Deals

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Right now, Coty Inc. looks a bit like a little girl who just raided her mom's makeup vanity: lipstick smeared outside the lines, way too much blush and awful blue eyeshadow.

But the $14 billion company will clean up and grow into itself...eventually. It will just take time and a lot of patience from Coty investors. 

Beauty Stock Dropout
Coty, which now owns the CoverGirl and Rimmel cosmetic brands, is the worst-performing member of this index over the past year:
Source: Bloomberg

Up until last October, Coty was predominantly a maker of perfumes -- designer brands including Chloe and Marc Jacobs and celebrity-branded scents such as Beyonce. Then on Oct. 3, the company completed a $12.5 billion acquisition of nearly four dozen beauty brands from Procter & Gamble Co. The deal gave Coty ownership of CoverGirl and Nice & Easy -- mainstays of drugstore beauty aisles -- and the Wella professional hair-care business.

It's a complete transformation for JAB Holding backed-Coty -- and it's off to a rocky start. Part of that, according to Coty, is P&G's fault. There were 15 months between the transaction announcement and completion dates, and inventory began to pile up that now needs to be cleared out. Coty said this cost its business more than 3 percentage points of growth in its second quarter, which ended in December. And not only is its stock an industry laggard, so are its margins:

Playing Catch-up
As Coty transforms into a beauty giant, it will take time to integrate and reposition newly acquired brands such as CoverGirl. But eventually, margins should improve:
Source: Bloomberg
Note: Figures are for calendar year 2016, while Coty's fiscal year ends in June. Industry limited to companies with market values exceeding $10 billion.

Many of the brands it purchased were also "orphaned" within P&G, as Coty executives put it, meaning they weren't given the attention and resources needed for them to live up to their potential.

The Coty team, led by CEO Camillo Pane, has its work cut out for it. Pane, 46, was promoted to CEO last year and before that spent most of his career at consumer-products company Reckitt Benckiser Group Plc. On Coty's earnings call earlier this month, Pane laid out a meticulous plan for how management plans to integrate the P&G deal and ultimately transform Coty into a beauty giant.

Despite the weak operating results and some unforeseen integration challenges, Pane's remarks were exactly what investors needed to hear. The sense, to me, was that he has a deep understanding of what's wrong, what needs to be done and is focused on doing just that. 

Step By Step
The $750 million of synergies Coty expects from the Procter & Gamble deal ramp up in fiscal 2019, which begins in July 2018
Source: Coty earnings call

One of the most meaningful changes Coty plans to make is to relaunch the CoverGirl and Max Factor brands in fiscal 2018 with new packaging and in-store appearance. Sooner would be better, though, because the longer the distraction, the more likely the brands cede market share or shelf space.

Coty is planning to rely less on traditional TV ads and target younger people more through digital platforms (perhaps YouTube or Snapchat), which is also less costly . And it's looking to identify cosmetic trends earlier and slash the time it takes to bring them to market, which it says is currently a year to 18 months. (Did the matte lipstick trend even last that long?)

Turnaround plans for other brands include Clairol. Pane said the consumer hair-care category has been "dormant" for a decade, which has resulted in the limited shelf space not offering what some customers are looking for. Meanwhile, the professional line of beauty products is strong and stable and should continue to be a bright spot for the company while it confronts challenges on the consumer-facing side.

By the end of this long (and costly) process, Coty is aiming for $750 million of synergies. But in the meantime, the company plans to use the cash these brands throw off to make strategic acquisitions that can offset any dilution that may occur from divestitures it pursues. Some brands will be on the chopping block, but probably none of the big ones it's purchased. 

Balancing Act
Coty plans to use M&A to offset any dilution from brands it sells off. This will require carefully managing the speculative-grade issuer's balance sheet:
Source: Bloomberg

There is the chance that sustained weakness in its operations and stock price makes Coty itself vulnerable to inbound offers. But one check on that is the company's 37 percent owned by JAB, the holding company of Austria's Reimann family. Coty said it has "long-term support" from JAB and one of the investor's senior partners, Bart Becht, is chairman of Coty's board.

Coty's makeover is risky, but Pane and his team are dedicated to investing in the brands and having the right people lead the efforts so that they can be successful. The stock may be a loser now, but investors who can bear the bumpy next few or more quarters will probably be glad they did. Beauty is pain. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. JAB may be better known for building what's been dubbed the "Budweiser of Coffee." It's rolled up Keurig Green Mountain, Krispy Kreme Doughtnuts and Peet's Coffee & Tea, among other targets. 

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net