Avon Products Essay Example

Avon's financial performance, and Exhibit 2 gives data by lines of business for the period 1982-1987.

Exhibit 3 shows balance sheets for 1986 and 1987, and Exhibit 4 gives an historical perspective on Avon's stock price . Recent Company History As a result of its strong cash flow , Avon was able to increase its dividend regularly in the late 1970s while aggressively seeking acquisitions. By 1981 Avon had raised the dividend on its common stock to $3. 00, up from $2. 55 in 1978. But more important, in the early 1980s, Avon made the major Professor Jonathan Tiemann prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrativesituation.

Copyright © 1989 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545 -7685 , write Har vard Business School Publishing, Boston, MA 02163, or go to http: / /www. hbsp. har vard. edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means-electronic, mechanical, photocopying, recording, or otherwise-without the permission of Harvard Business School. 1 289-049 Avon Products, Inc. trategic decision to diversify its business by entering the health care field. Its first acquisition in that field was in January 1982, when Avon acquired Mallinckrodt, Inc. , a specialty chemical company whose sales were largely to the health care industry. However , during this same period, an important demographic shift was beginning to th reaten Avon's Beauty Group. The majority of Avon 's sales representatives and their customers had traditionally been

women who spent much of the day at home. But increasingly these women were entering occupations that required them to be away from home during the day.

Therefore Avon w a s losing both its sales force and its customers. From 1979 to 1981, Avon 's margins on beauty product sales declined as the company broadened its direct-sales product line and offered increasingly generous sales incentives, and by 1982 beauty product sales began to decline as well. By mid-1982 , Avon suddenly found itself in a weakening cash flow position as a result of the declining beauty business and the $710 million Mallinckrodt acquisition. Strapped for cash , the company reduced its dividend in August 1982 from $3. 00 to $2. 00 per share per year.

Avon's stock price hardly moved when the company made the dividend announcement. but the Wall StreetJournal reported at the time that observers had expected the dividend reduction. In any event, Avon's stock price had dropped from $30 per share at the end of 1981 to $20. 375 per share immediately before the dividend announcement. In 1984, having just become Avon's CEO, Mr. Waldron began to reshape the company's beauty operations. Instead of remaining primarily a direct sales company, he decided, Avon w ould broaden its approach to the beauty business by developing additional distribution channels.

The company also continued to look for acquisitions in the health care area , so that Avon could remain viable in the event the changes it was making to its beauty business failed . In May 1984, Avon acquired Foster Medical Company in a share exchange. Foster Medical seemed a particularly attractive acquisition because of the possibility

that public health care policy would change to encourage a shift from expensive, hospital-based care to the less expensive home care, which was a major part of Foster's business. Avon also acquired Retirement Inns of America in November 1985 and the Mediplex Group in April 1986.

Mediplex operated sub-acute health care facilities such as alcohol and drug abuse treatment centers, nursing homes , and psychiatric hospitals. Mediplex and Retirement Inns both managed retirement living centers of various types. Consistent with this increasing focus on the provision of health care, Avon sold Mallinckrodt in 1986 for $675 million. Although Mediplex and Retirement Inns served patients who paid for care themselves or through private insurers, Foster Medical's revenues came primarily from Medicare, the largest public health insurance program in the United States.

A change in Medicare in 1986 effectively cut Foster Medical 's charges for Medicare patients by 18%. Foster Medical was not able to respond successfully to this change, and in 1987, Avon's management recommended to the board that it review Avon's commitment to the health care industry. The board concluded that Foster Medical, Mediplex, and Retirement Inns could no longer grow at an attractive rate and still show acceptable profits. In addition, by 1987 the performance of the Beauty Group had begun to improve markedly. The board decided that the Beauty Group's strength permitted Avon to shed the Health Care Group companies.

It started by selling Foster Medical Supply, a distribution company, in November 1987. Early in 1988, Avon also began the process of selling the entire Foster Medical Corporation. Avon anticipated an after-tax loss of $125 million on the sale. Also in 1987, Avon acquired Giorgio ,

Inc. for $165 million in cash and Parfums Stern, Inc. for $160 million. These acquisitions not only added prestige fragrances, sold through retail stores, to Avon's beauty line, but also continued Avon's transition away from the direct sales approach to the beauty business.

The Exchange Offer Mr . Waldron felt that at the same time that Avon was reorganizing its business, it should also reconsider its financial policies , including its dividend policy. The company was about to begin the last phase of its exit from the health care business with the sale of Mediplex and Retirement Inns. In addition, Mr. Waldron and the board agreed that Avon should redouble its commitment to its core beauty products business, whose recent results were encouraging. Among other things, this implied that Avon would continue to invest significant additional capital in that business.

In December 1987, Avon raised additional capital by selling 40% of the common stock of its wholly-owned Japanese subsidiary, Avon Products Company Limited, in a public offering in Japan that raised $218 million. The price was over six times book value and around 50 times earnings. Avon booked an after-tax gain of $121. 1 million, or $1. 72 per share, on the sale . The board also felt that Avon should conserve cash flow by reducing its dividend from $2. 00 to $1. 00 per share, but Mr. Waldron worried about the consequences of simply cutting Avon's dividend. Avon had maintained its dividend at $2. 0 per share per year since the dividend cut in August 1982. Although that reduction had not resulted in any sudden drop in Avon's stock price, Avon's stock had been falling for

some time in advance of the cut. This time might be different. Avon's 1987 annual report had stated that the firm expected to maintain the current annual $2. 00 dividend, and Avon's stock price had remained fairly steady during 1988. Exhibit 5 lists the 25 largest institutional holders of Avon stock. Many of those investors might sell their Avon shares quickly if Avon simply reduced its dividend. As Mr.Waldron put it, "For five years I had been telling them that we weren't going to cut the dividend, and for five years they had been telling me they didn't believe me. " Some investors had stated that they held Avon stock because it paid a high dividend. Avon's board asked its financial advisor, Morgan Stanley and Co. , what steps the company could take to avoid having the dividend reduction drive down the stock price. The exchange offer was one element of the solution.

Morgan Stanley proposed that Avon offer to exchange one share of a new $2. 00 preferred equity-redemption cumulative stock (PERCS) for each of up to 18 million of Avon's 7. 7 million outstanding common shares. The new preferred would pay, on the same dividend dates as its common stock, cumulative quarterly dividends of 50 cents ($2. 00 a year) accrued from September 1, 1988 to September 1, 1991. 1 Although the company would be able to redeem the preferred shares at any time before September 1, 1991, according to a declining schedule. f the important provisions concerned mandatory redemption of the PERCS shares in September I, 1991. On that date the PEReS shares would expire. Their holders would receive one common share for

every PERCS share if the price of the common stock was less than or equal to $31. 0, or $31. 50 worth of common stock per PERCS share if the common stock was above that price . As was usual with preferred stock, Avon would not be able to pay its common dividend at any time its preferred dividend was in arrears. In addition, this preferred stock included a restriction providing that Avon could never pay a common dividend of $1. 50 or more per share per year unless it first redeemed the preferred. 1 Short-term U. S. Treasury notes were paying about 8. 2% per year at the time. 2 The redemption price would be $34. 75 per share, plus accrued dividends, for the quarter starting June 1, 1988.

It would decline by 25 cents per share for each quarter thereafter through the quarter beginning March 1, 1991. The redemption price would fall to $31. 75 per share on June 1, 1991, and then to $31. 50 per share on June I , 1991. The company would have the option of redeeming the preferred for either cash or common shares. 3 289-049 Avon Products, Inc. Mr. Waldron felt confident that the financial markets would understand the new security. Third-party issuers had successfully marketed at least one product similar to the PERCS, Americus Trust PRIME units.

An Americus Trust was a corporation whose sole asset was common stock of a particular company. The basic idea was that shareholders of that company placed their shares in the trust, which issued two units, called a PRIME and a SCORE, against each share. The PRIME units received all the dividends

the stock earned; the SCORE units received no dividends. At a predetermined terminal date, the trust would liquidate the shares it held . The PRIME holders would receive the value of the shares up to a certain predetermined level, and the SCORE holders would receive any excess . The PERCS might appeal to investors w ho would buy PRIMEs. Mr .Waldron realized that he would need to convince his colleagues on the board that the terms of the offer would be fair to all the company's shareholders and also appealing to those who especially desired high dividends. Avon's stock closed at $24. 125 per share on June 1, 1988.

The closing price for Avon Products common stock on June 1, 1988, was $24 1/8. Note: An option is a contract giving the holder the right, but not the obligation, to buy or sell a given asset at a specified price (the exercise price or strike price) on or before a given date (the exercise date or expiration date). A call option gives the holder the right to buy, while a put option gives the holder the right to sell. The right is valuable, and options on many stocks are traded on organized exchanges. Exchange-listed options like these expire on the Saturday after the third Friday of the month indicated.

A contract represents an option on 100 shares. The entries in the table give the prices (sometimes called option premia) of the options themselves, per share of Avon stock. Thus, on June 25 call option contract gives the holder the right to buy 100 shares of Avon stock for $25 per share on or before Saturday , June

18, 1988. Such a contract traded on June 1 for $43. 75, which is $7/16 x 100. Tables like this one for most exchange-listed options appear daily in financial publicat ions, including The Wall Street Journal and the business section of the New York Times.