KARAN, LAUDER DO THE DEAL

NEW YORK — One of the most hotly contested and closely watched courtships in beauty history ended Tuesday with Donna Karan finally picking a suitor — the Estee Lauder Cos.
Donna Karan International signed a fragrance and cosmetics licensing agreement with Lauder, making good on a promise to testy investors to license the business that was launched in 1992 and has drained at least $20 million from the fashion company. For months, an originally reluctant Karan has promised a deal by the end of the third quarter. She beat the self-imposed deadline by a matter of hours.
In starting her beauty company in 1992, Karan, together with her husband, Stephan Weiss, was determined to break all the rules by maintaining ownership and pursuing a singular vision of how products should be created, distributed and promoted. But when it became clear that outside resources were needed, shareholder pressure mounted, and she sought help.
For Lauder — the dominant force in the prestige cosmetics market, with a 44 percent share of the U.S. department store business — the deal represented a victory over rival bids from Puig of Barcelona and Wella AG.
It also was the second jolt out of Lauder in as many weeks. Last Thursday, the company, which has been wedded to department stores since its founding in 1946, unexpectedly reached into the mass market with the acquisition of Sassaby Inc. and its Jane color cosmetics brand.
Neither Karan nor Lauder revealed the financial terms of their deal, but Wall Street sources speculate that the Karan firm will glean a 6 percent royalty on sales. It could not be learned whether Karan received any upfront payment.
John Idol, Karan’s recently appointed chief executive officer, said the wholesale volume of the Donna Karan Beauty Co. is about $40 million. That volume was generated by no fewer than 46 stockkeeping units comprising two major women’s fragrance brands; a men’s scent; Watermist, which Karan herself calls a “non-fragrance fragrance”; skin care, and home fragrances.
The running of Karan’s beauty business is scheduled to shift to Lauder’s uptown headquarters on Feb. 1, the beginning of the next retail year.
The yet-unnamed Karan division will be run as a separate business at Lauder, and it will be managed by Robin Burns, who will also continue as president and chief executive officer of the more than $700 million Estee Lauder USA & Canada division.
During an interview Tuesday that included Karan, Idol and Leonard Lauder, chairman and ceo of the parent company, Burns said the transition details have not been completed, such as the role of Jane Terker, president of Karan’s beauty company, and its roughly 100 employees.
Judging from Burns’s background, she should be a natural fit for working with Karan. In the early Eighties, Burns made her mark by building Calvin Klein’s flagging fragrance business into an industry powerhouse.
In describing this deal, Leonard Lauder was ebullient. Referring to Lauder’s first foray into designer licensing with Tommy Hilfiger, Lauder attributed the strong success of that venture to his partnership with the designer and with Bob Nielsen, president of the Aramis division, where the Hilfiger fragrance business is based. And he expects the same outcome from the relationship with Karan and Burns.
“I always say, ‘Great businesses are built by great people,”‘ Lauder remarked.
When he had previous discussions with Karan, Lauder added, “I didn’t feel that we had all the elements to offer her.” Motioning toward Burns, he said that now he did. He added that the combination of Burns and Karan does not mean one and one equals two but “one and one equals 10.”
Lauder sees two strategic advantages, one overseas where Karan’s name hasn’t been fully developed, although the company has a global network of distributors. He pointed out that two-thirds of his Aramis business is done overseas, and Karan’s fashion presence offers a huge potential in building a global beauty business.
When asked which countries he might focus on with the Karan business, he replied, “every country except Fiji.”
The other advantage is in the U.S., where Lauder feels his mammoth fragrance business could still use further growth, when compared to the dominant shares of the company’s color cosmetics and skin care businesses.
“It gives us a chance to increase our penetration,” he said, while making a reference to “separate Donna Karan counters.”
Burns said no decisions have been made regarding product development, distribution or personnel. But she, like Lauder, lavishly praised Karan’s work, saying that Karan has engendered a “woman-to-woman” connection with the customer that has not only given rise to innovative products but defined an entire lifestyle. “That potential,” she said, “is not limited to fragrance.”
“She brings to the partnership an objective viewpoint,” Burns said. “She has not been jaded by our industry.”
Karan and Weiss spearheaded its development along with Terker. The business grew to the point where it needed an infusion of capital to grow further. Last fall, the principals were ready to give up control in exchange for help from an outside partner.
But not everyone connected with the company was pleased.
During the annual meeting last June, many stockholders said they were frustrated by money-losing ventures — most notably the beauty division. “Have you considered discarding the beauty business, which has lost $28 million over four years?” was one angry question from the floor.
During the interview Tuesday, Idol pointed out that startups typically lose money.
But the beauty business now is in place, an original objective of Karan and Weiss. The business has grown steadily, as have the losses, with the division losing $20.4 million from 1992 through 1995, according to a June 1996 company prospectus. By 1996, the division came close to breaking even but is expected to return to its losing ways this year.
Volume, however, has surged, as Karan’s beauty sales totaled $8 million in 1993, $17 million in 1994, $30 million in 1995 and $44 million in 1996.
Karan said Tuesday that it was important for her to find a partner that appreciated the “cutting-edge, entrepreneurial business” that had been established. She noted that the entire Karan company is “a baby,” still in its infancy, and it needs a partner that can offer the infrastructure of a company like the $3.4 billion Lauder.
She painted the deal with Lauder in highly personal terms: “It’s a perfect relationship” between two family-based firms.
Karan noted that her relationship with executives at Lauder goes back to conversations they had when she started the beauty company, and it was important that “we establish ourselves.”
She added with a smile, “I don’t think they were ready for my rule breaking.”
On the touchy subject of creative control, both sides portrayed the relationship as a collaborative marriage. “You have to have the patience and respect [for your partner], Burns said. Although it sounds basic, she continued, “it doesn’t happen very often.”
Idol, who worked with Cosmair when he was an executive at Ralph Lauren, said Karan would work with Lauder to mesh the marketing of the fashion and beauty operations.
“It takes master branding to another level,” Burns quipped, in a reference to one of her ground-breaking strategies at Calvin Klein.
The initial reaction from Wall Street analysts was enthusiastic, but it failed to drive the stock up. They indicated that it will take some time to bear fruit.
Having already gained 1 1/2 Monday on news of Prince Al Waleed’s $24.2 million investment in Donna Karan, shares of the firm closed at 15 5/8 on Tuesday, down 1/2 on the New York Stock Exchange. Lauder rose 3/16 to 46 1/4 on the NYSE.
“I think it’s the right move for Donna Karan, going with the premier company in the beauty industry, and it’s the right move to license it,” said Brenda Gall of Merrill Lynch. Analysts said Karan’s beauty business will benefit from Lauder’s strengths in distribution and marketing. They also said the deal will free Karan to focus on designing apparel.
Although the terms of the deal were not disclosed, Peter Schaeffer of SBC Warburg Dillon Read, estimated the royalty rate will probably be 6 percent and pointed out that Lauder is not buying any of Karan’s beauty inventory.
He noted that “there were only a handful of companies who could do this deal for Donna Karan and have it make sense.” Lauder, he said, has the distribution structure and is not heavily into the designer beauty business.
Schaeffer said Karan’s beauty business posted a wholesale volume of $44 million last year but has never been profitable. However, he expects it to make money for Lauder from the outset.
Citing the success of Lauder’s licensed Tommy Hilfiger fragrance business, which has retail sales of $150 million to $200 million, Schaeffer said the Donna Karan beauty business could develop into a $350 million to $400 million business.
Schaeffer added that the new licensing deal is not affecting his earnings estimates for Donna Karan for this year or next year, noting that if anything, the company’s sales growth will probably take a hit without the beauty business.
The bottom line will also be affected. Donna Karan said Tuesday it will record a $30 million pre-tax charge in the fourth quarter to cover write-downs and restructuring of the beauty business.
In turn, the company said, the Lauder deal will eliminate an expected $7 million loss in the beauty division.
Janet Joseph Kloppenburg of Robertson Stephens & Co., said Lauder’s strengths in packaging and marketing are “unparalleled.” She said Lauder has the clout to gain shelf space in key locations, which is crucial to success in the highly competitive, crowded prestige beauty business.
Faye Landes of Smith Barney noted that something Karan lacked “was critical mass, and that’s certainly something Lauder has.” Landes said there is very strong potential for a DKNY beauty line, which has yet to be introduced.
Kloppenburg said the licensing deal is “terrific,” adding: “They can mirror, if not exceed, the success of the Hilfiger license.” Kloppenburg said there is very little overlap between these two designers. There might be some overlap between Hilfiger and DKNY, she said, but that might not be a problem because the DKNY customer is somewhat older and more affluent than the Hilfiger consumer.
Kloppenburg noted the two companies said it will take a year to roll out new packaging, products and ads; she would prefer a shorter time span, but said the companies are probably providing a deadline they are certain they can meet.
“To have a company like Estee Lauder as a licensee enhances the Donna Karan product, and now Donna can focus more on her primary business of designing beautiful clothes,” said Walter Loeb of Loeb Associates.
Loeb said the beauty business had been a drain on Karan’s time and resources.
Retailers, meanwhile, had a uniformly positive reaction to the new union. Karan has strong products and needs some financial support, merchants said, and Lauder can provide backing as well as a stronger infrastructure.
“I think it’s a terrific arrangement,” said Michael Gould, chairman and chief executive officer of Bloomingdale’s. “These are two of the best partners we have.”
He said Karan’s fragrance business, which initially had an exclusive run at Bloomingdale’s in 1992, “is one of our strongest fragrance businesses and has been from the start. Then you take Estee Lauder — in terms of execution, it just doesn’t get any better. With Donna Karan being one of the great names in the business and Lauder having the personnel, this looks to be a great combination.”
“This is a very exciting acquisition for Lauder,” said Barbara Moore, senior vice president of fragrances and cosmetics at Macy’s East. “The marriage of these two powerful companies should produce a wonderful growth opportunity.
“It’s an exciting alliance, but it will be interesting to see how the sales and marketing situation works out,” Moore added, referring to whether Lauder will keep Karan’s sales force or merge it with its own.
The Donna Karan products “have been doing very, very well — it’s a very important franchise at Macy’s. The original Donna Karan fragrance is very strong, along with the Cashmere body mist.”
Laurence Williams, vice president and divisional merchandise manager at Jacobsons, based in Jackson, Mich., said Karan is the number-one fragrance brand in the company’s Midwest stores.
“We have a great relationship with Donna Karan,” he said. “To have Lauder pick it up and give it the financial backing it needs is great news. And [Lauder knows] how to run a fragrance business, as well. We expect big things from both of them.”
Diane Gates, divisional vice president at Bon Marche in Seattle, said her store’s Donna Karan business is “fabulous.
“It’s a growing business for us,” she said, “and it’s been terrifically strong this year. Basically, it’s an amazing franchise with a lot of room to grow.”
“When you look at Lauder and what they’ve bought in recent years, it’s obvious that they know how to run a business,” said Nancy Schmidt, divisional merchandise manager for cosmetics at the Milwaukee, Wis.-based Carson Pirie Scott. “This looks like a win-win situation for both companies.”
One executive, who declined to be named, said Karan’s decision to hook up with Lauder was not the result of her seeing the necessity of an alliance: “They were told by the shareholders they had to sell it; it’s as simple as that. They didn’t have any choice in the matter.”
Vendors also thought the deal would benefit both parties.
Robert L. Brady, president and chief operating officer of Parfums Givenchy, said, “Donna Karan is a fabulous name,” and Lauder is “doing the right thing” with all its acquisitions. Karan offers strong points in “an enormous opportunity domestically, and the Donna Karan name is very exportable.”
Among the weak points are a lack of profitability and proliferation of sku’s.
“Creative control is the major issue,” Brady continued. “With creative control, Lauder will do a marvelous job. Without creative control, it will be an ongoing challenge.”
He also said there is “little opportunity” in Lauder’s core business to grow in the future. “Clearly, the intention with acquisition activity is to explore other areas of the market. A niche business today can be a monolith tomorrow.”
Geoffrey Webster, president and general manager of fragrance supplier Givaudan Roure, said Lauder “can provide commerciality to make Donna Karan the success it should have been.”
One problem, he said, is that “the products lack commerciality.” He explained: “They lack the volume of business to be able to be profitable.
“[Lauder and Karan is] a wonderful marriage,” he added. “It will provide [Karan] with an in-depth team of professionals that a small company could not dream of having. It gives them power in the trade.”

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