Stock Market Today: Why Avon Products (NYSE: AVP) Should Consider Coty Inc. Offer

Cosmetics company Avon Products Inc. (NYSE: AVP) rejected a $10 billion cash takeover offer from fragrance maker Coty Inc. - in what could be one of the first moves in a drawn out acquisition.

Privately held Coty offered $23.25 a share for struggling Avon. That's a 20% premium to Avon's closing price Friday.

Avon turned down the bid, saying it "significantly undervalued" the company. It also said the non-binding offer was "opportunistic," and Coty was simply trying to get a "free look" at Avon's financials without a solid commitment to buy.

But industry analysts said with all Avon's problems, the company should not be so quick to dismiss a purchase offer at a premium.

"It's an opportunity that the board should seriously consider," Sanford C. Bernstein & Co analyst Ali Dibadj told Reuters.

The news that Avon could be bought out soon pushed its stock up as much as 21% to $23.34 in early morning trading.

Sales, Scandal Hurt Avon Products (NYSE: AVP) Stock

Avon's share price tumbled 29.5% last year. It posted a $400,000 loss in its most recent quarter and a 4% drop in revenue from a year earlier to $2.9 billion.

In 2011, the company's revenue grew to a record $11.3 billion, but profits fell 15% to $513 million. Its sales have slipped in key emerging markets like Brazil and Russia, and the number of representatives has dwindled.

Avon currently is hunting for a new CEO to replace Andrea Jung, its leader since 1999.

Jung has been criticized for letting the company's market share and stock price slip over the past couple of years. She also took heat for landing Avon in a Chinese bribery scandal that's been under investigation since 2008.

During a 2005 audit of Avon, U.S. prosecutors found suspicious payments to Chinese officials around the same time the company sought to get licensing for door-to-door sales in the country. Many senior Avon executives have left the company since the investigation into its Chinese operations began.

Standard & Poor's last month cut the company's credit rating to BBB, just two steps above junk status.

Yet, despite its troubles, Avon claims a new CEO would push its value far above what Coty has offered.

What Coty Inc. Gets from Deal

Coty said a deal between the two businesses would round out the door-to-door offerings Avon makes, giving sales representatives access to popular brands like Calvin Klein, Vera Wang, and Stetson. Coty also is the name behind fragrances of celebrities Beyoncé Knowles, Sarah Jessica Parker, and Lady Gaga.

Coty is eyeing up emerging market growth and wants to get a hold of a company like Avon that can boost its exposure to that segment. Coty now gets 26% of its revenue from emerging markets while Avon rakes in more than 68% of revenue from the same regions. Door-to-door sales - Avon's trademark service - still dominate in these areas.

"Coty noted the opportunity of distributing Coty's brands via Avon's distribution channel and that a material part of cost synergies would be reinvested into the combined business if the deal were to go through," wrote Bank of America Merrill Lynch analyst Christopher Ferrara in a Monday note to clients.

The fragrance company has pursued Avon for weeks. It first made an offer early last month for $22.25 a share, which Avon deemed "insufficient."

Coty considers the latest bid a "full and fair one," said Coty Chairman Bart Becht, but did not rule out a higher offer if Avon could justify it.

"If you can demonstrate that there is greater value than is apparent from publicly available information, we would be prepared to consider increasing the price of our proposal," Becht told The Wall Street Journal.

Analysts said it looks like Coty was setting up to come back with an increased bid.

"On its face, Coty seems to have limited ability to materially increase its offer price but given a rumored IPO and equity and debt financing arranged through credible institutions, per the offer letter, we believe the likelihood of a deal at a higher price increases," noted Stifel Nicolaus analyst Mark Astrachan in a Monday note to clients.

Coty has become increasingly involved in M&A activity, gobbling up smaller cosmetics and skincare businesses in the past couple of years.

Coty went on an acquisition spree in 2010. It bought skin-care company Philosophy and nail-polish maker OPI Products Inc. for about $1 billion each, and a majority stake in Chinese skin-care company TJOY for $400 million. It also bought Dr. Scheller Cosmetics of Germany.

A $10 billion deal between Coty and Avon would have been the second-biggest in the industry. The biggest took place in 2005, when Procter & Gamble Co. (NYSE: PG) bought Gillette Co. for $57.3 billion.

Avon (AVP) was up about 10% this year, closing at $19.36 last Friday. Today's pop pushed it to $22.43 by 12:30 EDT.

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