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Avon's Coty Kiss Off Just First Step in Deal Dance

NEW YORK (TheStreet) -- Privately held beauty company Coty's unsolicited $23.25 a share cash bid for Avon Products (AVP) -- worth $10 billion -- has been spurned by management, but it may quickly turn into a prolonged friendly bid once the price is right.

Terms of the offer, and an immediate rejection to the bid by Avon Products indicate that a breakup or a price increase to the offer rest on whether the company will agree to open takeover discussions with Coty. Were Avon Products to consider Coty's non-binding offer that is contingent on debt and equity financing to be credible, friendly negotiations could lead to a bid increase, according to Coty and analysts.

In reaction to the unsolicited offer, Avon Products, the world's largest door-to-door cosmetics merchant, rejected Coty's offer saying that it "substantially undervalues" the company, which is struggling amid management change, slowing profits and an internal bribery probe. The New York-based company also noted that Coty's highly conditional offer gave it little reason to enter formal takeover discussions or open its finances for a bid. "Coty's indication of interest is non-binding and, by its own terms, subject to numerous conditions such as financing," noted Avon Products in a statement.

In its offer, Coty said that it would raise substantial equity and debt to finance the purchase, which would be the largest U.S. deal of 2012 if completed. Nevertheless, the possibility of a higher bid rests on whether negotiations can turn friendly and pave the way for a bid increase, with some analysts expecting such an outcome.

In Coty's bid, the maker of perfumes branded by Heidi Klum and Beyonce Knowles raised the possibility of a price increase if Avon were to enter friendly negotiations and its finances show a greater fundamental value of the company. A letter from Coty's Chairman Bart Becht said that prior to the unsolicited $10 billion offer; Avon's board had been unwilling to discuss a merger on friendly terms.

"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. Astrachan rates shares a "hold" and expects that Avon Products will enter friendlier negotiations because of its internal struggles and the absence of a competing offer from a strategic acquirer.

In early trading, Avon Products shares rose nearly 19% to $22.91, just below the offer price, signaling investor confidence in Coty's bid. Prior to the bid, Avon Products shares were up over 10% year-to-date. Nevertheless, the company is currently searching for a replacement to outgoing Chief Executive Andrea Jung and is cutting jobs in an effort to stem an near 50% stock drop in the past year.

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Bloomberg calculates is the largest in the cosmetics space since a $57.3 billion by Procter & Gamble (PG) for Gillette in 2005.

In its offer, Coty said that it would not make a hostile bid for Avon Products by attempting to elect a slate of directors to the company's board. Privately-held Coty also said it is working with BDT & Co for equity financing on its $10 billion offer and with JPMorgan Chase for debt financing.

"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. Ferrara suspended his rating on Avon Products in light of Coty's bid.

New York- based Avon Products shares fell amid an internal bribery probe stemming from its business in China and management change. In March, the company fired of its China-based executives, according to a regulatory filing.

While Astrachan of Stifel Nicolaus notes that Avon Products direct selling of cosmetics and the international tilt to its business make the company attractive, the company has struggled to keep its business model competitive, amid underinvestment and management change. Avon Products generates two-thirds of its sales from emerging markets, according to Astrachan.

In March, Standard & Poor's downgraded Avon Product's credit rating citing a lack of direction for the company and lack of confidence that new management will be able to execute a turnaround.

Prior to the takeover offer, analysts polled by Bloomberg gave Avon Products an average price target of $20.80 on six "buy" recommendations and 11 "holds." In 2011, the company's revenue grew to a record $11.3 billion, but profits fell 15% to $513 million.

For more on Coty's bid for Avon Products, see 5 ways to play Avon Products options.

-- Written by Antoine Gara in New York

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