This will be a quick portfolio update/investing log post updating my thoughts on my Avon position given last week’s announcement that Natura & Co. will acquire Avon.
I wrote about the Avon position about two months ago in this post: Bill Miller Explains Why I Own Coty and Avon. At the end of the Avon discussion I wrote: “Within the last few weeks reports emerged that AVP is involved in talks with a big Brazilian beauty company (Natura). We will see if anything good (i.e., $8-$10 per share) comes from that.”
My point here is that you should subscribe to my newsletter forthwith. hah! As I note before, there were reports of negotiations between the two for a while. I did not buy the stock because of that, because I am not an SAC trader with that sort of information. [Sorry, I am reading Black Edge and man is it entertaining to me so far. ] Seriously though, I do think that speculating on take overs (not merger arbitrage) is a fool’s errand for almost everyone.
Now that deal has been announced, I have to figure out what I’m going to do. As I’ve said before, I think the best default answer is to do nothing. Every time you do something you are using some mental focus/decision capital, not to mention the fact that you are stirring up costs (and maybe taxes). We also have to remember that the tendency for all of us is to miss out on upside by failing to let our winners run/riding the skew. So sitting tight is probably a good default choice.
The Deal Terms
Writing this post is a good exercise because it actually forced me to glance at the deal terms. This kind of stuff (plus creating something I can refer back to) is probably by far the biggest ROI for someone like me on a blog like this.
First, this is a stock deal. Avon shareholders get .30 shares of Natura Cosmeticos for each share. Natura is traded on the Bovespa and quoted in Brazilian Real. As of 05/31/19, I see a quote of $59.98. The real is trading at a 3.92:1 ratio to the USD. So that’s $15.30 x .3 = $4.59.
Kind of a huge merger arbitrage spread there it seems. I guess its kind of a long time until closing, especially given the uncertainties in the Brazilian (and heck U.S. for that matter) economy and political environment. Apparently, Brazil was trying to crack down on beauty spending or something with a tax under the prior regime. A lot of this risk is probably going to be transmitted via the currency exchange rates.
Brazilian real aside, I’m not overly enthused about the price. I was hoping to get $8 per share or more. I do note however that this is an all-stock deal so it’s not like the AVP shareholders are “cashiered” at this price. (unlike in a Brookfield Asset Management patented take-under. Sorry, $TOO soon?)
As an AVP shareholder, you are however getting your relative ownership in the combined surviving enterprise determined based on this valuation/ratio. So basically you are getting diluted if you think intrinsic value is a lot higher.
The good thing, however (and another reason to sit on my duff) is that merger announcements often make other bidders emerge. This makes me curious about the deal termination fees.
I scanned the 8-K. The deal terminates if not consummated by July 22, 2020. The termination fee for Avon is $78.6MM. The termination fee for Natura is $133MM plus another $242MM if the controlling shareholders don’t vote for the deal. It looks Avon walks with the $133MM if regulatory approvals blow the deal.
The Deal Dynamics
First, the termination fee for Avon doesn’t look huge to me. It’s only about 4% of the current Avon market cap. It seems like another bidder with U.S. quoted/listed stock could maybe come in and put together something more attractive than the current deal pretty easily. Then again, the reason Natura is interested is because Avon is almost an entirely emerging markets company now.
As far as the composition of the board and the shareholder base, you have private equity in control (Cerberus). So that kind of makes me think financial buyers/competitive bids are out (otherwise they probably would have done it). There are also some activist hedge funds on the board/in the stock. We haven’t seen any nasty-grams, lawsuits, or press releases yet. Though it did take Icahn a while to weigh in on the recently announced Oxy deal. BTW, if that OXY deal is Buffett’s hurdle/opportunity cost in this market environment, I feel pretty good about this post: Is 2019 Berkshire Too Big to Succeed?)
I’m sure these guys will field offers if there are any and they aren’t going to be placing whether they get to keep their office or retain use of the company’s jets at the top of the criteria list (like a hired manager might). I suppose, however, I won’t hold my breath on any competing bids coming in.
That begs the question, however, why these board members with large financial interests agreed to recommend the deal. Well, it seems like a pretty natural fit. Together they will dominate in Brazil and really all of Latin America. Natura also has some store/retail exposure via the Body Shop. Natura says that after the dreaded “synergies” they are only paying 5-6x EBITDA for Avon.
As for the security we will receive, Natura is going to list an ADR on the NYSE. It also looks like they pay a dividend. I am somewhat intrigued by some Brazilian exposure just because that economy has a lot of potential in my opinion and they kind of just finished up their own sort of great depression. Beauty is also a great industry in Brazil. It would be even greater if Brazil and emerging markets more broadly got back on an economic roll.
I am, however, really mulling over that (now arms-length) 10x EBITDA (and 5-6X EBITDA after synergies) figure. They are basically saying they expect to double the profitability of Avon (as measured by EBITDA). I suppose that seems pretty plausible when you look at the EV/Revenue multiples for Avon’s competitors.
In conclusion, I think I am just going to sit tight for now, because there is no compelling reason not to do so. I will at least give it a few months to see if any other bidders are spurred into motion. I will also continue to closely watch what Cerberus and the activist funds in Avon do.