Beauty companies and financial firms are in a buying mood.
After a lackluster year on the mergers and acquisitions front in 2013, the pace of deals is slowly beginning to pick up this year as more companies are actively scouting brands to add to the fold. But while their interest in deal-making is percolating, potential buyers are showing incredible restraint in waiting for the right assets to emerge.
“Buyers increasingly view M&A as a strategic imperative to fuel growth, but they have been more discerning about what fits their portfolio,” says Kelly McPhilliamy, a managing director at Wells Fargo Securities.
John Hansen, a managing partner at JH Partners, takes a similar view. “The beauty market today is pretty binary: There are some really wonderful, nicely positioned beauty companies. They go right away for a nice price and there’s good market activity,” he says. “Then there’s a bunch of not so nicely positioned firms that either aren’t growing or are not profitable enough and are languishing. That tells me that there are more-discerning buyers who are more sophisticated in terms of their ability to parse through the opportunities out there and identify those with real growth potential.”
A number of brands on the market—NYX Cosmetics and Perricone MD among them—are actively looking for a buyer; even more have recently explored the process, such as Carol’s Daughter, Yes To Inc. and Ahava. Some of the deals that didn’t get done last year are spilling over into this year, creating a nice momentum in the first half of 2014. The market has heated up since January, with L’Oréal acquiring Chinese facial masks–maker Magic Holdings International Ltd., TPG Growth buying a majority stake in E.l.f. Cosmetics from the brand’s founders and TSG Consumer Partners, and Japan’s Kosé Corp. acquiring a 93.5 percent stake in Tarte Cosmetics from founder Maureen Kelly and Encore Consumer Capital.
“The market is strong,” says Marco Habert, a managing director at Deutsche Bank. But he cautions, “We are not seeing a flood of deals due to limited supply. Many of the companies on the market have been there for some time. People are waiting for more attractive deals. But there is a lot of buyer interest.”
Those buyers include the biggest names in beauty. L’Oréal, Coty Inc. and Revlon Inc. have all been active on the M&A front in recent years, and the Estée Lauder Cos. Inc. has acknowledged it’s on the lookout for new opportunities. Of the major beauty firms, only Procter & Gamble Co. has declared that it’s sitting on the sidelines at the moment. “The last thing we need now is an acquisition in beauty. We have plenty of brands in the portfolio and we have plenty of product,” P&G’s chief executive officer A.G. Lafley told Wall Street analysts earlier this year at the Consumer Analyst Group of New York Conference.
While many of P&G’s peers lie in wait for the right brands to buy, they are eyeing several trends shaping the M&A landscape related to brand size, product category and geography. The smaller size of many assets currently on the market is prompting companies to revisit their strategy, with both financial and strategic buyers looking at brands under the traditional threshold of $50 million in wholesale sales. Although few strategic firms have shown an interest in actually acquiring these brands, they are giving them more thought than in years past and many are now contacting companies earlier in their life cycle.
L’Oréal has already shown a willingness to buy brands at an earlier stage. The beauty giant bought Essie Cosmetics in 2010, when the nail lacquer brand had wholesale sales of around $28 million, and in late 2012, it purchased the men’s grooming brand Baxter of California, when it generated an estimated $3 million in annual sales. Financial observers say Lauder, which hasn’t acquired a brand since its 2010 purchase of Smashbox Cosmetics, has been peeking at some smaller brands, including Butter London, a nail lacquer and cosmetics brand that generates an estimated $20 million in wholesale sales.
Lauder declined to comment on its interest in smaller-size assets, but the company did point to its history of nurturing acquired lines into large, global brands. “Acquisitions have played a strong role in our growth strategy for more than 20 years, beginning with the wildly successful and beloved MAC brand in 1994,” says Peter Jueptner, the company’s senior vice president of strategy and new business development. “[Lauder] has a proven track record of acquiring high-potential, entrepreneurial brands with global opportunity—like La Mer, Bobbi Brown Cosmetics and most recently, Smashbox—and shaping them into market leaders... We are continually monitoring the market for the right opportunities, looking at potential minority investments and acquisitions that present compelling opportunities to strengthen our position by geography, product category or channel.”
For now, many large beauty firms—Lauder included—seem to be in a browsing mode rather than a buying one. In fact, many deals on the market are failing because the targets are simply too small.
“There’s a point at which you’re just not relevant,” says one investment banker. “Brands with wholesale sales of $50 million and north seem to matter.”
Traditionally, brands with wholesale sales under $60 million have largely been the domain of private equity firms, which are eager to build scale and then sell to a strategic buyer or pursue an initial public offering.
Hansen explains that the larger beauty firms are often not set up to manage brands with less than $60 million in revenue. “They require a different level of attention, management and care,” he says.
The changing retail landscape—in which Sephora and TV retailers have morphed from a hospitable landing spot for newbies to powerful channels with more-stringent trade terms—have made smaller brands seem like a more risky bet to strategic buyers. “It’s harder and harder to buy small,” says Joyce Greenberg, ceo of CAP Greenberg. “It used to be that Sephora and TV retail provided a platform for small brands... Distribution has become very expensive, and more difficult for a new brand to obtain.”
To garner genuine interest from strategic buyers, Shaun Westfall, a managing director at Piper Jaffray, says a brand generally needs to meet three core criteria. “First, the business should benefit from distribution and relevance in three major accounts or channels—such as Sephora, Ulta and a direct channel like QVC—and at least a toehold internationally. Next, a brand needs to demonstrate a set of high-replenishment hero products. Lastly, you need to show success and brand awareness across multiple geographies and demographics,” he says. “Once you have met all three, you become highly valuable. Strategics will pay more for less risk.”
He says that when companies hit all three of these marks, multiples can reach 2.5 to 4 times revenue and double-digit earnings before interest, taxes, depreciation and amortization levels.
In terms of category, skin care still attracts the most interest from buyers, but there’s more activity swirling around color cosmetics thanks to the success of Urban Decay, which was purchased by L’Oréal in late 2012, and Lauder’s Smashbox. Steven Davis, a managing director at Intrepid Investment Bankers, expects color to remain an active space. “There are a number of color cosmetics firms owned by entrepreneurs that are doing well, and private equity groups have significant investments in good color cosmetics brands,” says Davis.
One of those brands is Too Faced Cosmetics, one of the last of the indies established in the late Nineties to resist a buyout offer from a large beauty firm. The private equity firm Weston Presidio acquired a majority stake in Too Faced in 2012, but cofounder Jerrod Blandino insists the fun, flirty makeup-artist brand is not for sale. “We are not looking to sell. We’ve never talked about that. We’ve had major giants contact us but we are happy and fulfilled,” says Blandino. Referring to Weston Presidio’s involvement, he says, “They help guide us and fund our growth. They don’t get in our way. They’ve helped propel us.”
NYX Cosmetics, which recently tapped investment bank Piper Jaffray in its search for a buyer, is getting lots of attention for its makeup-artistry positioning and social-media prowess. Founded in 1999 by Toni Ko and often referred to as the “MAC of mass,” NYX has recorded an average annual growth rate of almost 50 percent for the last five years, according to the company, which declined to comment on talk of a potential sale. Its wholesale sales are said to surpass $100 million, according to industry sources.
NYX’s use of social media—vloggers love the brand—has allowed the company to achieve higher margins than a typical mass color brand, says one financial observer.
A brand’s ability to leverage social media is also a crucial element when it comes to attracting attention. “Some incumbent firms have a harder time doing that and are learning to leverage their capabilities,” says Jennifer Baxter Moser, a managing director at TSG Consumer Partners. “The smaller brands don’t compete in either print or [any other] traditional advertising strategies, but are able to use digital and social media to scale quickly and compete with the larger companies.”
In her view, these companies provide value to consumers in ways that traditional brands sometimes are unable to deliver, whether it’s innovative products or different price points.
Davis at Intrepid says that while color is gaining in popularity, skin care is still a favored category. “The complexity of color can scare away some potential acquirers,” he says. “In skin care, the firms that could attract a little more attention are those that have some technological angle associated with the product.” Antiaging skin care is still an attractive market, he says, adding that men’s skin care—although still in the early innings of development—is another category that could gain traction.
Investors are also closely watching the device category. Andrew Charbin, a vice president at investment banking firm The Sage Group, says, “One industry space that seems to be gaining more attention is the beauty tools and device sector.” L’Oréal’s acquisition of Clarisonic in 2011 and the recent Iluminage Beauty venture between Unilever and Syneron Beauty are two of the more-recent developments that have brought attention to this space. “Strategic buyers are always creating formulas for new products, and the tools and device category brings an added dimension of engagement to the consumer experience, combining hard and soft technologies, not to mention the potential there is from a marketing and distribution perspective to cross-sell and make claims of optimized efficacy,” says Charbin.
On the international front, a growing number of Asian buyers are active in the beauty M&A space, whether it’s Western multinationals looking to expand their footprint eastwards with brands that are relevant to consumers in emerging countries, or Asian companies looking to become bigger players in the West.
“Asia-based companies are becoming real players in M&A processes, and their objectives are changing,” says Vennette Ho, a managing director at Financo. “It used to be they only wanted to buy brands that had proven success in Asia. Now they are also looking at brands that extend their reach beyond Asia.”
Kosé’s recent acquisition of Tarte Cosmetics has amplified the growing trend of Asian companies buying foreign brands, often to gain a foothold in markets outside of Asia, such as the U.S. Within the last three years, Pola Orbis Holdings Inc., a leading Japanese player, purchased two skin-care companies, namely Australia’s Jurlique Group and the U.S.-based H20 Plus. Shiseido Co. Ltd. has also expanded its presence well beyond Asia with bold acquisitions such as Bare Escentuals in 2010. In some cases, Asian companies are also the sellers. In February, Shiseido agreed to sell two brands, Carita and Decléor, to L’Oréal.
The same trend is happening outside of Japan in Korea. Andrew Postal, a managing partner at advisory firm Marketing Management Group Inc., which works with Korean firms, says that many of them are now “looking outside of Korea for growth. One place is China, but they are also looking at the U.S.” Postal explains that they are looking at brands to bring back to Korea, as well as how to bring their home-grown brands overseas. At press time, for example, Korean giant LG Household & Healthcare Ltd. was reportedly considering a bid for Elizabeth Arden, among other companies.
Observers expect all of these dynamics to further accelerate the pace of deals this year, particularly with beauty companies and private equity firms armed with money to invest in expanding their portfolios. William D. Busko, a managing director at investment banking firm Consensus Advisors, says, “Beauty has been an active sector across all investment classes, whether venture capital, private equity or traditional and nontraditional strategic buyers.”
Says Financo’s Ho, “Good brands that exhibit good growth are always attractive targets. If you are a willing seller, it’s just a matter of timing.”