Coty Tries To Kiss and Makeup With $10.7B Avon Bid (Update 1)

Updated to reflect Bank of America comments and updated share prices.

NEW YORK (TheStreet) -- Privately held fragrance maker Coty has upped its unsolicited bid for Avon Products ( AVP) to $10.69 billion or $24.75 a share, in an effort to turn what was a hostile negotiation friendly.

In raising its bid by roughly 6.5% from $23.25, Coty said it would need a confidentiality agreement from Avon Products and the ability to conduct due diligence on its bid by Monday.

Avon Products, which recently reported weaker than expected first quarter earnings, had its credit rating downgraded and hired a new chief executive, has so far been unwilling to enter the friendly negotiations that come with Coty's bid increase.

In a letter disclosed by Avon Products on Thursday, Coty chairman Bart Becht is offering a $1.50 increase to the company's April 2 initial offer, in an effort to turn takeover negotiations friendly. The letter said that when first approaching Avon Products, talks started at $22.25 and rose by $1 when an offer was first publicly announced. Coty also unveiled Warren Buffett run- Berkshire Hathaway ( BRK.A) as an underwriter for the offer, which is contingent on siginificant debt and equity financing.

In response, to Coty's initial bid valued at roughly $10 billlion, Avon Products immediately rejected the April offer. However, Thursday's play by Coty and its attempt to enter friendly negotiations may warrant a closer look. When releasing Coty's $24.75 a share offer, Avon Products said it would consider the bid "in due course."

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Since the takeover battle first emerged, Avon Products has hired Sherilyn S. McCoy, a former Johnson & Johnson ( JNJ) executive as its chief executive after Andrea Jung stepped down as CEO in December, amid the company's underperformance and bribery allegations in its China-based business.

When making its initial non-binding offer Coty said that a turn to friendly negotiations left open the prospect of a bid increase. The increase has come, but with under the condition that Avon Products change its posture.

"As you know, we contacted Avon last week in an effort to break this deadlock. We indicated that we were prepared to engage in non-public discussions and discuss an increase to our proposal of $23.25 if substantiated through a three-week diligence process... we are revising our proposal to $24.75 subject to due diligence and the other conditions," said Becht in the letter.

"We remain keenly focused on understanding Avon's operational and financial challenges, evidenced by your disappointing first quarter results and outlook, as well as your recent credit ratings downgrades. We need to confirm our synergy estimates, the availability of which will be critical to our final valuation and the reinvestment required to implement a turnaround of Avon."

Becht also highlighted the Avon's operational expense and its exposure to litigation tied to potential violations of the Foreign Corrupt Practices Act as other reasons why it will only raise its bid when confidentiality agreements are signed. If Avon Products doesn't agree to the increased bid, Coty said it will withdraw its bid next Monday.

Avon Products shares fell slightly in early Thursday trading to $21.55. The company's shares surged 9% on Wednesday when on reports of Coty's financing signaled a revival of the takeover offer after a month-long standoff. Still, shares are nearly 13% below Coty's offer, signaling continued uncertainty over the deal.

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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. On Thursday, Avon Products shares surged when the parent company of Coty said it would sell $2 billion of Reckitt Benckiser shares to help fund the deal. On Thursday, Coty said that its equity financing for the deal will come from BOT Capital Partners and Berkshire Hathaway ( BRK.A), while debt financing will come from JPMorgan ( JPM ).

In reaction to Coty's initial unsolicited offer, Avon Products, the world's largest door-to-door cosmetics merchant, rejected the 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.

In Coty's initial offer, 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.

"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 reaction to the April 2 offer. Astrachan rated Avon Products shares a "hold" and expected that it would eventually friendlier negotiations because of its internal struggles and the absence of a competing offer from a strategic acquirer.

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

"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 April. 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.

In May, Fitch Ratings and Standard & Poors downgraded Avon Product's credit rating into near junk status citing weaker than expected earnings and questions on how quickly a turnaround can be executed.

Still, after Coty's bid was disclosed, some analysts said that with new management, Avon Products could recover from its waning sales and cash flow, in addition to management change and lingering corruption investigations. "While Avon clearly has long-term trouble spots like the U.S., we believe evidence suggests that its most critical issues are within its control and therefore likely could be corrected," noted Ferrara of Bank of America in an April 5 note detailing a contrarian argument to Coty's bid. Shortly thereafter, Avon hired McCoy of Johnson & Johnson as its new CEO.

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

-- Written by Antoine Gara in New York