Avon-Coty Combo Could Be Messy

We are leaving our $25 fair value estimate for  Avon Products  unchanged in the wake of the news that the firm has received an unsolicited offer of $23.35 per share in cash (representing a total offer of $10 billion) from privately held beauty company Coty. Avon's board has rejected the offer, believing it substantially undervalues the firm and calling out that it represents a multiple of 1.1 times trailing-12-month revenue and 8.7 times trailing-12-month EBITDA.

While Avon faces a perfect storm of problems at the moment, it's clear that Coty smells blood. The perfume maker, which posted sales of about $4.1 billion for the year ended June 30, 2011, believes a combination would benefit Avon's direct salesforce as the representatives would have Coty's fragrance brands such as Lady Gaga and Calvin Klein to distribute. Any such deal would probably be quite messy, in our view, as Coty has strong department store relationships in the United States. We doubt these retailers would enjoy seeing the same brands that sit at department store counters distributed by direct sales representatives. Additionally, outside the U.S., in markets such as Brazil and Russia, we are not sure how much traction many of Coty's celebrity brands would have. Growth in the fragrance category can be fairly volatile, and while currently it appears to be doing better than it has in some time (based on results we've seen from competitors like  Estee Lauder (EL)), it's also suffered significant category contraction in recent years. We're not sure how compelling Avon representatives would find Coty's product offering over the long run.

It's possible that a higher bid will emerge, as this is already Coty's second bid but the first that's been made public. It's also possible that at some point Avon's board may have to reconsider should the offer price climb higher. Coty has said it will not attempt a hostile takeover, but the longer it takes Avon to offer the strategic overhaul that was promised months ago and is long overdue, and the longer it takes the firm to appoint a new CEO, the more Avon will leave itself open to these unwanted assaults. Avon's self-inflicted wounds are having unintended consequences.

Considering that Avon has declined the offer and we think the likelihood is low that Coty's pursuit will succeed, we are leaving our BBB+ issuer credit rating unchanged. If Avon were to accept a higher offer from Coty, we would re-evaluate our rating based on the proposed financing and structure of the transaction.

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