THE PROFIT IMPERATIVE
Byline: Sidney Rutberg
NEW YORK — Executives at Revlon Inc. will remember 1996 as a watershed year.
For the first time in at least five years, the giant beauty company, which was acquired by Ronald O. Perelman in a bruising 1985 buyout battle, produced a bottom-line profit.
Founded by Charles Revson about 60 years ago, Revlon is today a survivor of the now-deflated leveraged-buyout boom of the Eighties.
Unlike high fliers like Federated Department Stores and R.H. Macy & Co. that were forced into Chapter 11 by the sheer weight of leveraged debt, Revlon weathered the fallout of the early Nineties.
Although it has shown bottom-line losses for years because of special charges and huge debt-carrying charges, in 1996 Revlon broke into the black. After paying out $133 million in interest costs, or about 6 percent of sales, the company still showed a net profit of $18 million, or 49 cents a share.
Wall Street is estimating that Revlon will earn $1.20 a share in 1997. Lynne R. Hyman, an analyst at CS-First Boston, said the company has done an outstanding job in product development and marketing. She is projecting sales to be up about 11 percent in 1997 from last year’s $2.16 billion. For 1998, she expects sales to rise another 10 percent and earnings per share to grow to $1.95.
About a year ago, Revlon tapped the equity market for about $180 million through the sale of 7.5 million shares at $24 a share. After the sale, Perelman continued to control 97.7 percent of the voting power in the company. Proceeds of the offering were used to pay down some short-term debt, but Revlon remains heavily indebted.
The company lists $1.35 billion in long-term debt and, in old-fashioned accounting terms, a shareholders’ deficit of $497 million.
William J. Fox, Revlon’s chief financial officer, says there are other factors to be considered.
“You have to look at it in its historical perspective,” says Fox. “The book value of the company is based on the book value of the assets at the time it was acquired in 1985. The negative net worth comes from the recapitalization that took place in 1992. But the intrinsic value of the company and the fair value of the company and assets are substantially higher than the book value.
“But looking at the market capitalization at $30 a share, to make it easy, times 51 million shares out there, and when you add that to the $1.4 billion in debt, you have an enterprise value of $3 billion. And that’s just in today’s market. It’s in flux.”
Revlon stock, traded on the New York Stock Exchange, closed Thursday up 1 1/8 to 32 3/8.
High-yield analyst Rosemary Sisson at CIBC Wood Gundy agrees with Fox’s appraisal.
“In our analysis, we look more at cash flow and debt coverage than debt to capital,” she said. “Revlon has had great success with its ColorStay lines, with very effective advertising. There are similar products in drugstores, but they just haven’t been promoted as effectively as Revlon.”
Turning to Revlon’s high-debt service costs, Fox said he was sure it could be handled. “The company has been growing very nicely now for three years. We have 12 or 13 consecutive quarters of increases in sales and profits, increases in sales and operating income and EBITDA (earnings before interest, taxes, depreciation and amortization). We have been reducing debt and reducing interest costs. We’ve been increasing our profits, and we’ve been doing it in a time while we’ve had this billion of debt. We have never had a situation where we didn’t have enough liquidity to invest in the business.
“If you go back to 1989 and 1990, the company had $3 billion in debt, and we paid off a lot of it,” Fox continued. “We know from experience how to work with a company that is leveraged. And what happens when you have leverage? You do even better because your return to the shareholders increases at a much higher rate.”
On top of Revlon’s debt, Revlon Worldwide Corp. — the holding company for Revlon Inc. — has about $1.11 billion in zero coupon bonds that will mature March 15, 1998. Revlon itself has no maturity problems until l999, when $200 million in its bonds fall due.
Emphasizing that the zeros are not obligations of Revlon Inc., Fox nevertheless says he is convinced they will be repaid or refinanced when due. For one thing, he said, Revlon could go back to the public market and sell some more stock.
“We sold 17 percent in the IPO, so we have 83 percent of the stock,” he said. “It could be one or a combination of any various sources that could be used to retire the debt in March 1998. I’m not concerned in the least.”
CIBC’s Sisson noted that based on the action of the bond market, investors expect the Revlon Worldwide issue to be paid off on time.
‘The zeros are trading at about 90, which is where you’d expect them to be at this point,” Sisson said. “I think Perelman will manage to refinance or repay the bonds at maturity.”
Fox said he expects to build sales at more than 10 percent a year over the next couple of years.
“We’re not fully distributed outside the U.S.,” he said. “We have presence in 170-something countries, but volume is small in a lot of those places, and we have the ability to grow those much wider. Even in the U.S., we are not as fully distributed as we would like to be. We don’t have as much space in the stores as we would like to have. As our market share has been growing, and with new product offerings, we’ve been gaining more retail space.
“When you put all of that together, along with the fact that we’ll make acquisitions when it’s appropriate, we see that it is reasonable to expect that, without price increases, we can grow the business at double digits for at least the next couple of years,” Fox continued. “And by the time we get to the end of the decade, we should start seeing the international business explode.
“International business,” he added, “will be as big as the domestic business.
“The gross profit of our business is strong because we have a pretty low cost of manufacturing. We’ve been bringing that cost down through globalization — globalizing our factories, globalizing how we source our products, globalizing our products’ design so that we’re not making 15 different products for the same lipstick in 15 different factories. That’s increasing our gross profit.
“When you take that, combined with our administrative cost savings, as we increase our volume and become more efficient, we’re putting some of that back into advertising,” he said. “Despite the fact that we’re increasing our advertising each year, we still tend to come out with more operating income margin.
“We’ve been able to increase the operating income margin and the operating income dollars at a rate faster than the sales growth rate,” Fox noted. “So if we’re growing sales 10, 11, 12 percent, we’re growing income 15, 20, 25 percent and more.
“Then you look at the leverage,” he said. “We’ve been reducing our interest rates because we’re getting stronger. Every time we go back to negotiate with the banks for working capital, we get a better interest rate. We did that with the IPO domestically, and then we went around the world and met with most of our international banks, and most of them reduced our interest rates as well.
“Then, as we are putting cash flow into reducing our bank debt, because that’s what we first reduced, we can cut our interest expense further. So by deleveraging and by being more efficient with our cash, we reduce our interest expense, and that increases the pretax earnings. By the time you get down to net income, that income is growing at an even faster rate than operating income. So you see how we can get a growth rate of 30 to 40 percent in earnings per share.”
Asked if a dip in the economy would be a serious setback for the highly leveraged company, Fox again expressed confidence that the company could weather the downturn.
“It’s funny,” he said, “because this company usually does very well in a recession. If you go back and look at the recessions of the Seventies, Sixties and early Eighties, the cosmetics business does very well, particularly mass market cosmetics. That doesn’t mean you can do exceptionally well, but we’re going to do well. We wouldn’t have to worry about surviving.”
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