AVON PRODUCTS, INC.
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CASE OBJECTIVES
To analyze the recent diversification strategy of Avon Products, Inc. into
the sub-acute health care industry.
 To underscore the importance of focusing on Core risks and staying
away from Non-Core risks.
 To understand dividend policy and dividend clienteles.
 To analyze the issuance of a new security PERCS, and how it can help in
satisfying two dividend clienteles at Avon.

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MAIN ISSUE
By mid-1982, Avon suddenly found itself in a weakening cash flow
position as a result of the declining beauty business and the $710 million
Mallinckrodt acquisition.
 Strapped for cash, the company reduced its dividend in August 1982
from $3.00 to $2.00 per share per year.
 Avon’s stock price had dropped from $30 per share at the end of 1981 to
$20.375 per share immediately before the dividend announcement.
 What should have been the Avon management correct response facing
this weakening position?

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COMPANY BACKGROUND – A SUCCESSFUL DIRECT MARKETING FIRM
Avon Products, Inc., founded in 1886, was one of the world’s largest
manufacturers and marketers of beauty products.
 The company was famous for its direct selling beauty business, in which
a sales force of independent contractors purchased products from Avon
and then resold them door-to-door, largely to their friends and
neighbors.
 Avon’s Beauty Group produced and sold cosmetics, fragrances,
toiletries, and fashion jewelry and accessories; it also sold gift and
decorative products.

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COMPANY BACKGROUND – A SUCCESSFUL DIRECT MARKETING FIRM
While it sold several fragrances through retail establishments, most of
the Beauty Group’s revenues were from its direct sales operations.
 In 1988 Avon had 1.4 million active sales representatives worldwide,
including 400,000 in the United States.
 As a result of strong cash flow, Avon was able to increase its dividend
regularly in the late 1970s while aggressively seeking acquisitions.
 By 1981 Avon had raised the dividend on its common stock to $3.00, up
from $2.55 in 1978.

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COMPANY BACKGROUND – SHIFTING DEMOGRAPHICS
However, during this same period, an important demographic shift was
beginning to threaten Avon’s Beauty Group.
 The majority of Avon’s sales representatives and their customers had
traditionally been women who spent much of the day at home. But
increasingly these women were entering occupations that required
them to be away from home during the day.
 Therefore Avon was losing both its sales force and its customers.

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COMPANY BACKGROUND – SHIFTING DEMOGRAPHICS
From 1979 to 1981, Avon’s margins on beauty product sales declined as
the company broadened its direct-sales product line and offered
increasingly generous sales incentives.
 And by 1982 beauty product sales began to decline as well.
 By mid-1982, Avon suddenly found itself in a weakening cash flow
position as a result of the declining beauty business and the $710 million
Mallinckrodt acquisition.

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COMPANY STRATEGY – SHIFTING DEMOGRAPHICS
Strapped for cash, the company reduced its dividend in August 1982
from $3.00 to $2.00 per share per year. Avon’s stock price hardly
moved when the company made the dividend announcement.
 Avon’s stock price had dropped from $30 per share at the end of 1981 to
$20.375 per share immediately before the dividend announcement.

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COMPANY STRATEGY – DIVERSIFY INTO NON-CORE AREA
In 1984, having just become Avon’s CEO, Mr. Waldron began to reshape
the company.
 Instead of remaining primarily a direct sales company, he decided, Avon
would broaden its approach to the beauty business by developing
additional distribution channels.
 The company also continued to look for acquisitions in the health care
area, so that Avon could remain viable in the event the changes it was
making to its beauty business failed.

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COMPANY STRATEGY – DIVERSIFY INTO NON-CORE AREA
In May 1984, Avon acquired Foster Medical Company in a share
exchange.
 Avon also acquired Retirement Inns of America in November 1985 and
the Mediplex Group in April 1986. Mediplex operated sub-acute health
care facilities such as alcohol and drug abuse treatment centers,
nursing homes, and psychiatric hospitals.
 Mediplex and Retirement Inns both managed retirement living centers of
various types.

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COMPANY STRATEGY – REALIZING THE MISTAKE OF DIVERSIFYING INTO
NON-CORE
Trigger: A change in Medicare in 1986 effectively cut Foster Medical’s
charges for Medicare patients by 18%. Foster Medical was not able to
respond successfully to this change.
 In 1987, Avon’s management recommended to the board that it review
Avon’s commitment to the health care industry.
 The board concluded that Foster Medical, Mediplex, and Retirement Inns
could no longer grow at an attractive rate and still show acceptable
profits.

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COMPANY STRATEGY – REALIZING THE MISTAKE OF DIVERSIFYING INTO
NON-CORE
In addition, by 1987 the performance of the Beauty Group had begun to
improve markedly.
 The board decided that the Beauty Group’s strength permitted Avon to
shed the Health Care Group companies.
 It started by selling Foster Medical Supply, a distribution company, in
November 1987.
 Early in 1988, Avon also began the process of selling the entire Foster
Medical Corporation. Avon anticipated an after-tax loss of $125 million
on the sale.

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COMPANY STRATEGY – GOING BACK TO THE CORE BEAUTY BUSINESS


Avon acquired Giorgio, Inc. for $165 million in cash and Parfums Stern,
Inc. for $160 million.
These acquisitions not only added prestige fragrances, sold through
retail stores, to Avon’s beauty line, but also continued Avon’s transition
away from the direct sales approach to the beauty business.
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THE NEED TO CUT DIVIDENDS


The Avon board felt that Avon should conserve cash flow by reducing its
dividend from $2.00 to $1.00 per share, but Mr. Waldron worried about
the consequences of simply cutting Avon’s dividend.
Avon had maintained its dividend at $2.00 per share per year since the
dividend cut in August 1982. Although that reduction had not resulted in
any sudden drop in Avon’s stock price, Avon’s stock had been falling for
some time in advance of the cut. This time might be different.
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THE NEED TO CUT DIVIDENDS
Avon’s 1987 annual report had stated that the firm expected to maintain
the current annual $2.00 dividend, and Avon’s stock price had remained
fairly steady during 1988.
 Exhibit 5 lists the 25 largest institutional holders of Avon stock. Many of
those investors might sell their Avon shares quickly if Avon simply
reduced its dividend.
 As Mr. Waldron put it, “For five years I had been telling them that we
weren’t going to cut the dividend, and for five years they had been telling
me they didn’t believe me.”

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THE NEED TO CUT DIVIDENDS


Some investors had stated that they held Avon stock because it paid a
high dividend.
Avon’s board asked its financial advisor, Morgan Stanley and Co., what
steps the company could take to avoid having the dividend reduction
drive down the stock price. The exchange offer was one element of the
solution.
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THE PERCS EXCHANGE OFFER


Morgan Stanley proposed that Avon offer to exchange one share of a
new $2.00 preferred equity-redemption cumulative stock (PERCS) for
each of up to 18 million of Avon’s 71.7 million outstanding common
shares.
The new preferred would pay, on the same dividend dates as its common
stock, cumulative quarterly dividends of 50 cents ($2.00 a year)
accrued from September 1, 1988 to September 1, 1991.
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THE PERCS EXCHANGE OFFER
Although the company would be able to redeem the preferred shares at
any time before September 1, 1991, according to a declining schedule,2
the important provisions concerned mandatory redemption of the
PERCS shares in September 1, 1991.
 On that date the PERCS shares would expire. Their holders would receive
one common share for every PERCS share if the price of the common
stock was less than or equal to $31.50, OR $31.50 worth of common
stock per PERCS share if the common stock was above that price.

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THE PERCS EXCHANGE OFFER
Upon their expiration on September 1, 1991, the holders of the PERCS
would receive one common share for every PERCS share if the price of
the common stock was less than or equal to $31.50, OR $31.50 worth of
common stock per PERCS share if the common stock was above that
price.
 The common shareholders who do not accept the PERCS offer would
keep their common shares and receive cumulative quarterly dividends
of only 25 cents ($1.00 a year) accrued from September 1, 1988 to
September 1, 1991.

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THE PERCS EXCHANGE OFFER
Mr. Waldron realized that he would need to convince his colleagues on
the board that the terms of the offer would be fair to all the company’s
shareholders and also appealing to those who especially desired high
dividends.
 Avon’s stock closed at $24.125 per share on June 1, 1988. Exhibit 6 gives
the June 1 closing prices of options on Avon’s stock which were listed on
the Chicago Board Options Exchange.

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THE PERCS EXCHANGE OFFER

1 PERCS + 1 Call option = 1 Common Share
+ PV (Extra Dividends
for 13 quarters)
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CALL OPTION FORMULA

C = S N(d1) – K e-rT N(d2)
𝑆
𝐾

d1 = {ln

d 2 = d1 –  𝑇
+ 𝑟+
2
2
𝑇}/{
𝑇}
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AVON PRODUCTS INC. – CASE QUESTIONS



Q1. Evaluate Avon’s investment and financing decisions in the 1980s. Why
was Avon restructuring its business in 1988? Did the changes make
sense?
Q2. Evaluate Avon’s financial condition in mid-1988. Why was Avon
reducing its dividend?
Q3. What was the purpose of the Exchange offer?
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AVON PRODUCTS INC. – CASE QUESTIONS


Q4. As an institutional investor holding Avon stock, how would you
evaluate the trade-off between accepting the new preferred and keeping
the common stock?
Q5. As an institutional investor holding Avon stock, should you just sell
the common stock and ignore the offer all together?
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