Avon Products, Inc. (NYSE:N:AVP) is a company under siege, partly because of poor execution and partly because of tough macroeconomic conditions. The problems have left the company struggling with shrinking revenues, rising costs and cash shortage.
As part of its restructuring efforts, Avon is in the process of separating its North American operation in a move that is widely seen as an overhaul transaction.
Overhaul of Avon
How does the sale of the North American business change Avon? The company will be able to drop a problematic business, refine focus on international operations, trim debts and boost cash at hand.
Avon Products, Inc. (NYSE:AVP) has entered into a definitive agreement to sell 80.1% of stake in its North American business to Cerberus Capital for a total of $170 million. The transaction will see Avon’s North American unit privatized. In addition to buying the majority stake in Avon North America, Cerberus Capital will also take a stake of 17% in Avon’s remaining operations through preferred stock investment to the tune of $435 million.
Overall, the dealing with Cerberus Capital is expected to yield $605 million for Avon.
Debt reduction:
Avon Products, Inc. (NYSE:AVP) will allocate $100 million in cash to its North American business earmarked for privatization. On top of that, Avon will transfer $230 million of its liabilities to the North American business.
Avon also intends to use $250 million of the funds generated from the transaction witherberus to pay down its outstanding debt. At the end of the last quarter (3Q2015), Avon’s balance sheet reflected nearly $2.2 billion in long-term debt with total debt hovering around $2.3 billion.
Financial flexibility:
The management of Avon sees the transaction with Cerberus as an opportunity to bring the much-needed financial flexibility in the company’s balance sheet. The $605 million capital injection from Cerberus will not only enable Avon to trim its debts, but also implement its various capital and operational plans for long-term growth and profitability.
Besides the direct cash infusion from Cerberus, Avon also stands to lower its cost burden as it separates a business that has largely been a serious pain in its flesh. Avon North America’s sales declined 17% in the last quarter.
Avon has also suspended dividends in another move aimed at preserving cash for reinvestment in growth. Avon’s quarterly dividends had dropped to $0.06 per share from $0.23 in late 2012. The savings from the separation of the North American business and dividends withdrawal are expected to be incremental boost to Avon’s financial flexibility in the new dispensation.
After privatizing Avon North America, Avon will embark on a mission to grow its international business. The CEO, Sherilyn McCoy, has promised that the company will release its international growth plan in January 2016.
Board shakeup:
The streamlined Avon (without the North American business) will have a lean board of directors. The company’s board membership is set to drop to 11 directors from the current 12 directors. New faces will also be joining the board as six of the current directors are set to step down. Among those leaving Avon’s board is current board chairman Douglas Conant. On Avon’s new board of 11 members, Cerberus will have three representatives, thus giving it a greater say on the board.
The transaction with Cerberus presents Avon with an opportunity to turn around faster than it would have done on its own.
Poor execution and under-investment
Avon Products, Inc. (NYSE:AVP)’s problems are not caused by a sales strategy that is fading in relevance. Direct sales model remains effective, especially as Avon targets emerging beauty markets. Because the problem doesn’t reside in the sales strategy, you get the impression that what has held Avon back is years of miss-execution and under-investment. For example, attracting and retaining talents has been a major problem at Avon.
With the capital injection from Cerberus and a now leaner business structure, the management of Avon should work to improve execution and invest in growth. The fact that the management is already hailing the financial flexibility of the simplified Avon offers hope of better execution going forward.
Pressure points
Declining revenues hurt margins
Avon Products, Inc. (NYSE:AVP)’s revenues have been on a free fall for several years. The topline decay has continued led by North American business, whose total revenue in the initial three quarters of 2015 declined 17% YoY to $731.3 million. In 3Q, Avon’s revenue fell 22% YoY to $1.67 billion. The company posted adjusted EPS loss of $0.11 down from EPS of $0.23 in the same period a year ago.
The chart below shows Avon’s quarterly revenue trend-line:
The shrinking revenues are also pulling down margins because the company is also facing soaring costs, thus presenting the management with a complex situation to deal with.
Competition
Avon Products, Inc. (NYSE:AVP)’s beauty products business is prone to competition from newcomers (online vendors) and established players. As the new structure makes the company more dependent on the international markets, increase in overseas competition can have serious adverse impact on Avon’s growth and profitability.
Venezuelan issue
The Venezuelan government in January 2014 decided to devalue the country’s currency to deal with fiscal deficit and adverse forex movements. Because such currency devaluation moves inspire inflationary reactions, the government may artificially restrict price increases by companies to try to sidestep inflation. Given that Avon generates 5% and 14% of its total revenue and operating profit, respectively, from Venezuela, price controls by the government threaten its growth and profitability in the country.
In is not only in Venezuela that Avon faces the challenge of possible government interference with prices. Such problems exist in Argentina.
Higher international risks
After privatizing the domestic business, Avon Products, Inc. (NYSE:AVP) will increase its exposure to the international markets, which are typically more unpredictable than the U.S. As such, Avon is likely to be more vulnerable to adverse foreign exchange movements, political instability and government interferences in the international markets.
Avon’s regional performance
Avon’s performance has been decaying everywhere and separating the North American business only solves a fraction of the existing problem.
In 3Q, Avon’s North American business recorded a 17% YoY decline in sales to $230.6 million. Things weren’t better in Latin America where sales slipped 26% YoY to $790.9 million. Avon’s EMEA region recorded 19% decline in sales to $499.2 million.
In Asia-Pacific, Avon registered a 16% descent in sales to $146.2 million.
Loss of sales representatives and decline in order values are some of the factors that contributed to widespread decline in Avon’s 3Q revenues.
Bottom line
Shedding the North American business is a step in the right direction for Avon Products, Inc. (NYSE:AVP). However, there is more for Avon to do to get firmly on the path to recovery.
Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.