Thursday, 5 October 2017

More on Coty / P&G

After I published my last piece, a good friend of mine asked me if I thought Coty had overpaid for the P&G brands. I hold this friend in highest esteem as he is a sharp guy.

Here are some follow up comments:

Some rough estimates on the Coty / P&G transaction:
  • Per P&G's 2017 annual report, P&G reported receiving consideration of $11.4B (to be cross checked vs. Coty's 2017 annual report in their business combination note disclosure below)
  • Per P&G's 2015 annual report disclosure on discontinued operations, it appeared that the to be discontinued portfolio sales were $5.5B, but the ultimate revenue resulting from the P&G brands based on the most recently published Coty factsheet was closer to $4.4B. $11.4B / $4.4B = 2.6x sales.
  • Per P&G's 2014 annual report, the entire Beauty segment generated $2.6B net (after tax) on sales of $18.14B. This works out to a net margin of 14.2%.  
  • We can work backwards to figure out the net margin contribution from the 2015 Coty brands: Total NM of 14.2% = $2.18B/$12,608 + 403M/5.5B, puts the Coty brands at around 7% NM, or 1/2 that of the remaining brands. $403M / (1-.35) = $620M pretax
  • $11.4B / 620M  = 18.4x pretax. Not cheap.
  • Did they overpay? Maybe, maybe not. If they can't generate synergies, they paid 18.4x pretax earnings. In 2015, Coty had adjusted pretax earnings of $518M alone, say around $1.43 per share. At an average price of $17.80 per Coty share pre combination in 2015, their own pretax multiple was 12.4x, so it appears they paid a premium to their own multiple in the deal

2015 Coty  / Discops (per P&G)

2014 Coty  / Discops (per P&G)

2017 business combination note, per Coty

Based on Coty's annual report, let’s call the purchase multiple 18.5 x pretax (11.5b / 620M = 18.5x)

Coty is guiding for $750m in synergies. Now it’s, probably aggressive to attribute 100% synergies to just the P&G deal. The potential synergies are a function of company wide optimization, i.e. not just P&G brands, but the entire reshaping of all of the brands under the company umbrella.

Let’s say the deal doubled their size, and P&G pre-combination accounted for 50% of company size. Let’s say $750m is 50% attributable to P&G, so that’s $375m. Next, let’s say synergy realization is a coin flip. 50/50 chance it gets realized. Then realizable synergies are $750m x 50% x 50% = $187.50 (undiscounted)

Ok, so would it be reasonable then to assume that the deal was thus valued at 11.5b / (620 + 187.5) = 14.2x pretax earnings?

Again, it’s possible they overpaid if they can’t realize synergies and increase margins. If they are able to realize synergies and increase margins, then it doesn’t look like they overpaid. They bought a boatload of brands abandoned by P&G for 14.2x pretax, but this is still a premium to their own multiple however you slice the synergies.

Maybe these guys are fantastic brand managers and they will be able to re-market and re-position the brands that P&G gave up on. Maybe it’s a lost cause and the brands are actually crap. I think this uncertainty creates a situation where value "might" exist. Certainly, Coty is unloved, down +40% off its 2015/2016 highs, and a good deal of the +40% may be attributable to P&G shareholders receiving Coty shares as part of the deal and not wanting the shares. This is not a slam dunk by any means, but it’s not a bad idea.

The real research comes in the form of trying to figure out whether they bought a boatload of crap, &/or whether potential synergies are realizable.

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