Avon Products is a stock that we started buying and selling puts on in November of 2011 for some clients.  During that time period Avon’s share price had dropped significantly due to regulatory problems in Brazil, and poor management from Andrea Jung. Today the company announced that privately held Coty Inc., offered to buy the company for $10 billion or $23.25 a share.  Avon has rejected the bid but we wouldn’t be surprised to see Coty increase the offer as the offer is only 8.9 times EBITDA versus 10.8 times EBITDA for deals in this industry on average.  Avon has a nice business model and a great brand but it needs a lot of work on the corporate governance side.  Andrea Jung has not been a good leader for the company and when the company announced that they were making a change at the chief executive position, they blew their credibility be keeping Jung on to oversee the process.  Below is the write up that T&T Capital Management put out last November on the company.  The stock is up about 27% from the day of the write up.

November 3rd
AVP – $17.95
433MM Shares Outstanding
Market Cap $7.7 Billion
Forward P/E 9.1
Dividend Yield 5.16%
Description- Avon Products (AVP) is a unique marketing company, selling their beauty (cosmetics, fragrances, and skin care) and fashion products through its 6.5 million active representatives in more than 60 countries and territories.  International sales account for about 80% of the firms total with the majority of their profit being earned in Latin America, in Brazil in particular.  The company is about 125 years old.
Investment Thesis- Avon Products is an excellent example of a wonderful business trading at a more than fair price, with the only real problem being mismanagement.  The stock has recently come down quite significantly to around $18 from the mid $20’s due to an earnings miss and news of a possible SEC investigation relating to how the company shares information with Wall Street Analysts.  Avon has two primary target markets.  The first is women that are looking for beauty and fashion products where they face significant competition from companies like Loreal and Estee Lauder.  Their second target market is for their sales representatives in that they need to provide an attractive employment opportunity.  Avon sells their products to their sales reps at a discount, and then their reps sell the products at a retail price through a variety of different sales channels.  Beauty products such as lipstick and makeup are generally pretty resilient even through a negative economic environment.  Avon is not really a North American story.  Their largest market is actually Brazil and they have extensive operations in Russia, Mexico, Europe, and they are seeing solid growth out of China.
Several year ago Avon embarked on a strategic restructuring designed to improve operating margins and to accelerate growth particularly in emerging markets.  While earnings and sales have remained fairly stable in a difficult climate, the company has not seen the margin improvement that they expected. Between 2001-2005 operating margins hovered in the mid-teens, while over the last 5 years they have had difficulty breaking double digits.   A big problem is that costs have been up due to problems associated with incentivizing representatives, and developing the needed infrastructure for both manufacturing and distribution on an appropriate scale.  Avon has made some positive moves in terms of reducing their bloated management team and simplifying the communication channels to the sales reps.
This is a wonderful business in that it requires very little capital investment due to the multilevel marketing business model.  This enables the company to earn fabulous returns on invested capital, enabling them to pay a growing dividend which currently sits around 5.16%.  The stock is a wonderful hedge against the US$ due to the fact that the vast majority of sales are international.  Several years ago before the Great Recession, Avon was regularly talked about as a potential LBO candidate due to their unique business model, which could potentially be levered up if needed.  The company is undergoing some serious leadership issues and I wouldn’t be surprised to see a management change which I think could be a positive catalyst for the company.
At less than 10 times forward earnings Avon boasts an earnings yield in excess of 10%.  I think 3-5% revenue annual revenue growth is certainly within reason and if the margin picture improves, I believe this company can grow earnings in excess of 10% a year over the next 3-5 years.  In my opinion this is the type of business that a Warren Buffett wouldn’t mind owning outright if given the opportunity to buy it at this price.  The company’s balance sheet is solid and I believe that it is very likely that free cash flow will improve particularly strongly when the global economy shows signs of strength, due to their investments in the supply chain to keep up with orders. Of course past performance is not indicative of future results, but the stock has rarely been this inexpensive over the last decade pointing to an extreme level of pessimism that exists both in the market and for this company.  I think the stock should easily generate earnings of $1.75 within the next 2-3 years and at 15 times earnings would place the stock at $26.25.  That upside with what I believe to be a lower risk profile, and a possible buyout call option, makes this a compelling investment opportunity.
This is a stock that we are beginning to accumulate in some portfolios and I just wanted to share some of our analysis.  We will likely use a combination of covered calls, buying stock outright, selling puts, and our hybrid strategy.  As always we will try and dollar cost average into the position.  Thank you very much and if you have any questions or thought at all please don’t hesitate to share.