Now what?

Avon Products Inc. may have found a solution for one of its oldest and most nagging problems — its challenged North American business – but it faces the challenge of how to grow its international operations.

The direct seller on Thursday confirmed widespread reports and signed a $605 million deal with Cerberus Capital Management to remake its operations, spinning off its North American business into a privately held company. The private equity firm will pay $170 million for an 80.1 percent stake in the soon-to-be separate Avon North America, while investing $435 million in Avon’s preferred stock, gaining control of about 16.6 percent of that business.

Under the terms of the deal with Cerberus, which is expected to close in the spring, Avon North America will assume $230 million of long-term debt from Avon Products, which will be partially offset by a $100 million cash contribution from the beauty firm.

“Today marks a pivotal moment for Avon,” Avon’s chief executive officer Sheri McCoy said on Thursday during a conference call detailing the deal. “We announced a strategic partnership with Cerberus Capital Management that will allow us to drive an enhanced focus on our international markets, enable revitalization of our North American business and deliver value to our shareholders.”

McCoy may have been bullish on the split, but Wall Street had a mixed reaction. Shares of Avon spiked 25 percent in premarket trading on news of the Cerberus deal, but the enthusiasm quickly cooled off and the shares finished down 1.3 percent to close at $4.04.

Sanford Bernstein analyst Ali Dibadj said the moving stock price does suggest investors are split on the value of the deal. In his view, “It does suggest Avon had its back against the wall.”

He said Avon, with McCoy at the helm, now has a limited time frame of a year or two to get things right. The changes on the board have some financial observers wondering if McCoy will stay on as ceo.

Javier Escalante, an analyst at ConsumerEdge Research, suggested Avon’s recently elected board member Susan Kropf — who served as president and chief operating officer of Avon from 2001 to 2006 — could serve as a possible interim ceo, should McCoy leave.

Meanwhile, activist investors aren’t going away. James A. Mitarotonda, chairman and ceo of Barington Capital Group, which has an Avon position, said: “Cerberus clearly recognizes, like us, that Avon is an extremely valuable brand. The Avon board apparently does not — it has sold 80 percent of its North American business and a 16.6 percent stake in the company at what we believe are ‘fire sale’ prices. While we are pleased that six existing board members have agreed to step down, we are astonished that Sheri McCoy remains as ceo. We intend to explore all available options.”

McCoy was hired to turn the company around in 2012, the year Avon shot down a $10 billion overture from Coty Inc. as part of a long and drawn-out battle.

The deal ties Avon and Cerberus together in a symbiotic partnership, with the direct seller retaining nearly a 20 percent stake in the newly separated North American business and obtaining two board seats.

At the close of the transaction, Avon will reduce the size of its board to 11 from 12, with Douglas Conant, Paula K. Stern, V. Ann Hailey, Maria Elena Lagomasino, Sara Mathew and Gary Rodkin stepping down. Three new board members will join from Cerberus, with two other directors being approved by Avon and Cerberus.

Avon is betting on Cerberus to do a better and faster job of fixing the North American business, which has seen sales and representations drop off, particularly in recent years.

Cerberus, meanwhile, is betting that — without the distraction of North America — Avon can figure out a way to overhaul its international business and add luster to its brand heritage. Both are big bets.

Escalante at ConsumerEdge said, “[The deal] is important because Cerberus needs to fix the U.S. business to prove that the business model can survive a highly developed retail environment.” He followed this point up in a research note, writing, “the retail landscape is developing the fastest in the hyper-competitive emerging markets where Avon is most exposed to — Brazil, Russia — and this creates structural pressures not only on Avon’s margins, but also on Brazil’s Natura and Russia’s Oriflame.”

In Escalante’s view, Cerberus’ involvement adds better governance and financial might to Avon, but he cautioned that the company still has to address troubles pressuring its international markets.

Fixing North America is no easy task either, as Avon’s repeated efforts have shown. The North American business generates $1 billion through the sales of 400,000 representatives, according to Avon. Escalante noted that translates to each representative producing about $2,500 in sales a year. He added that even at the high-end of their compensation structure, that translates to roughly $1,200 in earnings each year, or $100 a month — making Avon’s recruitment of sales reps a tough sell.

Stifel analyst Mark Astrachan also expressed concerns about achieving a turnaround in North America. He wrote in a research note on Thursday, “Overall, we view the investment favorably in that it provides time and modest incremental funds to reinvest to improve recent underperformance. That said, given an already prolonged turnaround and numerous restructuring and cost-savings initiatives undertaken in recent years, we believe the cash infusion and intellectual contribution from Cerberus is unlikely to result in a meaningful change in business trajectory.

“Specifically, New Avon faces the same challenges — that it continues to lose share and consumer relevance in a number of key markets. We continue to believe significant reinvestment is required to improve the company’s sales growth and operating margin performance, with net proceeds from today’s announcement totaling $359 million, or 5 percent of 2015 [estimated] sales.”

During her tenure at Avon, McCoy has repeatedly been asked by analysts about whether the company should consider divesting the North American business. Last year she said although Avon was facing challenges in the U.S., walking away from the market “doesn’t make sense.”

At the time, she added, “Wall Street is frustrated, rightly so, because we aren’t growing and we have some profitability challenges. If we look at the growth, it’s all coming outside the U.S. But our goal is to get the U.S. stable and look at how we learn from that because it is a developed market and we need to understand direct selling in a developed market.”

On Thursday, she expressed a different view, saying the partnership with Cerberus allows Avon Products to focus on revving up its international business. “Having separated out the North American business, we can develop financial, capital and operational plans that fully support the international business, which accounts for 86 percent of our revenues and 100 percent of our growth and profitability,” said McCoy.

Even so, during Avon’s conference call, Dibadj at Bernstein asked McCoy whether or not Cerberus was better equipped than Avon to tackle the company’s problems in North America given it lacked direct-selling expertise. McCoy said Cerberus will benefit from direct-selling knowledge within the organization — and will have the benefit of working to address the challenges from behind closed doors, away from the spotlight that comes with being a publicly traded company.

 

 

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