Long Avon? Take the Money and Run

On Monday, shares of Avon ( AVP) drifted slightly lower after the company received an unsolicited bid on Monday from privately held cosmetics giant Cody. Investors spent the day holding out hope that a counter-offer for the embattled company would emerge. But, in my opinion, there is no counter-offer in the works. If you were lucky enough to own the stock before the big 20% pop on Monday, I have one piece of advice: Take the money and run.

On Tuesday I saw a number of comments from big value-type investors who owned Avon shares and were holding out hope that someone will swoop in with a bid greater than $10 billion. But honestly, what cosmetics company wants to run a direct sales force? That's especially so with Avon, given the amount of problems that saddle its sales force.

A quick look at the fourth-quarter results should give any bidder pause. Revenue was down 1%, gross margin fell, and operating profit came in at a paltry $13 million on $3 billion in revenue. Yes, you read that right: $13 million left over on revenue of $3 billion. Let me put it another way: Imagine you were flushing $3 billion in cash down the toilet. The toilet would clog long before you got down to your last $13 million. You'd probably have hundreds of millions leftover -- but not Avon.

Avon has troubles all over the world, but Latin America, has been the worst. Latin American revenue grew just 2%, while operating profit fell 33.6%, as the company was plagued by inventory problems in Brazil, its largest market. You only have to look back a few years to see how far the company has fallen. In 2010, Avon had an operating margin of 13%. It fell to 9.4% in 2011, and then to a microscopic 0.4%.

But the damage isn't limited to Brazil. North America has been no picnic, either. Sales there fell 7% to $596 million. After the company made just $21 million in all of North America last year, operations in the region lost $241 million for all of 2011.

For the year, earnings fell 11.5% to $526 million on $11.3 billion in sales.

While, for other companies, it's tempting to acquire Avon to get into Brazil (38% of revenue), it hasn't been easy to make money in that country. I can't see the other fragrances and cosmetic outfits topping Cody's bid -- all the other cosmetics companies have been very successful selling through retailers.

I've heard some arguments that say Brazilians like the personal selling of a direct sales force, and will never buy makeup in a department store. But I believe that's wrong. Brazilian women will buy at retail. They are not that different. For $10 billion you have to a have a lot of conviction in the direct sales model and have a strong turnaround plan. If Cody is successful with its bid, the management team will have a lot of work to do if it wants to turn around Avon. Good luck to them.
At the time of publication, Laudani had no positions in the stocks mentioned.

Christopher Laudani is the founder and president of ShortIdeas.com, a short-only equity research firm.

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