P&G bids beauty care adieu this week

Procter & Gamble's split from 41 beauty brands is nearing completion as the consumer giant wraps up an exchange offer this week.

Unknown until just before the closing of the deal: the exact structure of P&G’s split with its beauty brands. The final structure of the deal will shape Procter’s financial position and will influence future moves by the Cincinnati-based consumer product giant’s from potential acquisitions to a boost in dividends.

P&G is asking existing shareholders to swap some or all of their shares for stock in the new-and-improved Coty. P&G officials won’t say how many have expressed interest. P&G says it will distribute any unsold shares in the departing beauty brands to all P&G shareholders.

With the closing of the beauty divestiture, P&G will complete its massive brand divestiture announced two years ago aimed at paring 100 noncore labels. When the deal is done, P&G executives have promised their company will be smaller, easier-to-run and poised to resume growing sales and profits.

Jack Russo, an analyst with Edward Jones, said the transaction will benefit both P&G, which wants to get smaller, and Coty, which wants to bulk up.

"For P&G, this allows them to get rid of underperforming brands and focus their capital and resources on the best brands within their beauty business," Russo said. "Meanwhile, Coty will be able to meaningfully improve the size and scale of its beauty business with this deal."

Bill Chappell, an analyst with SunTrust, said completion of the complex deal will allow P&G to get back to basics, which it has promised to do for the last two years.

"Shareholders will be happy to see them reach the finish line, so they can focus on their core business," Chappell said. "P&G won't know if their plan will work until they get past this transaction."

How the stock swap is supposed to work

On Sept. 1, P&G opened the offer to swap P&G shares for shares that will become part of Coty. The exchange offer expires on Friday, Sept. 29, at midnight.

Specifically, P&G shareholders are being offered a $1.075 worth of stock for every $1 P&G shares they tender. The final exchange ratio will be based on the volume-weighted average price of both P&G and Coty shares during the last three days of the offer this week. P&G shareholders who take the deal appear poised to get between 3.7 and 3.9 shares of Coty for every share of P&G they exchange based on both stock prices.

The consumer products giant said it will issue nearly 410 million shares in Galleria, the company that will merge with Coty. Participating P&G shareholders will collectively own 54 percent of the super-sized Coty, which will have 746 million shares outstanding and a market capitalization of about $19 billion.

Shareholders who have opted to trade in their P&G shares have until the last day to change their mind and cancel their transaction. P&G needs 110 million shares of company stock to complete the transaction.

It's not known how shareholders are reacting to the exchange. P&G officials declined to describe interest in the offer.

If too many shareholders try to swap out their stock, P&G will prorate the new stock to be issued. If P&G doesn't get enough shareholders willing to surrender their shares, P&G will distribute the unsold portion to all P&G shareholders as a one-time stock dividend.

How successful P&G is in selling off Galleria to its shareholders will have a noticeable effect on the company’s finances. P&G prefers to sell all the Galleria shares in exchange for Procter shares because it will minimize taxes to shareholders, but it also preserves capital.

Using the divestiture to shrink P&G’s outstanding shares saves the company money on shares repurchases – freeing up money that can be spent elsewhere on innovation, marketing, acquisitions or future dividend increases. If P&G gets enough shares tendered to cover the entire divestiture, P&G will effectively repurchase about 4 percent of its shares.

P&G’s deal to sell Duracell batteries to Warren Buffett’s Berkshire Hathaway was similar because that brand sale was also transacted in $4 billion worth of P&G shares – not cash. That deal reduced P&G’s outstanding shares or “float” by 2 percent. Stock exchange transactions are attractive vehicles for restructuring because the taxes are dramatically lower than all-cash deals.

Cutting shares outstanding could also boost the company’s stock because earnings per share will increase.

If there aren’t enough takers, P&G can still dispose of the remaining stock in the outgoing brands by distributing them to all stockholders as a one-time dividend. But such a dividend would be taxable income for shareholders.

Should P&G shareholders take the deal? 

Analysts say P&G shareholders have a stark choice in deciding whether to surrender some of their shares to bet on Coty.

While P&G investors have seen choppy performance for nearly half a decade, the company’s stock has steadily risen this year as it approaches the latest divestiture. In contrast, Coty shares have slid in the year since the pending deal was first announced amid uncertainty over what will likely be a complex integration.

Barclays analyst Lauren Lieberman says Coty might be a solid investment worth enduring its transition.

"Frankly, we’re a bit surprised just how under the radar Coty has been of late," Lieberman wrote in a Sept. 19 note to investors. "While there are surely many moving pieces from a technical perspective that will make the stock volatile over the coming weeks, fundamentally, we think many either under appreciate or simply are not familiar with the merits of the corporate transformation story that is unfolding."

Lieberman said Coty will need to "revive" several of its beauty brands with declining sales, but was compelled the transaction creates a large beauty player that appears hungry to grow even larger. Future moves may include trimming back after the merger, but future acquisitions may also follow.

Coty plans to cut $750 million worth of expenses over the next four years following the deal.

"It strikes us as unequivocal that there is a growth mandate at Coty," Lieberman wrote. "We think this is just the first step in a long journey toward establishing itself as a 'challenger' in global beauty."

The transformative deal will double the size of New York-based Coty, making it over as the world’s No. 3 beauty player doing $9 billion in annual sales. Coty will also add 10,000 former P&G employees and assume control of eight factories, including one in Maryland and seven in Europe.

Coty, the maker of Rimmel makeup and Calvin Klein perfume, will also acquire household names, such as CoverGirl makeup, Wella and Nice 'n Easy hair coloring, and a raft of licensed fragrances.

While there will be a transition period at Coty, P&G has arranged for its interested shareholders to acquire Coty shares at a 7.5 percent discount. Portfolio managers also point out for clients with too much wealth concentrated in P&G shares, this is a tax-free opportunity to diversify some of those holdings.

Michael Chasnoff, president of Truepoint Capital in Blue Ash, said he's had several clients ask about the tender offer. He said Coty shares are riskier given the pending integration, but might be a smart move for some clients who need to broaden their portfolio.

"Some investors have too much P&G stock – this is a tax-free way to diversify," Chasnoff said.