Avon Products Inc. (AVP:US) is on the brink of losing its investment-grade ratings at Standard & Poor’s and Fitch Ratings because of potential debt tied to Coty Inc.’s bid for the company and weaker-than-expected first-quarter earnings.
Avon, with about $3.3 billion of debt, had its BBB- credit grade placed on “negative” watch today by Grace Barnett, a Fitch analyst, who said in a note that if Coty’s $10.7 billion bid is accepted and financed “with significant amounts of debt,” the new entity won’t merit investment-grade status. S&P cut New York-based Avon one grade to BBB- yesterday and maintained its “negative” outlook, according to a note.
Coty raised its offer for Avon today to about $10.7 billion and said Warren Buffett’s Berkshire Hathaway Inc. (A:US) will provide equity financing for the deal. The deal would add a new door-to- door distribution channel for Coty’s cosmetics and more than twice its $4.5 billion in annual sales. Avon rejected the perfume-maker’s bid last month, saying it undervalued the company and that it was working on a turnaround. Today, Avon said it will consider Coty’s letter “in due course.”
In Avon’s favor, Coty has said it wants to keep the combined company investment grade, and Berkshire’s involvement “certainly supports the concept of trying to be investment grade because they don’t typically invest in highly levered companies,” Barnett, who’s based in New York, said in a telephone interview today.
Avon has been (AVP:US) ranked investment grade by S&P and Fitch for at least a decade, according to data compiled by Bloomberg. Moody’s Investors Service rates Avon as A3 with a “negative” outlook.
‘To Its Knees’
Buffett warned against the risks of leverage in his 2010 annual letter to shareholders, saying “even a short absence of credit can bring a company to its knees.”
“Companies with large debts often assume that these obligations can be refinanced as they mature,” Buffett wrote. “That assumption is usually valid. Occasionally, though, either because of company-specific problems or a worldwide shortage of credit, maturities must actually be met by payment. For that, only cash will do the job.”
Avon’s $500 million of 5.625 percent senior unsecured notes due in March 2014, the most actively traded of the company’s outstanding debt today, fell 0.2 cent to 104.25 cents on the dollar to yield 3.17 percent at 11:09 a.m. in New York, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority.
The acquisition by Coty may require $9 billion of debt and $5 billion of equity, according to Fitch. To maintain investment-grade status, the equity component would need to increase to the $8 billion range, or the company may offer “a rapid and credible deleveraging plan,” Barnett said in today’s note.
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