Industry analysts handicapping Coty Inc.'s $10 billion bid to acquire Avon Products Inc. say there is a low probability of success for the deal to go through.
Coty made the $23.25 per share cash bid for Avon public on Monday, April 2, after Avon had rejected the fragrance seller's private efforts to discuss a deal.
In rejecting the bid the same day, Avon described the offer as "opportunistic." Coty, meanwhile, claimed the debt and equity financing needed to do a deal was available and that it had "no intention" to go hostile with its offer.
Despite Coty's insistence that financing for the deal is available, industry analysts questioned whether Coty could raise a financing package large enough to pull off an acquisition of its much larger peer. To be sure, Avon generated $11.3 billion in revenue in fiscal 2011, while Coty said it has about $4.5 billion in annual revenue.
Morningstar Inc. analyst R.J. Hottovy said that the financing "would have to be creative" for a deal of this size.
Typically, debt financing can be obtained for deals valued at 6 to 6.5 times Ebitda, Hottovy said. Coty's offer values Avon at 8.7 times 2011 Ebitda, meaning Coty would have to pay at least $2.5 billion to $3.1 billion in cash, assuming it raises a debt package of $6.9 billion to $7.5 billion.
Yet, Avon has made it clear Coty would have to raise its bid to seal a deal. Consequently, that would also increase the amount of cash on top of debt needed to finance the deal. Hottovy declined to speculate on how much Coty would have to sweeten its offer to get Avon to agree to a deal. Both Avon and Coty declined to comment for this story.
BMO Capital Markets analyst Connie Maneaty said that Coty indicated it could increase its offer. Assuming Coty has a minimal debt load, the company could borrow against its own Ebitda, Maneaty said. Coty said it had $4.5 billion in revenue and a 17% Ebitda margin, which would be the equivalent of about $765 million.
Avon had about $3.3 billion in total debt on its balance sheet and roughly $1.2 billion in cash and cash equivalents, as of Dec. 31.
While combining Avon and Coty's portfolio of brands makes strategic sense, Hottovy said, the fact that the companies have two vastly different business models could complicate integration. Avon has a direct-sales model in which its own sales representatives go directly to consumers to sell its product, while Coty sells its merchandise through retailers. Maneaty said Coty has to make the case for merging two different channels of distribution and explain where it will find synergies beyond making Avon's working capital more efficient and cutting its overhead.
Hottovy said that given Avon's declining financial position, Coty's bid is not surprising and acknowledged the possibility of private equity suitors emerging. He characterized Coty's move as opportunistic and an angle to obtain greater access to emerging markets that Avon has a strong presence in, particularly Latin America. Maneaty agreed, saying Coty's offer is too low and based on Avon's "poor" results from the past 12 months, passing all the value to the acquirer and leaving none for the shareholders.
Avon's operating profit for fiscal 2011 plunged by about 22%, to about $855 million, from nearly $1.1 billion in fiscal 2010. That's a drop from a little more than $1.3 billion in profit in 2008 and about $1 billion in 2009. Avon's net income dropped from $606 million in 2010 to about $515 million in 2011.
Private equity firms, Hottovy said, probably wouldn't rule out a bid for Avon, as there are a number of opportunities to turn the business around. Avon would likely benefit as a private company as it attempts to execute a turnaround plan and deal with investigations by the Securities and Exchange Commission into bribery of foreign officials in China, India and Latin America; and improper disclosure of information to analysts and others in the financial services industry.
Avon is seeking a new CEO after Andrea Jung announced her intention to step down as chief executive but remain chairman. Hottovy said that if a suitable CEO can't be found for Avon, shareholders may push for a deal.
Maneaty said that if Avon were to put in place an experienced chief executive and a turnaround strategy in the near term, then by the back end of 2013 the company might see earnings growth again. At that point, the cosmetics giant could explore a sale because more normal valuations could be applied in an early-stage recovery.
Yet Coty's offer may complicate Avon's CEO search, Maneaty said, creating a Catch-22.
"The search for a CEO is infinitely more complicated," she said, adding that top-notch candidates will be deterred taking a job that may not exist.
Working in its favor, Coty has the exact kind of leadership Avon may need in the form of chairman Bart Becht, who was previously CEO of consumer products giant Reckitt Benckiser plc, Maneaty said.
According to Dow Jones LBO Wire, Avon considered buying Coty at the beginning of this year. Avon was interested in bringing on board Coty's executives, Becht told the news service, but Avon ultimately did not make an offer for Coty and didn't offer an explanation.
Yet, a marriage between the two companies could make sense, as Coty could provide the cash Avon needs in the U.S., while Avon's strength in emerging markets could provide a platform for Coty's products. Coty's strength in Europe would also be a boost to Avon products in that region, with Coty's seasoned executive management team filling in the vacancies at Avon.
Though analysts have said there is low probability of a deal happening, Coty is not deterred. It has the financial resources of majority owner Joh. A Benckiser GmBH, and has lined up J.P. Morgan Securities LLC to arrange debt financing and BDT & Co. LLC to raise money from the Joh. A Benckiser companies, as well as BDT Capital Partners.