credit process, avon · •on april 2, 2012, avon received an unsolicited bid from coty inc. to...

© Barry M Frohlinger 1981 - 2012

CREDIT PROCESS, Avon

Barry M Frohlinger

© Barry M Frohlinger, Inc. copyright 1981 - 2015

Company 12 pt. Profiles Scorecard

1

Analysis KSF/Credit Implication Recommendation

Business Risk Profile Recommendation

Earnings Profile

Asset Profile Recommendation

Liquidity Profile Recommendation

Cash Flow Profile

Capital Structure Profile Recommendation

Debt Instrument Profile Recommendation

Debt Maturity Profile Recommendation

Financial Profile

Legal Structure Profile Recommendation

Cash Flow ProjectionsProfile

Credit Structuring Profile Recommendation

© Barry M Frohlinger, Inc. copyright 1981 - 2015 2

Transaction Assessment

• As of April 2015, Avon has a three-year, $1 billion revolving credit facility, which expires in March 2017; they would like an extension.• We recommend ????????????.• Avon requires financing because

– Its North America operation has experienced prolonged earnings problems– The firm had been paying an outsized dividend

• Dividend payment is now reasonable– Significant amount of cash is trapped, creating a significant mismatch between cash needs and cash sources.– With the strengthening dollar, the firm’s financial condition has weakened.– The firm has a significant 2016 payment of debt.


Transaction Assessment

• Borrowings under this credit facility is based on a spread over LIBOR; reflecting Avon’s credit default swap rate, – with an interest coverage covenant exceeding 4 : 1, – a limit on subsidiary debt and – leverage of 3.75:1.

• The full $1 billion line is not available to the firm without violating covenants.• On July 31, 2012, the firm needed waivers from the banks for a financial covenant breach, due to the impairment

charge of Silpada. • On December 21, 2012, the interest coverage ratio [revolver] was amended to exclude

– (i) extraordinary expenses and one-time fees or charges incurred in connection with any asset sale, equity issuance or repayment of debt or refinancing or amendment of any debt instrument and

– (ii) cash charges incurred in connection with any restructuring or relating to any legal or regulatory action in an aggregate amount not to exceed $400

• Avon has no more headroom to exclude charges.• The revolver backs up the firm’s $1 billion CP program, which has $0 million outstanding at FYE 2013 & 2014;

– Avon has no access to CP market, because of its ratings.– Private Notes were repaid in 2013, giving Avon increased liquidity, but still no CP access due to Avon ratings


Executive Summary

• Loan Cause: Avon is currently under a restructuring program to recover profitability which has significantly decreased since 2007

– EBITDA Margin: 750bps reduction between 2004 and 2014 [17.5% to 10.0%]• Seasonality further leads to increased working capital [inventory] financing needs in the high season• Purpose: Rating agencies require sufficient credit lines to ensure liquidity of the firm. The Company’s cost of debt is

tied to its credit rating which has been recently corrected downwards by all rating agencies. Stronger liquidity, together with margin improvements from the restructuring activities, will allow the Company to improve its ratings, which are non IG by S&P, Moody’s and Fitch.

• Lending Rationale: Avon borrows through its US operations, which has poor performance, significant cash is “trapped” outside the US; both due to tax reasons and certain country restrictions.

• This should be cash flow loan– although the firm also has some seasonality

• Some items to consider:– Management’s proven commitment to boost cash flow (4Q 2012 Dividend Cut)

• CapX cut in 2014– However, neither earnings or leverage have improved

• Even with the current profitability issues, the firm generates satisfactory cash flow– Successful refinancing of their Private Notes and Term Loan Prepayment through the issuance of new public

notes due 2016, 2020, 2023 and 2043


Avon Overview

Revenue Breakdown by Region

• Global manufacturer and marketer of beauty and related products operating worldwide. Unlike most of Avon’s CPG competitors, which sell their products through third-party retail establishments, Avon’s business is conducted worldwide primarily in one channel, direct selling through the direct selling channel with about 6 million selling representatives

•Significant management changes in 2012 to address key issues of Avon business:

•Competition from large scale global beauty products in developing markets

•Execution problems: inventory management, misjudging product demand, poor representative recruitment

•Significant legal issues

Latin America,

48%North

America, 14%

Europe, 31%

Asia, 8%


Industry

6

Skin and Sun Care29%

Fragrance12%

Hair Care20%

Color Cosmetic14%

Personal care16%

Mens Grooming9%

207 212 215 224 234 244 253

0

50

100

150

200

250

300

2007 2008 2009 2010 2011 2012 2013

Revenue in Bn


Business Operations & Corporate Strategy

• Selling process:• Independent representatives contact customers selling primarily through brochures • Representatives forward orders from customers to a Avon distribution centers• Avon sell the products to the representatives at a discount price and they on-sell to the customer.

• Promotion and marketing:• Sales campaigns generally run for 2-4 weeks• Supporting activities such as new brochures, samples and demonstration products are provided to support the representatives

to reach new customers• Print, TV and other advertising is used to increase awareness of Avon products• Training and support is provided through district sales managers

Business Operations

4


Business Operations & Corporate Strategy

• Driving profitable growth by improving access to brands and products [Poor Execution]• Strengthen and leverage the direct sales force [Poor Execution]• Maximize geographic portfolio and expand brands and channels [Poor Execution]• Reduce Operational costs to achieve low double digit operating margin by 2016• Restructuring or closure of certain smaller, underperforming markets, including exit from the South Korea, Vietnam and

Ireland markets

Corporate Strategy

4


Industry Overview - Consumer Staples

Changing lifestyles in developing international markets could provide growth opportunities

• The beauty and beauty-related products industry is highly competitive.• Seasonal in nature – holiday sales peak in Q4

Worldwide, Avon compete against products sold to consumers in a number of distribution methods, including; • Other direct-selling companies, • Internet • Products sold through the mass market and • Prestige retail channels.• Direct selling accounts for

• 29% of Brazil’s beauty and personal-care market• 14% of China• And only 8% in the U.S.

Outlook

5


Significant Events• On December 13, 2011, Avon initiated a search for a new chief executive and stated Andrea Jung will continue as chairman of the board for the next

two years. – Jung joined Avon in 1994 as the company's president in its product marketing group and in November 1999, Jung was promoted to chairman

of the board and chief executive officer. Many felt she did an atrocious job as CEO and her tenure was reflective of corporate governance problems.On October 5, 2012 Andrea Jung, announced her resignation But remain as a senior advisor through April 2014.

• A multitude of controversies compelled Jung to announce her resignation. – The company's stock dropped 45% in 2011.

• Stock was down 58% in past 5 years while S&P up 9% and peers up 21%– Avon disclosed that there were two ongoing SEC inquiries. – The financial results trailed analysts’ projections for years. – There was also a three-year probe into an alleged bribery of foreign officials, which led to the former interim CFO to leave

• On April 2, 2012, Avon received an unsolicited bid from Coty Inc. to acquire Avon for $23.25 per share, a 20% premium to the then price of $18.60. On May 14, Coty withdrew its proposal. By YE 2012, Avon’s share price was $16.50.

– In February 2014, Avon began marketing Coty Products through its 1.5 million Brazilian reps.• In April 2012, Avon brought in Sheri McCoy, a Johnson & Johnson (JNJ) vice chairman as CEO.

– At J&J she oversees the global pharmaceutical business and the consumer unit, which includes skin-care brands like Neutrogena. • McCoy has embarked on an ambitious turnaround plan that includes wringing out $400 million in costs, sharply increasing sales and

almost doubling operating margins within three years. • This is the third turnaround since 2005

– Management is attempting to correct many problems• Senior talent • Stabilization key markets, North America, Brazil and China • Prioritize product categories, Fast track mobile and social media • Reduce cost base and improve focus on cash management, Improve capital structure • New management states they have “relentless focus on our Representative and consumer”


Recent Events• Avon’s peers include the following

– NuSkin, Estee Lauder, P&G, Clorox, Revlon, Tupperware, L’Oreal, Colgate-Palmolive and Kimberly Clark

• Avon’s segments are based on geographic operations in four regions [was 5]:– North America– Latin America– Western and Central Europe– Asia Pacific

• In conjunction with organizational changes, effective in the second quarter of 2012, the results of Central and Eastern Europe and Western Europe, Middle East & Africa were managed as a single operating segment.

• The firm made a similar organizational change in 2011, managing China as part of the Asia Pacific segment. In the two years since the reporting/organizational change in Asia Pacific/China, China revenue is down over 50%.

• Avon had reported three product categories– Beauty - cosmetics, fragrances and skin care.– Fashion - jewelry, watches, and apparel.– Home - gift and decorative products, housewares, leisure products and nutritional products

• Now, reporting 2 product categories– Beauty and Fashion


Peers

12


Management Assessment

Sheri McCoyCEO and Dir

Sheri McCoyCEO and DirectorMore than 30 years experience Johnson and Johnson most recently serving as Vice Chairman of the Executive CommitteeIn 2013, Ms. McCoy ranked #20 on Fortune magazine's "50 Most Powerful Women in Business" list, which she has been on since 2008

Kimberly A. RossEVP and CFOJoined Avon in 2011 after after 10 years at Royal Ahold, a Netherlands-based international group. [credited with helping Ahold after its 2003 accounting crisis]

Fernando J. AcostaSVP & President, Latin AmericaJoined Avon in 2011 after 19 years in Unilever[Latin America and Europe are key]

• Avon has a new management team led by Sheri McCoy who joined Avon in April 2012

• CEO Andrea Jung and CFO, Charles Cramb stepped aside at the end of 2012 following multi-year restructuring programs and regulatory challenges in China

• New financial goals of the new management team include mid-single digit constant dollar revenue growth and low double digit operating margin over the next three years

• Cost savings of at least $400 million is also targeted in the next 3 years

• While the new management changes may be positive, there is risk in their ability in direct sales business

Brief Overview Executive Management

2

Douglas R. Canant Chairman Former President & Chief Executive Officer, Campbell Soup Company; Founder & Chief Executive Officer, Conant Leadership


Management Assessment

Kimberly A. RossEVP and CFOJoined Avon in 2011 after after 10 years at Royal Ahold, a Netherlands-based international group but left Avon in October 2014.

On September 8, 2014, Avon announced that Kimberly Ross will be resigning as of October 2, 2014.Robert Loughran, Vice President and Corporate Controller of the Company will serve as acting Chief Financial Officer, effective October 2, 2014, while the Company completes its search process for a Chief Financial Officer.Loughran, has been Vice President and Corporate Controller of the Company since May 2012, and prior to that, served as Vice President and Assistant Controller since 2009 and Executive Director and Assistant Controller since joining the Company in July 2004.

Avon announced February 1, 2015 the hiring of a new CFO, James Scully, previous COO of J Crew, apparel retailer, who led J Crew through 2 years of poor performance.

Brief Overview Executive Management

2


Management Assessment: Medium/High Risk

YEAR ROLE NAME RATIONALE COMMENTS2011 CFO Charles Cramb Steps Down.

Continues as Vice-Chairman

Interim CFO Replaced byKimberly Ross

May2011

CFO Kimberly Ross CFOappointed

Replacing Charles Cramb Previously CFO of AHOLD

May2011

VariousExecutives

S.K. Kao, G.Manager

Jimmy Beh, CFO China

C.Q. Sun, Head Corporate affairs for China

Ian Rossetter, Head of global internal audit and security

In conncetion to allegedAvon bribery in Chinainvestigation that startedin 2008

Dec2011

CEO Andrea Jung Steps Down as CEO. RemainsChairman

2001-2011 CEO of AVON. Under allegations of bribery in China, replacedin Apr 2012

Replaced by J&J vice-chairmanSherilyn McCoy

6

• High turnover of key senior management since 2011, notably CFOs• CEO remains stable• Lack of execution on key areas (Cost reduction, IT development, Internal audit, amongst others)


Management Assessment – Medium/High Risk Continued

YEAR ROLE NAME ACTION RATIONALE COMMENTSApr2012

CEO Sherilyn McCoy Appointed Previously 30 yrs at J&J, latest position Vice-Chairman

Replacing Andrea Jung as CEO

Jan2012

Vice-Chairman

Charles Cramb Dismissed AVON alleged bribery China

Dec2012

Chairman Andrea Jung

Resigned Replaced by Fred Hassan (independentDirector at AVON)

Apr2013

Non-ExecutiveChairman

Fred Hassan Resigned from theBoard

To spend more time on otherprofesional commitments

Replaced by Doug Conant (BoardDirector)

Apr2013

Chairman Doug Conant

Appointed

Sept 2014

CFO Kimberly Ross Resigns Move to Baker Hughes as CFO

Replaced by Robert Loughran

Sept 2014

CFO Robert Loughran

Appointed Acting CFO Corporate Controllerat AVON

Jan2015

CFO James Scully Appointed Replacing acting CFO Robert Loughran

9 years at JC Crew, latest CEO

7


Share purchases [$4 billion at $24]

17


Acquisitions and Disposals

Announced Closed Type Entity Value Description

12 02 Jul '13 03 Jul '13 MBO Silpada Designs, Inc. 100 Acquired by Silpada Designs Management

11 08 Nov '10 21 Dec '10 Disposal Avon Products Co. Ltd 50 TPG acquired 93.8% stake in Avon Ltd (Japan)

10 12 Jul '10 28 Jul '10 Acquisition Silpada Designs, Inc. 650 US-based manufacturer of Handcrafted jew elry

9 25 Mar '10 25 Mar '10 Acquisition Liz Earle Beauty Co. Ltd. -- UK-based manufacturer and (direct) distributor of beauty products

8 28 Nov '05 28 Nov '05 Acquisition Avon Manufacturing (Guangzhou) Ltd.

28 Nov '05 28 Nov '05 Acquisition Avon Products (China) Co. Ltd.

7 07 Oct '05 18 Oct '05 Acquisition Maverick Holdings 154 Cayman Islands-based HoldCo w ith business in Colombia

6 15 Mar '04 15 Mar '04 Acquisition Avon Products (China) Co. Ltd. 50 Minority Stakes in China business

5 20 Jan '99 20 Jan '99 Disposal Discovery Toys LLC -- Kids Toys business

4 22 Jan '97 22 Jan '97 Acquisition Discovery Toys LLC -- Kids Toys business

3 05 Feb '96 05 Feb '96 Acquisition Justine Pty Ltd -- South Africa-based direct seller of cosmetics

2 26 Jul '94 29 Aug '94 Disposal Giorgio Beverly Hills, Inc. 150 US-based manufacturer of natural & synthetic perfumes

1 01 Sep '93 01 Sep '93 Acquisition Avon Cosmetics SA -- Remaining stake of Avon's Spanish business

Remaining stakes of Avon's Chinese business39

1 2

34

5

6

7

89

10 11

12

05101520253035404550

01.01.1990 01.25.1993 02.19.1996 03.15.1999 04.08.2002 05.02.2005 05.26.2008 06.20.2011

7


Significant Events

• Avon issued $1.5 billion bonds in 2013, including 2043 notes with a 6.95% yield, in order to repay maturing debt, prepay their 2010 private notes, with a make whole payment of $68 million, and repay $380 million of the 2012 term loan.

• The company's stock hit a multi-year low of $13.81 in November 2012 after Avon slashed its dividend; it rebounded to $22 within a year but has fallen back to $8.90

• In February 2013, Fitch lowered Avon’s Credit Rating from BBB- to BB+ and Moody’s to Baa2 [Stable Outlook] from Baa1 [negative Outlook]. S&P Rating BBB-. Fitch lowered the rating again in November 2013 to BB and Moody’s lowered rating again in February 2014 to Baa3, and S&P lowered rating to BB+ in November 2014.

• Significant liquidity and net worth trapped in Venezuela

http://online.wsj.com/article/SB10001424052970204712904578092590880279214.html


Competitors

AmericasEMEAAsia Pacif ic

FragrancesColor CosmeticsSkin & Body CareOther

N/A

8

L'Oreal Revlon Estee Lauder Shiseido Beiersdorf Coty NuSkin Average

Revenue 30,500 1,500 10,400 7,500 8,200 4,500 3,200 9,400

EBITDA 6,300 280 1900 930 1150 680 580 1,689

EBITDA margin 20.7% 18.7% 18.3% 12.4% 14.0% 15.1% 18.1% 16.8%

Operating Profit 5,100 200 1,500 540 1,000 420 550 1,330

OPM 16.7% 13.3% 14.4% 7.2% 12.2% 9.3% 17.2% 12.9%

EV 95,000 3,100 25,500 7,900 22,000 7,400 4,600 23,643

EV/EBITDA 15.1 11.1 13.4 8.5 19.1 10.9 7.9 12.3

EV/Sales 3.1 2.1 2.5 1.1 2.7 1.6 1.4 2.1

Debt/EV 6% 62% 5% 21% 1% 35% 4% 19%

AVON

Revenue 8,766Op Profit 649EBITDA 880EBITDA margin 10.0%

EV 5,118

EV multiple 5.8


Business Risk ProfileRisk Description Probability Impact/

ConsequenceMitigant Recomendatiion

FX Cash Flows and Loans are in different legal entities and different currencies Very High Very High

Repatriate cash to US. Increase Local Currency borrowings

Representatives Fundamental challenge in direct selling is getting people to sell products, not getting buyers. 5% decline in reps in 2014. Reps want raise in commissions, lower cost brochures and ease up on pressure to recruit more reps

Very High Very High

New management focus

Management Prior Management demonstrated execution weakness & acquisition failures; multiyear unsuccessful restructuringand weak corporate governance. Weak management of reps New management team, however, untested and recent departure of CFO and new CFO. New Board.

High Very High

73-89% of comp tied to performance; srleadership must hold stock more than 6X comp

Towers of Debt Large Towers in 2016, 2018 and 2019

Very High HIgh

DCM still open to the firm, however, at a cost.

Competition Natura in Brazil North America operations are unprofitable

High High

Over 1 million reps in Brazil

Sale of North America

5


Business Risk ProfileRisk Description Probability Impact/

ConsequenceMitigants Recomendatiion

Poor Financial Results

Avon Stock price down 75% while peers up 88% over past five years

High High

EV reflects existing core business is still somewhat acceptable. Business Model requires limited CFOps.

Government regulations

FCPA

High Moderate

Management believes they have a settlement for $135 but agreed to an 18 month regulatory supervision

Business Model Avon model was built on convenience of buying from comfort of home. Internet has made access to cosmetics easy

High Moderate

Product and Business Model work in selected countries, requires proper strategy and execution.

Bring In IB for Strategy Discussions

Operational Reliance on direct selling modelIT InfrastructureManagement of Inventory levels (Seasonality)High costs in maintaining a working and stable IT infrastructure platform across 50+ countries

Moderate Moderate

5


Six Considerations for Credit Weakness

• Management Weakness• Weak internal controls

– Financial and/or non financial• Weakness in business

– Cost structure• Weakness in strategy

– Unrelated acquisitions, excessive cap X• Inappropriate financial policies

– Excessive debt, wrong currencies• Competition

23


“customer reps”Get product at discount

“casual sellers”Earn 2X min wage

“top sellers”15 hours per week

“top leadership”Full timeProvides

median income

“top leadership”“wealth creator”

2 - 3 X median income

Earnings Potential from Avon

Time spent

Reps


Invest-Rising StarsChina, India, Turkey

ExitSouth Korea, Vietnam

Fix Big GunsUS and Uk

Drive GrowthRussia and Brazil

LeverageAustralia and Italy

Strategy


Seasonality

4th 20

14 3 2 1

4th 20

13 3 2 1

4th 20

12 3 2 1

4th 20

11 3rd2nd 1s

t

4th 20

10 3rd2nd 1s

t

4th 20

09 3rd2nd 1s

t

4th 20

08 3rd2nd 1s

t

4th 20

07 3rd2nd 1s

t

4th 20

06 3rd2nd 1s

t

4th 20

05 3rd2nd 1s

t

4th 20

04 3rd2nd 1s

t

4th 2

003 3rd2n

d

AR Inventory


Revenue, change in reporting

Beauty0%

10%

20%

30%

40%

50%

60%

70%

80%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014Beauty 69% 69% 69% 70% 72% 72% 71% 73% 73% 73% 73%Fashion 31% 31% 31% 30% 28% 28% 29% 27% 27% 27% 27%

Beauty

Fashion


Revenue – Geographic

0

1,000

2,000

3,000

4,000

5,000

6,000

2004 2006 2008 2010 2012 2014

North AmericaLatin AmericaEuropeAsia


Contribution Revenue per segment

0%5%

10%15%20%25%30%35%40%45%50%

2006 2008 2010 2012 2014

Latin AmericaNorth AmericaEuropeAsia


Non Beauty sales

0%5%

10%

15%

20%

25%

30%

35%

40%45%

2014

USRest of WorldGlobal


KPI’s, Avon utilizes key performance indicators (“KPIs”) to evaluate its business.

-6%-4%-2%0%2%4%6%8%10%12%14%

200420052006200720082009

2010

20112012

2013

2014

Reps 13% 3% 5% 7% 1% 9% 4% -1% -1% -2% -5%Units 11% 6% 2% 9% 7% 3% 1% -2% 0% -5% -5%

RepsUnits


Revenue - Geographic

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2004 2006 2008 2010 2012 2014

USBrazilRest Of World


Revenue – Geographic [China business off 42%,20%, 22%, 10% in past 4 years, different model, Russia business up in 2014]

BRC 18% 21% 23% 26% 28% 29% 29% 27% 26% 27%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014


OPM, adjusted [best case, all “noise” removed]

0%

2%

4%

6%

8%

10%

12%

14%

16%

2004 2006 2008 2010 2012 2014

OPM


OPM per segment

-4%-2%0%2%4%6%8%

10%12%14%16%

2010 2011 2012 2013 2014

Latin AmericaNorth AmericaEuropeAsia


OPM compared to peers

-5%

0%

5%

10%

15%

20%

25%

2004 2006 2008 2010 2012 2014

AvonNu SkinRevlonL'OrealTupperwareColgate PalmoliveCloroxKimberly ClarkP&G


OPM compared to peers

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

2004 2006 2008 2010 2012 2014

AvonComps


Returns on Assets and CapitalLevel is still ok, but trends are down

0%

10%

20%

30%

40%

50%

60%

2007 2008 2009 2010 2011 2012 2013 2014

OPM

RROIC


Efficiency, Revenue/Invested Capital

0

1

2

3

4

5

6

7

2007 2008 2009 2010 2011 2012 2013 2014

Rev/IC


Efficiency

Revenue Op Profit Op Assets Inv CapitalCAGR 07 - 14 -2% -9% 0% 9%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%CAGR 07 - 14


Earnings

0%

10%

20%

30%

40%

50%

60%

70%

2007 2008 2009 2010 2011 2012 2013 2014

GPMOPM

41


Profitability

• Year 2014– Avon’s profitability metrics are mediocre. Management believes fourth quarter of 2014 begins to show some improvements but impacted to

due dollar strength. Latin America remains the largest segment, but Europe remains the most profitable segment, due to a strong business in Central Europe, where the direct sales model appears well matched to the market. North America, the third largest segment, performed very poorly during 2014. Avon struggles with a North America cost structure not in line with the revenue. North America was unprofitable at the operating profit level, on an adjusted. Venezuela is also a problem for the firm. Avon performs much below peers, attributable to management inability to execute.

– One of the key metrics for the firm is reps, the firm has 6 million reps globally; Avon has had problems retaining reps in key markets, including North America, where the firm lost 18% of reps in 2014. Avon’s field representatives have thrown in the towel since the company launched its transformational “One Simple Sales Model” initiative in 2011, which involved slashing district sales manager positions and reassigning existing representatives. Non beauty sales, which have lower margins than beauty, represent 45% of US sales, consistent with prior years.

– In the process of reducing the number of district managers and reassigning representatives, Avon broke some critical relationships, • direct sales is a relationship business• And the recruiting engine “fell apart” as the disruptive program was rolled out.

– Avon still generates acceptable returns on capital, because it is not a capital intensive business; it has a short cash cycle with limited fixed assets. The firm is management intensive.

• Year 2013– Avon’s profitability metrics remain mediocre. Fourth quarter 2013 results were very weak, with a 5% decline in reps. Latin America remains

the largest segment, but Europe remains the most profitable segment, due to a strong business in Central Europe, where the direct sales model appears well matched to the market. North America, the third largest segment, performed very poorly during 2013, due to its cost structure. 2013 marked the first time North America was unprofitable at the operating profit level, on an adjusted basis The firm lost 16% of reps in 2013.

• Trend 2014 versus 2013– Revenue declined in FY2014, due to a strong dollar along with a reduction in units shipped. Revenue declined in all segments, and margins

remained essentially flat in two largest segments.


Profitability

• Trend 2013 versus 2012– Revenue declined in FY2013, due to a strong dollar along with a reduction in units shipped. Revenue declined in all segments, although margins rebounded in two largest

segments, Europe and Latin America due to improved product mix and lower supply chain costs. Management also attributes the turnaround in the UK due to improved representative engagement.

• Year 2012– Avon’s earnings are significantly lower than peers; and most profitability metrics for Avon are mediocre. For segment reporting, Central

Europe was merged with Western Europe and now is the most profitable segment, due to a strong business in Central Europe, where the direct sales model appears well matched to the market. North America, the third largest segment, performed very poorly during 2012.

• Trend 2012 versus 2011– Revenue declined modestly in FY2012, mostly due to a strong dollar as most of Avon’s business is transacted in currencies not the US

dollar. Along with revenue decline, profitability fell significantly. The firm continues to struggle with implementation of its stabilization strategies, cost savings initiatives, multi-year restructuring programs and other initiatives, including Service Model Transformation in order to achieve anticipated savings and benefits from such programs and initiatives. The firm has been attempting to implement these strategies since 2004, with no success; Consolidated Operating Profit Margin fell in 2012 due to increases product costs, the product mix and increases in selling, general and administration costs; due to unfavorable operating leverage. Revenues and margins fell in all four of the segments; Latin America and Europe, accounting for 74% of revenue, were both impacted by currency and profits impacted due to supply chain problems and currency. Also, Europe was impacted due to bad debts. North America remained weak in 2012, due to reduction in the number of reps, units shipped and the investment in the RVP.

– In summary, margins declined in all segments. • Earnings Trend

– Over the past 11 years, Avon has experienced a significant decline in earnings, operating profit margins in addition to reduced returns on assets and capital. The reduced earnings have occurred throughout the entire firm. The year 2008 represented a possible turnabout in the firms results; however, this has not been sustained with operating failures in key markets. The sad story really starts around 2005, when Ms. Jung was in her sixth year as C.E.O. Rising competition, an outdated electronic supply system in Brazil, missteps in Russia and China, bloated management, misdirected marketing — all combined to choke off profits. By 2009, Liz Smith, the company’s highly regarded president, left. A flurry of regional managers exited as well. Even after Ms. Jung cut $1 billion in costs in the latest of two restructurings, profitability kept dwindling. As the share price sank, the company began to look like takeover bait. Rumors circulated that L’Oréal might swoop in. Ms. Jung simply made bad decisions. Avon spent $3 million on a Super Bowl ad in 2009 to recruit sales representatives but didn’t invest enough to train the new employees. It spent $650 million in 2010 to acquire Silpada, a direct seller of silver jewelry, only to write down the investment the next year largely because of a rise in silver prices. Then legal and regulatory issues rocked Avon. In 2011, the Securities and Exchange Commission started an investigation into possible breaches of the Regulation Fair Disclosure rule, known as Reg FD, related to corporate information that the company shared with financial analysts. That same year, Avon became the focus of an investigation into accusations that it violated the Foreign Corrupt Practices Act by bribing officials in China — an issue that has cost the company more than $250 million in legal costs and led to the dismissal of at least four executives. (Ms. Jung wasn’t accused of wrongdoing.)


Balance Sheet Profile

0

200

400

600

800

1000

1200

1400

WC needs PPE intangibles

44


Balance Sheet Profile, relative to peers

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

WC needs PPE Intangibles

45


Balance Sheet Profile

Intangibles

Equity

PPE LT Debt

0

1000

2000

3000

4000

5000

6000

Assets Financing

46


Cash cycle

0

50

100

150

200

250

2007 2008 2009 2010 2011 2012 2013 2014

AvonNu SkinEstee LauderCloroxColgate PalmoliveKimberly ClarkP&G


Cash cycle, Avon

0

20

40

60

80

100

120

2007 2008 2009 2010 2011 2012 2013 2014

AR daysInventory daysAP days


BS Management

0%5%10%15%20%25%30%35%40%45%

2007 2008 2009 2010 2011 2012 2013 2014

OPWC/SalesIntangibles/SalesPPE/SalesIC/Sales


BS Management• Avon has a moderately short cash cycle, shorter than cosmetic peers, due to short

ar days and good financing from suppliers. Avon has short ar days due to its business models; where they sell to almost 6 million global reps and provide little financing to these customers.

– Receivable risk has increased in recent years as 3% of sales are uncollectable and operating margins have been reduced.

• In addition, inventory days for Avon are significantly shorter than other cosmetic firms because Avon has a continuous introduction of new products, as a sales technique for its reps.

• Avon’s cash cycle is consistent to other packaged goods companies.• Avon has a moderate need for capital to finance non current assets, with a

nominal investment in tangible fixed assets. Avon had a noticeable increase in intangibles assets, in 2010 due to the Silpada acquisition. The firm has few intangible assets, but a large DTA.

• Overall, the capital financing requirements of Avon are moderate, which is very favorable. However, asset growth over the past 5 years has not produced revenue or additional profits, which is very troubling.The firm has begun to show an improved efficiency in using invested capital as the firm has pared back Cap X.


Cash Flow Profile

0200400600800

1,0001,2001,4001,6001,800

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

EBITDA

Funds Flow

Cash Flow fromOperations


Cash Flows

-200

0

200

400

600

800

1,000

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Cash Flow fromOperationsCapital Spending

Dividends

Actual Cash Flow[Credit-SR]


Cash Flows

0

200

400

600

800

1,000

1,200

1,400

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Funds Flow

Mandatory CapitalSpendingDividends

Long Run Free CashFlow


Cash Flows

0

200

400

600

800

1,000

1,200

1,400

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Funds Flow

Cash Flow fromOperationsMandatory CapitalSpendingDividends

Long Run Free CashFlow


Cash Flows

050

100150200250300350400450

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Capital Spending

Mandatory CapitalSpending


Cash Flows

050

100150200250300350400450

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Capital Spending



Cash Flows

(200)0

200400600800

1,0001,2001,4001,6001,800

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

EBITDA

Funds Flow

Cash Flow fromOperationsCapital Spending


Credit Free CashFlowsLong Run Free CashFlow


Cash Flows

-100

0

100

200

300

400

500

600

700

800

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Actual Cash Flowsto repay debtLong Run CashFlow


Cash Flows

02,0004,0006,0008,000

10,00012,00014,00016,000

Total 2004 - 2014

Total 2004 -2014

14,271 10,319 7,444 EBITDA Funds Flow CFOps


Cash Flows

01,0002,0003,0004,0005,0006,0007,0008,000

Total 04 - 14

Total 04 - 14 7,444 2,753 3,157 1,534

CFOps CAP X Dividends Credit FCF


Debt Maturity ProfileTowers, Actual and Projected

-100

0

100

200

300

400

500

600

2012 2013 2014 2015 2016 2017 2018 2019

Actual CF to repay debt CPLTD


Cash Flow Profile

• Avon’s Cash Flows during 2014 were good. Avon generated modest earnings, but as the firm is not capital intensive and has a modest dividend payout, Avon generated residual cash flows for debt payment. The firm had a small tower of debt due in fiscal 2014. In the short run, cash flows during 2014 were acceptable; Avon’s maturity schedule allowed limited financial flexibility, as the next tower is due in 2016.

•Avon’s Cash Flows during 2013 were acceptable. Avon generated modest earnings, but as the firm is not capital intensive and has a modest dividend payout, Avon generated residual cash flows for debt payment. The firm had a sizeable tower of debt due in fiscal 2013. In the short run, cash flows during 2013 were acceptable; Avon’s maturity schedule allowed them some financial flexibility, as the next tower is due in 2016.

•Avon’s Cash Flows during 2012 were not strong. Avon generated modest earnings and with a large dividend payout, the firm has no residual cash flows for debt payment. Avon converted most of earning into cash flow; however, the actual cash flow from operations just covered both the capital spending and dividends, as the firm is slightly expanding and has a very high dividend payout ratio. The firm had a small tower of debt due in fiscal 2012. In the short run, cash flows during 2012 were not very good.

–The 74% dividend cut at YE 2012 helped stabilize the firms cash flows•During 2011, Avon did not convert a noticeable amount of earning into cash flow; this is concerning. The actual cash flow from operations didn’t cover both the capital spending and dividends, as the firm is expanding tangible fixed assets and has a very high dividend payout ratio. In the short run, cash flows during 2011 were not very good, but the firm has good potential in the long run to satisfy all its requirements.

•Over the past 11 years, EBITDA and Funds Flow haven’t increased as Avon has an earnings problem. Free Cash Flows weakened from 2007 - 2012. With the smaller dividend, long run cash flows could approximate $262 million p.a.


Liquidity Profile

0

500

1,000

1,500

2,000

2,500

2007 2008 2009 2010 2011 2012 2013 2014

Working CapitalNeedsWorking Capital

Cash


Liquidity

0

500

1000

1500

2000

2500

2007 2008 2009 2010 2011 2012 2013 2014

CashUnused RevolverLiquidity


Liquidity

0%

5%

10%

15%

20%

25%

2007 2008 2009 2010 2011 2012 2013 2014

Cash + unusedrevolver/Sales


Liquidity Profile

66

Avon Estee Lauder

Sales 8,851 10,969Cash 961 1,629

Unused Revolver 825 1,000

Total Liquidity 1,786 2,629

Liquidity 20% 24%CFOps 360 1,535

Maturity date revolver 2017 2019

Rating BB+ A+Towers in next 5 years $260 million in 2016, $507

million in 2018 and $367 million in 2019

$300 million in 2017


Liquidity Profile

• With a short cash cycle, Avon appears to have sufficient working capital at FYE 2014; however, some of the liquidity [cash] is trapped in foreign subs; this could cause a liquidity issue. Some is tax trapped and some is actually restricted.

• Avon reported during the fourth quarter of 2012, as a result of the uncertainty of financing arrangements and the domestic liquidity profile, Avon determined that the Company may repatriate offshore cash to meet certain domestic funding needs. Accordingly, Avon no longer asserted that these undistributed earnings of foreign subsidiaries are indefinitely reinvested and, therefore, recorded an additional provision for income taxes of $168million on such earnings.

• Cash Flows during 2014 were adequate [because no towers of debt were due]; 2013 were almost adequate; 2012 were not strong; the firm has some seasonality.

• The firm’s revolver provides some access to credit, but the facility is used to support the firm’s commercial paper program [none outstanding at FYE 2012]. Unused availability is $1,000 million, but based upon financial covenant restrictions the firm can only access $825 million. The firm is not using CP as it has been effectively shut out of the market, due to rating.

• Avon’s liquidity relative to Estee Lauder is weak.


Capital Structure ProfileDebt/EBITDA

0

0.5

1

1.5

2

2.5

3

3.5

4

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Avon Nu SkinEstee Lauder


Solvency, also do not miss litigation and SEC

0

200

400

600

800

1000

1200

1400

1600

1800

2007 2008 2009 2010 2011 2012 2013 2014

Underfundedpensionrent adjustment

Securitizations

Total


Solvency, also do not miss litigation and SEC

0

1,000

2,000

3,000

4,000

5,000

6,000

2007

2008

2009

2010

2011

2012

2013

2014

debt+pension+leaseEBITDARP


Solvency [debt+pension+lease]/EBITDARP

0.000.501.001.502.002.503.003.504.004.505.00

2007 2008 2009 2010 2011 2012 2013 2014

leverage


Solvency

0510152025303540

20042005200620072008200920102011201220132014

EBIT/InterestEBITDA/Interest


Solvency

0%

20%

40%

60%

80%

100%

120%20

0420

0520

0620

0720

0820

0920

1020

1120

1220

1320

14

Funds Flow/Total DebtFree OCF/Total DebtEBIT/CapitalTotal Debt/Capital


Solvency

0%2%4%6%8%

10%12%14%16%18%20%

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

EBITDA marginCAP X marginNet


Solvency

0%2%4%6%8%

10%12%14%16%18%20%

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

EBITDA marginCAP X marginDividends/revenue


Solvency

0%2%4%6%8%

10%12%14%16%18%20%

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

EBITDA margin

EBITDA-CAPX -dividends


Equity Cushion

0

200

400

600

800

1000

1200

1400

1600

2011 2012 2013 2014

EquityDTASoftwareGoodwillIntangiblesBrochure


Capital Structure ProfileEquity Cushion

0

500

1000

1500

2000

2500

2011 2012 2013 2014

EquityIntangibles


Balance Sheet

equity

Ltd

0

1000

2000

3000

4000

5000

6000

assets Financing

CashotherAR&InvPPEIntangibles

79


Debt Rating Profile

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

EBIT/Interest AAA AA- A+ A+ A+ A+ A+ A+ BBB+ BBB+ BBB

EBITDA/Interest AAA AA- A+ A+ A+ A+ A+ A+ BBB+ BBB+ BBB+

Funds Flow/Debt AA+ A+ A+ A A BBB+ BBB- BBB B+ BB BB

FCF/Debt AA+ AA- A+ BBB- BBB- BBB+ BB+ BB+ BB+ BB+ BBB+

EBIT/Capital AAA AAA AAA AAA AAA AAA AA- A+ BBB A A

EBITDA margin A BBB BBB BB BB B- B- B- CCC- B- B-

LTD/Cap BB+ BB+ BB- BB- BB- BB- BB- BB- B+ B+ CCC

TD/Cap BBB BB- BB- B B BB- BB- BB- B+ B+ CCC

Debt/EBITDA AAA A+ A A A A- BBB BBB- BB- BBB- BB

EBITDA/Assets AA+ AA+ AA AA+ AA+ A+ A A B BBB BBB


FINANCIAL RISK PROFILE

BUSINESS RISK PROFILE Minimal Modest Intermediate Significant Aggressive Highly

Leveraged

Excellent AAA AA A A- BBB -

Strong AA A A- BBB BB BB-

Satisfactory A- BBB+ BBB BB+ BB- B+

Fair - BBB- BB+ BB BB- B

Weak - - BB BB- B+ B-

Vulnerable - - - B+ B CCC+

Financial Risk Indicative Ratios*:

FFO / Total DebtTotal Debt / Capital

Total Debt / EBITDA

>60%<25%<1.5x

45 – 60% 25 – 35%1.5 – 2.0x

30 – 45%35 – 45%2.0 – 3.0x

20 – 30%45 – 50%3.0 – 4.0x

12 – 20%50 – 60%4.0 – 5.0x

<12%>60%>5.0x

Business Risk Factors

1) Metrics: Adjusted leverage ratios, cash flow, margins / profitability

Financial Risk Factors

We estimate the Company’s business risk profile as ‘Satisfactory/Fair’ and its financial risk profile as Significant/Aggressive, suggesting a BB indicative rating.

1) Industry Factors

Cyclical, Competition2) Company

Management, FX, Hedging of Debt, Liquidity, Dividend Policy, Reps, Government Regulations


Solvency

• Avon is the world's largest direct selling company; it has a good brand and acceptable earnings along with broad geographic diversification.

• However, there is concern about the current value of the brand.

• Avon uses significant debt to finance its nominal capital needs.

• The debt/cap ratio is has consistently been an outlier for Avon, signaling the use of debt to finance the balance sheet, even though financing needs are not significant. This was not a concern until the recent downturn in earnings. Also, there is large risk in the balance sheet; intangibles, deferred tax assets, foreign operations and assets and pension.

• Leasing is not significant for the firm; although litigation is. The current pension underfunding is not significant, although the assumed rate of return on pension assets seems unreasonable Also, the switch to debt investments and hedging appears to be a risk. Also, the firm has significant capital spending commitments and product purchase obligations.

• Solvency has declined considerably over the past 10 years. Financial Risk looks synthetically like a BB firm, the business risk is just satisfactory, due to weak management, which now is untested. With a change in management and changes in operations, the firm may regain its IG rating, but this will require a profitability turnabout.

– Equity has been reduced due to currency and pension concerns

• FX is difficult to hedge; hedging pension may be a risk


Debt Instrument Profile

0

500

1000

1500

2000

2500

3000

Sr SecuredDebt

Fixed RateSr Notes

ST Debt Sub Debt Revolver UnusedRevolver

83


Debt Instrument Profile

0

500

1000

1500

2000

2500

3000

US Dollar Debt US$ EBITDA Non US Dollar Debt Non US DollarEBITDA

Revolver USD

84


Debt Profile

2013 2014Price Avon Debt 99.2 91.010 yr Treasury 3.04% 2.17%

85


Hedging Profile [Notional]

Avon Estee Lauder

F/X Forwards 174 1,597

F/X Translation [net assets]

0 [ended in 2012] 0

Interest Rate 0 [terminated fixed to floating in 2011]

0 [terminated fixed to floating in 2011]

Commodity 0 0

86


Enterprise Value, Year end 2014

Book Value Fair Value [market survey]

Cash =961+21+36.4 1,018

Operating Assets 4,479

Total Assets 5,497

Supplier Financing 2,590

Debt Financing 2,601 2,380

Min Int Financing 16 16

Equity 290 3,869

Total Financing 5,497

1,889 5,246


Enterprise Value, 2014

Peers Avon

Operating EBITDA 880

Peer Multiple 12.3X

Enterprise Value by Comp 10,824

Enterprise Value by Market Survey 5,246

Total Debt 2,601

Debt/EV 50%

EV by DCF


Risk

Peers Avon

Equity Beta [Avon] 2.24

Equity Beta, EL 1.35

Debt/EV, EL 8%

Debt/EV, Avon 50%

Equity Beta, Nu Skin 2.89

Equity Beta, Herbalife 3.30

Equity Beta, L’Oreal 1.10


Projections [from 2013]

• A key success factor for Avon is the generation of earnings.• The firm has weakness in its key markets, the year 2012 was a very bad year for earnings, 2013 was better.• In addition, working capital management, investment in fixed assets and the dividend policy influence the firms

cash flows and ability to repay debt.• During early 2013, Avon’s three year outlook was mixed because

– operating improvements will be delayed as a result of sluggish macroeconomic conditions, – heightened competition in the direct selling channel – Corporate governance issues and the uncertainty surrounding the financial impact of certain SEC

investigations into potential compliance violations. Also, new management is untested.• Equity Research, guided by management, suggested no revenue growth for 2013, followed by modest growth in

2014 and significant 2015 growth. OPM improves in 2013 and continues through 2015. Under this scenario, Avon faced a refinancing risk in 2013, unless they can unlock the trapped cash outside the US.

• However, the firm did much better in 2013 than originally forecast, due to slightly better margins and significantly lower CapX.


Forecasting, Base Case, from 2013

Original forecast Actual results2013 2014 2015 2013 2014

Sales 10,610 10,939 11,365 9,955 8,851Operating Profit 796 941 1,091 791 649OPM 7.5% 8.6% 9.6% 7.9% 7.3%EBITDA 1,071 1,231 1,397 1,059 880Funds Flow 703 822 949 751 513CFO 409 637 829 540 360Cap X -319 -351 -364 -198 -131Dividends -104 -104 -104 -107 -110Residual Cash Flows -14 182 361 235 119CPLTD -390 -652 -566 -390 -29


Credit Decision

• Lenders mitigate risk using several methods:– Risk-based pricing– Guarantees– Collateral– Credit derivatives – Covenants

• Borrowers with high profitability and low earnings volatility generally have interest coverage and/or debt to EBITDA covenants. These ratios, are informative for stable, profitable firms.

• In contrast, borrowers with low profitability and high volatility earnings are likely to have net worth covenants. – Tightening

• Tightness is defined as the distance between the threshold and the initial value of a covenant ratio. • Business risk

– Are you monitoring changes [acquisitions, disposals]?• Financial risk

– collateral helps to manage financial risk• Collateral Risk

– How will we be repaid in the event of a default? – What is the appraised value, volatility and salability of the collateral?

• Structure risk – Have we properly boxed the risks with the appropriate covenants and term?– Are you lending to the correct entity?– Guarantees

• Reporting Risk– Is there any change in the firms reporting?

• Funding risk– Conditions Precedent? MAC

• Position Risk– Cross Default?


When a firm has financial problems

• Stabilize the business• Gather information• Evaluate Options

– Short or Medium term • Repayment of debt

– Full or part• Sale of assets, entire business or subsidiaries• Sale of the debt• Reduce debt, improve operating working capital, extend maturities• Inject equity • Buy Protection

– Long run• Restructure the operations• Create joint venture• Debt for equity swap• Strategic investor• Restructure debt and/or interest payments

• Formulate proposal• Negotiate

93


OPM, adjusted

0%

2%

4%

6%

8%

10%

12%

14%

16%

2004 2006 2008 2010 2012 2014

OPM

credit process, avon · •on april 2, 2012, avon received an unsolicited bid from coty inc. to...

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