which Coty recognizes. “Mid-teens” EBIT margins may be aggressive, but again, that will depend on the progress Coty can make in operational improvements. The big question mark for us is how the distribution channel integration will work given AVP’s direct selling strategy versus Coty’s retail approach.
At a valuation at ~9.0x 2012E EBITDA, based on Coty’s offer, this is comparatively low to historical beauty industry deals. In the last couple of years Health and Beauty Product M&A transactions have priced at an average of 13.0x to 14.0x TTM EBITDA (March 2011 Colgate/Sanex, November 2010 Reckitt/SSL, July 2010 Avon Silpada, January 2010 Shiseido/Bare Escentuals). We think it makes sense that AVP will be bought at a discount to that multiple range given declining profits, a Foreign Corrupt Practices Act (FCPA) investigation, foreign exchange volatility, lack of a CEO, among other troublesome issues. If AVP accepts the offer, it is likely that its CEO search would end. Former CEO, Andrea Jung, will become the company’s Executive Chairman, once a new CEO is named. Note that there have been some changes to the Board of Directors. Former Campbell Soup (CPB) CEO, Douglas Conant, has joined the AVP Board and current board member Paul Pressler, former Gap (GPS) CEO, will not be up for re-election.
While we think that Coty has the ability to pay more, the question remains if AVP is worth a higher multiple given the issues outlined above. AVP has revenue CAGR of ~2.5% over the last 5 years and a negative EBITDA CAGR. We do not see many viable buyers that share the direct selling business model and would be surprised if companies to the likes of Estee Lauder (NYSE: EL), Inter Parfums (NASDAQ: IPAR), and Revlon (NYSE: REV) submitted bids.