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Beauty companies and private equity firms have started the year in a buying mood.

This story first appeared in the January 6, 2012 issue of WWD.  Subscribe Today.

On Thursday, sources said the private equity firm Weston Presidio completed a majority investment in Too Faced, a longtime holdout from the indie cosmetics brand craze. At press time, neither firm could be reached for comment. With Too Faced potentially off the table, industry watchers have turned their attention to other possible investment or acquisition targets, including fellow independent beauty brand Urban Decay and on the larger end, Avon Products Inc., given its recent string of challenges.

All eyes also are on the Estée Lauder Cos. Inc., as the beauty behemoth has declared both Asia and skin care strategic priorities, making an acquisition of an Asian skin care company seem likely.

In fact, international plays are expected to be the big story in 2012. The Japanese company Pola Orbis Holdings Inc. is expected to complete its acquisition of the Australian skin care company Jurlique from the private equity fund JH Partners later this year. The two firms are currently in contract. Both Jurlique and H2O Plus, which Pola Orbis acquired in July, have a strong resonance in the Asian markets, said Vennette Ho, a director at the investment bank Financo, which advised e.l.f. Cosmetics on its sale to TSG Consumer Partners in 2010. She added that buyers are looking for brands with a broad global reach.

Although not as impressive as the size of deals that marked 2010 — think Shiseido Co. Ltd.’s purchase of Bare Escentuals, Coty Inc.’s acquisition of Philosophy and Lauder’s bid for Smashbox — last year was awash with M&A activity.

Investment banker Elsa Berry, head of Houlihan Lokey’s cross-border consumer coverage, expects that pace to continue.

By her count, there were 27 beauty M&A deals in 2011, up from 20 in the prior year. “Those are very strong trends,” she said, adding that attractive acquisition targets continue to emerge. For instance, as more players fortify their presence in Eastern Europe, Oriflame — once a leader in this market — may be a target or a buyer of another group outside Eastern Europe.

She also anticipates Japanese and Korean beauty firms to eye companies that would expand their reach to the U.S. and Europe. “Global players are looking for innovation and an entrepreneurial approach that they can bring to the next level,” said Berry.

But from Berry’s vantage point, Latin America may garner the most interest.

“If there is a place to buy, it is Brazil,” she said, noting that Jequiti, a Brazilian direct seller, is on the hunt for a buyer. An acquisition in the Brazilian market could lower some of the numerous barriers to entry to the Latin American market, she added.

In the U.S., the retail environment has become less hospitable to independent beauty brands, prompting their founders to sell, said financial observers.

“The bar has been raised in terms of what critical mass means,” said Joyce Greenberg, a partner at the investment bank Coburn Greenberg Partners, referring to rampant consolidation within beauty. Greenberg forecasted that a number of independent companies, with revenues under $50 million, will sell to strategic buyers. “You’ll see further consolidation this year.” In terms of categories that she thinks will be brisk movers on the M&A front Greenberg said, “everything but fragrance.”

“Sephora and QVC offered a lifeline to new brands and they’ve all had to rationalize their businesses. It’s more difficult for independent brands to get in their doors,” Greenberg said. “There are still opportunities to launch brands in these channels, but they are more limited.”

Michael John, a partner JH Partners, said two dynamics have changed the M&A landscape: Smaller brands are finding it more difficult and costly to do business at retail, but at the same time strategic buyers are showing more of an interest in smaller-sized brands. “It’s less expensive to buy a brand than create one from scratch,” said John, adding he anticipates more movement of brands with less than $100 million in revenue.

But, others assert, retail opportunities are still plentiful for the right brands.

“Ulta is still rolling out significantly more doors and HSN and QVC are expanding into new markets,” said Sandra Horbach, managing director of the Carlyle Group and head of its Consumer & Retail team. The private equity fund sold Philosophy to Coty in 2010 for an estimated $1 billion. Horbach noted the multiples remain high and are holding rather steady at a range of 2 to 4 times revenue and low- to mid-digits times earnings before interest, taxes, depreciation and amortization.

Horbach expects the antiaging skin care category to garner significant interest this year. “Skin care continues to be very attractive. We are also looking at health and wellness, or beauty from within,” she said.

Jani Friedman, a managing director for the investment bank Demeter Group, which advised Ole Henriksen on its sale to LVMH Moët Hennessy Louis Vuitton, said the rise of retail concepts, such as Duane Reade’s Look Boutique, are beginning to play the role that Sephora did in the previous decade as an incubator of niche brands. These concepts, said Friedman, “are not focused on exclusivity but more on novelty.” Friedman said the hair care category is attracting lots of interest, as firms such as Living Proof and Carol’s Daughter introduce straightening and strengthening treatments, tapping consumers’ growing obsession with a perfect coif.

Meanwhile, LVMH is busy making changes to Ole Henriksen’s top ranks, appointing Alexandra Kole as chief executive officer. She was previously senior vice president of strategy and business development at Sephora.

On the acquisition front, Jeff Menashe, Demeter Group’s ceo, said bids by pharmaceutical firms or life sciences companies are likely as they increasingly look at beauty as a way to reach a broader consumer base. He named derm-centric skin care brands as a likely fit.

He said that in 2011, strategic buyers accounted for nearly 80 percent of the deals, and in 2010 approximately 85 percent, with private equity accounting for the remainder. “We expect that will hold true this year,” said Menashe.

“Beauty is still a very interesting space,” said Menashe. “This is an area that continues to reward innovation.”

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