A Tale of Two Acquisitions
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Outline: |
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Intro |
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We all have that one influencer we are obsessed with. Track every post across all social media platforms. Worship the ground they walk on. Believe everything they say and wish we looked half as good as they do in every single photo… Looking at you, Ryan Fischer! |
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But what is it about these influencers that draws us in so easily? Surely, there are not that many people who fall out of bed looking 10/10 day in and day out. |
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In this age of social media following, influencers make looking good seem easy – but there must be something they all need to accomplish that? No matter how perfect you think your favorite influencer looks, there is most definitely more behind the scenes that we don’t see. |
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The simplest answer: cosmetics and beauty products! |
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If all these influencers are using beauty products, and we know they are raking in the dough right now, it would make sense that beauty products might be an area to examine a little further for investment. |
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Social media isn’t going away and neither are influencers. As more influencers rise up, or current influencers get more popular, that appears to be a direct demand for more beauty products. |
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But, even if this space is growing, does that mean all companies are good investments? Should we just buy an index fund for consumer discretionary or cosmetics and call it good? |
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We say no. |
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A great example of why throwing money into the wind and hoping it catches fire can be seen when we examine Revlon and Estee Lauder and specifically how they approached similar acquisitions in 2016 / 2017. |
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Let’s dive in! |
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Revlon, Inc ($REV) |
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Revlon is a storied cosmetic manufacturer – they have a household name that almost anyone can recognize for what it is: the biggest eyelash blaster you have ever seen and never used. It feels like you can’t watch a single sports game without seeing a commercial for Revlon - something. Hair products. Makeup. Eyeliner. |
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If you can think of something related to beauty and cosmetics, you can bet Revlon makes or sells it. Cosmetics, hair care, skin care, beauty products, fragrances - Revlon does it all. |
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But, does this mean Revlon is a worthy investment? Just because they have won the battle of being top-of-mind in this space, do they have good business practices and a profitable enterprise – or, at least growth prospects? |
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Most likely not. |
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Why? |
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Because they just filed for Chapter 11 bankruptcy.💀 Bankruptcy scares everyone, but Chapter 11 is one of the “nicer” filings for bankruptcy. It means that the business will live on, that operations can be maintained, and the company just needs to reorganize its debt and have creditors agree to new terms (because the company can’t pay based on the old terms). |
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Revlon has been around since 1932. It is not a high-flying tech company that started in your mom’s garage in late 2019, exploded in 2020, went public, and now is struggling to figure out how to make payroll next week. |
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This is an ancient giant. There is a reason Revlon occupies our top-of-mind bias – they have been around since before most of us were born! |
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In 2016, Revlon acquired Elizabeth Arden for nearly $1bn to further expand their reach and asset base as a globally focused cosmetic brand, catering to men and women in all areas of health and beauty. Unfortunately for Revlon, a once-profitable business, this appears to have been the beginning of the end for them. |
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Revlon acquired Elizabeth Arden for cash, paying $14 per share of Elizabeth Arden, a 75% premium over the price RDEN was trading at 6 months prior but a 70% discount to the all-time high price of $47 just 4 years prior. Revlon funded this deal with an additional $2.2bn of debt consisting of a $1.8bn senior secured term loan and $400m senior secured asset-backed term loan. |
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Revlon estimated in their 2016 filing that the acquisition would provide additional channels for sales growth and improved synergies to reduce costs. Just like every other merger announcement ever: we can increase sales and reduce costs by combining forces! |
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One of the specifics mentioned in the annual filing was an expected direct reduction in SG&A (Selling, General and Administrative Expenses) to be realized within the first year of the acquisition. |
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That did not happen. (probably why Warren Buffett does not factor in synergies in his models) |
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In fact, SG&A went up by 25% and stayed around that level until 2020, which is when the company estimated the final synergies from the acquisition would be fully realized and integrated within the company. |
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The bigger issue is that interest expense rose by 50% after this acquisition. And even though revenue increased by 15%, this amount of synergy does not appear to be justifiable. |
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It may not have been the case, but it appears that the acquisition of Elizabeth Arden may have been the straw that broke the camel’s back for Revlon and began the troubles that led them to today. |
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In 2016, Revlon was trading at, or around, $36 per share. Today it trades at $3.73. Market cap in 2016 hovered around $1.5bn. A cosmetics behemoth. |
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Today, market cap stands at about $193m. Or, 5% of total LT debt. Revlon has about $3.7 billion of long-term debt on its books right now. |
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That’s like having a trading card worth $200 and owing your bookie $4,000. Not quite enough to protect your kneecaps, if you know what I mean. |
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What is unique about this situation is what led them to bankruptcy was actually a blunder by their banker, Citigroup, and not their continued downtrend into further debt and less ability to service it. |
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In the past, Revlon had called up their creditors directly to work out extension deals to avoid resulting to bankruptcy proceedings to continue operations. Not until a Citigroup banker accidentally sent Revlon’s creditors a payment for $900 million, effectively paying off the entire debt, instead of making the agreed-upon interest payment. What is interesting about this is that Citigroup paid the $900m using their own funds. Revlon is not on the hook for these funds. |
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Some creditors gave funds back to Citigroup, but about $500m was kept by creditors who were paid off - which means that Citigroup would step in as a creditor to Revlon if they cannot get those funds returned (which they pursued in court, lost and are currently appealing). |
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It seems rather clear that Revlon is in trouble but when the bank you are using to help make your way out of trouble makes such a colossal mistake, too, it feels like the end may be closer than expected. |
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This does not mean they are not open for investment, in fact, there are rumors that an Indian company, Reliance Industries, is looking to make the leap into cosmetics by acquiring Revlon. And what better way to break into a new line of business than buying a nearly 100-year-old brand name for pennies on the dollar? |
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Key Metrics |
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Estee Lauder |
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Another historic giant in the cosmetic and beauty space is Estee Lauder, founded in 1946. If you thought Revlon was a household name, check your cabinets. I imagine between Revlon and Estee Lauder (and all the brands they own), about 95% of your bathroom cabinet is accounted for. Don’t believe me? Look at all the brands under those two names: |
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Still don’t believe me? |
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These two behemoths dominate the industry – but Revlon appears to be falling behind the times. Is that the way the rest of the industry is going – is the beauty industry doomed to follow Revlon down the drain? |
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Guess again. |
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Estee Lauder stands as a beacon of hope in the storm of post-pandemic bear market concerns. Why? Because they saw the writing on the wall and took action. Not only do they have similar lines of business as Revlon (haircare, makeup, fragrances, etc.) but they have worked hard to build up their online business - Estee Lauder picked up on the growing population of millennials and the primacy of their factor in sales going forward. And they catered directly to them. |
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Most of this space saw massive consolidation as the world shifted away from brick and mortar stores to online retail focused. The younger generation became the driving force for success in many of these brands. |
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Estee Lauder responded beautifully by gobbling up the smaller names that were getting big publicity from younger generations, brand names that were newly formed but taking a strong stance on animal abuse, organic materials, and other areas the younger generation was focused on. |
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They started looking closely at these smaller names and recognized the fact that they could command much larger sales in the near future, so EL did what any forward-thinking business should do: they started buying up the competition! |
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The biggest of these names was Too Faced, a trend-setting, cruelty free makeup that would give EL a solid foothold in the prestige makeup category, from which they could further grow their sales. Too Faced was acquired in 2016 (around the same time Revlon acquired Elizabeth Arden). |
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Too Faced was a much younger company than Elizabeth Arden, being founded only in 1998, but in the short 18 years of operations, they had experienced massive growth in sales and profits, driven by their high-quality products and distinct packaging. Mainly among younger generations, who have become more and more concerned with putting high-quality materials in and on their bodies, rather than harmful and toxic products. |
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Estee Lauder acquired Too Faced for $1.45 billion in 2016, funded entirely with debt – similar to Revlon – but instead of a term loan (i.e. long term debt), EL funded their purchase with the issuance of commercial paper, a short-term debt instrument. |
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The other big difference between these two acquisitions? The size. |
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Revlon’s acquisition of EA was equivalent to 50% of the entire market cap of Revlon (EA was acquired for $870 million and the market cap of Revlon, as of the end of 2016, was $1.76bn). What’s interesting is that Revlon took on $2.2 billion of new debt to fund the acquisition – equivalent to 130% of the market cap at that time. |
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Compare that to Estee Lauder’s acquisition of Too Faced. Estee Lauder acquired Too Faced for less than 5% of its market cap. Too Faced was acquired for $1.45 billion when Estee Lauder had a market cap of $30 billion in 2017. And while Estee Lauder funded the acquisition with new debt, their total debt load (not just the new debt) after the acquisition was only 13% of the market cap at that time. |
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Key Metrics |
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Conclusion |
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Sometimes companies we think are the best, the ones whose brand we have littered across our bathroom floor, are not always the most well-run companies. Not only is it important to understand how a company makes money and operates its business, but it’s also massively important to understand its history. |
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Many might think that a simple Chapter 11 restructuring will be a positive signal for Revlon and they will begin healing and improving their business. But it is going to take a lot more strategic initiative to overcome such significant debt loads without paying attention to the rising trends of today. Ignoring the younger generation, the ones who buy more makeup and cosmetic items than any other generation, only makes the pain worse. |
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Companies that can change with the times (partner/acquire upcoming startups without bankrupting the business), like Estee Lauder, will most likely be around for the long haul and provide ample opportunity for further investment. |
