Can youplease help with the attached case study 1 Read and analyze the case study Avon Products Assignment questions Evaluate Avons investments and financing decisions in the 1980s Why was

Can youplease help with the attached case study.

1. Read and analyze the case study "Avon Products". Assignment questions:

Evaluate Avon's investments and financing decisions in the 1980s. Why was Avon restructuring its business in 1988? Did the changes make sense?

As an institutional investor holding Avon stock, how would you evaluate the trade-off between accepting the new preferred and keeping the common stock? Might you just sell the common stock and ignore the offer altogether?

• Evaluate Avon's financial condition in mid-1988. Why was Avon reducing its dividends?

• What was the purpose of exchange offer?Harvard Business School 9-289-049
Rev. August 5, 1994
Professor Jonathan Tiemann prepared this case as the basis for class discussion rather than to illustrate either effective or
ineffective handling of an administrative situation.
Copyright © 1989 by the President and Fellows of Harvard College. To order copies or request permission to
reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to
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used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying,
recording, or otherwise—without the permission of Harvard Business School.
1
Avon Products, Inc.
On June 1, 1988, Hicks B. Waldron, chairman and chief executive officer of Avon Products,
Inc., was reviewing a package of proposals that he and his financial advisors were to present to the
Avon board of directors for final approval the following day. These proposals included (1) a public
announcement that Avon would explore plans to divest two of its businesses, probably at a
considerable book loss; (2) a reduction of the dividend on Avon’s common stock; and (3) an exchange
offer under which Avon would issue an unusual preferred stock in exchange for up to 25% of its
common shares.
Background
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. In addition, by the mid-1980s, the company was
an important national provider of sub-acute health care services.
Avon’s Beauty Group produced and sold cosmetics, fragrances, toiletries, and fashion jewelry
and accessories; it also sold gift and decorative products. 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. Avon’s other principal business group was its Health Care Group, which comprised Foster
Medical Corporation, the Mediplex Group, and Retirement Inns of America. They provided home
health care, operated retirement living facilities, and provided certain sub-acute health care services.
Exhibit 1 gives a 10-year review of Avon’s financial performance, and Exhibit 2 gives data by lines of
business for the period 1982-1987. Exhibit 3 shows balance sheets for 1986 and 1987, and Exhibit 4
gives an historical perspective on Avon’s stock price.
Recent Company History
As a result of its 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. But more important, in the early 1980s, Avon made the major
289-049 Avon Products, Inc.
2
strategic decision to diversify its business by entering the health care field. Its first acquisition in that
field was in January 1982, when Avon acquired Mallinckrodt, Inc., a specialty chemical company
whose sales were largely to the health care industry.
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. 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. 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. but the Wall Street Journal
reported at the time that observers had expected the dividend reduction. In any event, 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.
In 1984, having just become Avon’s CEO, Mr. Waldron began to reshape the company’s
beauty operations. 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.
In May 1984, Avon acquired Foster Medical Company in a share exchange. Foster Medical
seemed a particularly attractive acquisition because of the possibility that public health care policy
would change to encourage a shift from expensive, hospital-based care to the less expensive home
care, which was a major part of Foster’s business. 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. Consistent
with this increasing focus on the provision of health care, Avon sold Mallinckrodt in 1986 for $675
million.
Although Mediplex and Retirement Inns served patients who paid for care themselves or
through private insurers, Foster Medical’s revenues came primarily from Medicare, the largest public
health insurance program in the United States. 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, and 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. 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.
Also in 1987, 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.
Avon Products, Inc. 289-049
3
The Exchange Offer
Mr. Waldron felt that at the same time that Avon was reorganizing its business, it should also
reconsider its financial policies, including its dividend policy. The company was about to begin the
last phase of its exit from the health care business with the sale of Mediplex and Retirement Inns. In
addition, Mr. Waldron and the board agreed that Avon should redouble its commitment to its core
beauty products business, whose recent results were encouraging. Among other things, this implied
that Avon would continue to invest significant additional capital in that business.
In December 1987, Avon raised additional capital by selling 40% of the common stock of its
wholly-owned Japanese subsidiary, Avon Products Company Limited, in a public offering in Japan
that raised $218 million. The price was over six times book value and around 50 times earnings.
Avon booked an after-tax gain of $121.1 million, or $1.72 per share, on the sale.
The board also 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.
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.” 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.
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 7.17 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, 1991.1 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.
As was usual with preferred stock, Avon would not be able to pay its common dividend at
any time its preferred dividend was in arrears. In addition, this preferred stock included a restriction
providing that Avon could never pay a common dividend of $1.50 or more per share per year unless
it first redeemed the preferred.
1 Short-term U.S. Treasury notes were paying about 8.2% per year at the time.
2 The redemption price would be $34.75 per share, plus accrued dividends, for the quarter starting June 1, 1988.
It would decline by 25 cents per share for each quarter thereafter through the quarter beginning March 1, 1991.
The redemption price would fall to $31.75 per share on June 1, 1991, and then to $31.50 per share on June 1,
1991. The company would have the option of redeeming the preferred for either cash or common shares.
289-049 Avon Products, Inc.
4
Mr. Waldron felt confident that the financial markets would understand the new security.
Third-party issuers had successfully marketed at least one product similar to the PERCS, Americus
Trust PRIME units. An Americus Trust was a corporation whose sole asset was common stock of a
particular company. The basic idea was that shareholders of that company placed their shares in the
trust, which issued two units, called a PRIME and a SCORE, against each share. The PRIME units
received all the dividends the stock earned; the SCORE units received no dividends. At a
predetermined terminal date, the trust would liquidate the shares it held. The PRIME holders would
receive the value of the shares up to a certain predetermined level, and the SCORE holders would
receive any excess. The PERCS might appeal to investors who would buy PRIMEs.
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.
289-049 -5-
Exhibit 1 Ten-Year Financial Summary, 1978-1987 (millions of dollars except per share data)
1978 1979 1980 1981 1982 1983 1984 1985 1986 1987
Net sales $2,014.7 $2,377.5 $2,569.1 $2,613.8 $3,000.8 $3,000.1 $3,141.3 $2,470.1 $2,883.1 $2,762.5
Cost of sales 721.0 899.7 959.9 1,018.1 1,278.7 1,290.1 1,330.4 959.5 1,034.0 980.3
Marketing, distribution, administrative
expenses 859.5 1,034.8 1,169.4 1,199.2 1,306.8 1,368.7 1,435.0 1,256,3 1,530.4 1,495.3
Interest expense, net (24.5) (33.4) (39.8) (49.3) (7.2) 4.3 19.3 16.9 38.6 46.2
Other (income) expense, net 2.7 (3.8) 7.3 .1 30.5 26.8 20.4 13.1 6.5 (143.8)
Total expenses $1,558.7 $1,897.3 $2,096.8 $2,168.1 $2,608.8 $2,689.9 $2,805.1 $2,245.8 $2,609.5 $2,378.0
Pre-tax earnings from continuing
operations 456.0 480.2 472.3 445.7 392.0 310.2 336.2 224.3 273.6 384.5
Income taxes 228.1 229.5 231.0 225.8 195.4 145.8 154.5 96.1 114.9 146.3
Net earnings from continuing operations $ 227.9 $ 250.7 $ 241.3 $ 219.9 $ 196.6 $ 164.4 $ 181.7 $ 128.2 $ 158.7 $ 238.2
Discontinued operations
Net earnings (loss) -- -- -- -- -- -- -- 34.9 -- (55.4)
(Loss) on sale, net -- -- -- -- -- -- -- (223.0) -- (23.7)
Net earnings (loss) $ 227.9 $ 250.7 $ 241.3 $ 219.9 $ 196.6 $ 164.4 $ 181.7 $ (59.9) $ 158.7 $ 159.1
No. of common share (millions) 58.16 60.14 60.15 60.15 71.46 74.49 83.84 79.35 71.65 71.65
Net earnings per share 3.92 4.17 4.01 3.66 2.75 2.21 2.16 (.76) 2.23 2.26
Cash dividend per share 2.55 2.75 2.95 3.00 2.50 2.00 2.00 2.00 2.00 2.00
Cash, short-term investments $ 339.6 $ 307.0 $ 308.4 $ 257.8 $ 161.2 $ 183.7 $ 124.5 $ 86.1 $ 80.2 $ 73.8
Net property and equipment 285.7 382.2 465.8 518.3 729.6 760.4 807.7 666.4 743.2 637.5
Capital expenditures 74.8 116.3 117.7 114.2 128.9 128.3 140.5 91.2 120.5 90.8
Total assets 1,226.1 1,406.0 1,571.4 1,567.8 2,233.2 2,285.5 2,437.7 2,289.0 2,296.3 2,559.2
Long-term debt 3.1 4.1 2.6 4.8 297.3 318.4 440.5 617.8 709.2 816.4
Shareholders’ equity 738.4 857.2 921.2 933.0 1,219.4 1,204.2 1,157.1 926.4 681.3 758.6
Return on equity 30.9% 29.2% 26.2% 23.6% 16.1% 13.7% 15.7% --- 23.3% 21.0%
289-049 -6-
Exhibit 2 Line-of-Business Data, 1982-1987 (millions of dollars)
Net Sales
Pre-Tax
Earnings
Identifiable
Assets Net Sales
Pre-Tax
Earnings
Identifiable
Assets
1982 1983
Cosmetics, fragrances,
toiletries $1,998.0 $ 279.8 $ 969.9
Cosmetics, fragrances,
toiletries $1,884.3 $ 219.8 $ 945.7
Fashion jewelry, accessories 338.3 61.9 185.0 Fashion jewelry, accessories 330.2 43.5 166.7
Health care 340.6 52.7 713.3 Health care 402.2 63.6 747.6
Direct response 124.3 17.1 32.4 Direct response 144.0 11.7 55.7
Fine jewelry, tableware 114.6 6.7 111.2 Fine jewelry, tableware 124.6 8.1 127.8
Other 86.9 7.5 87.3 Other 119.7 14.2 87.8
Corporate, eliminations (1.9) (10.4) 134.1 Corporate, eliminations (4.9) (19.6) 154.5
Consolidated $3,000.8 $ 415.3 $2,233.2 Consolidated $3,001.1 $341.3 $2,285.8
1984 1985
Cosmetics, fragrances,
toiletries $1,832.3 $237.2 $932.9
Cosmetics, fragrances,
toiletries $1,609.6 $ 192.3 $ 963.2
Fashion jewelry, accessories 350.9 55.0 201.3 Fashion jewelry, accessories 394.2 42.3 244.2
Health care 542.9 91.7 961.3 Health care 260.3 51.2 315.6
Direct response 186.0 2.9 100.2 Direct response 205.2 8.8 128.8
Other 234.3 11.7 142.5 Discontinued operations -- -- 524.9
Corporate, eliminations (5.1) (22.6) 99.5 Corporate, eliminations .8 (40.3) 112.3
Consolidated $3,141.3 $ 375.9 $2,437.7 Consolidated $2,470.1 $ 254.3 $2,289.0
1986 1987
Cosmetics, fragrances,
toiletries $1,923.8 $ 236.8 $1,089.1
Cosmetics, fragrances,
toiletries $1,807.9 $ 251.3 $1,385.5
Fashion jewelry, accessories 310.0 45.0 204.1 Gift and decorative 412.3 54.6 157.0
Health care 431.8 65.0 731.9 Fashion jewelry, accessories 375.2 45.7 237.3
Direct response 216.2 11.6 139.7 Health care 167.1 10.1 396.5
Other 1.3 -- .7 Discontinued operations -- -- 253.4
Corporate, eliminations -- (39.7) 130.8 Corporate, eliminations -- 22.8 129.5
Consolidated $2,883.1 $ 318.7 $2,296.3 Consolidated $2,762.5 $ 384.5 $2,559.2
Avon Products, Inc. 289-049
7
Exhibit 3 Balance Sheets, 1986 and 1987 (millions of dollars)
1986 1987
Cash and equivalents $ 80.2 $ 73.8
Accounts receivable (less allowance) 371.6 310.5
Inventories 410.1 398.6
Prepaid expense and other current 184.8 144.1
Current assets $1,046.7 $ 927.0
Total property and equipment 1,132.4 1,046.4
Less, accumulated depreciation 389.2 408.9
Net property and equipment $743.2 $ 637.5
Net assets of discounted operations -- 253.4
Other assets 506.4 741.3
Total assets $2,296.3 $2,559.2
Short-term debt $110.2 $ 62.4
Accounts payable 169.0 196.1
Accruals 211.0 277.7
Taxes payable 182.7 222.6
Current liabilities $ 672.9 $758.8
Long-term debt 709.2 816.4
Other liabilities 66.2 117.3
Deferred income taxes 166.7 108.1
Net worth 681.3 758.6
Total liabilities and net worth $2,296.3 $2,559.2
Exhibit 4 Stock Price Performance, 1978-1988
Price
Average
Weekly
Volume
High Low Closing (000 shares) S&P 500
1978 $63 $43 $50 ¾ 373.5 96.11
1979 56 37 ¼ 39 420.5 107.94
1980 40 ¾ 31 34 570.0 136.76
1981 42 28 30 491.4 122.55
1982 30 ½ 19 26 ¾ 992.7 140.64
1983 36 21 ¼ 25 1,277.2 164.93
1984 26 19 ¼ 21 1,229.2 167.24
1985 29 17 27 1,572.4 211.28
1986
First Quarter 34 25 ¾ 33 ½ 1,319.6 238.90
Second 36 30 ¾ 35 ¾ 1,217.6 250.84
Third 36 31 ¼ 32 1,026.2 231.22
Fourth 34 27 27 1,296.7 242.17
1987
First Quarter 32 ½ 26 ¼ 31 1,769.3 291.70
Second 35 28 ¾ 33 ¾ 1,577.2 304.00
Third 35 32 35 1,503.6 321.83
Fourth 35 19 ¼ 25 ¾ 1,345.8 247.08
1988
First 28 22 24 1,369.1 258.89
Second (through 6/1) 26 ¼ 22 24 1,310.9 266.69
Note: As of June 1, 1988, the historical volatility of Avon stock was 31.3% per year over the previous six months and
35.5% per year over the previous three months.
289-049 Avon Products, Inc.
8
Exhibit 5 Twenty-Five Largest Institutional Shareholders
Shares Purchased
or Sold Jan. 1 -
Mar. 31, 1988
Share Held March
31, 1988
Percent of Total
Avon Shares
Outstanding
Primary Investment
Objectives of
Owner
Delaware Management Co. -1,489,400 4,467,900 6.3% Yield
United Banks of Colorado 0 3,603,425 5.1 Turnaround
Lazard Freres & Co. 0 3,515,800 4.9 Yield
Barrow Hanley Mewhinney 1,665,500 3,487,300 4.9 Yield
PNC Financial Corp. 0 1,618,037 2.3 Mixed
Wells Fargo Bank N.A. 0 1,479,546 2.1 Index
Scudder, Stevens & Clark 0 1,443,733 2.0 Mixed
New York St. Common Ref. 0 1,202,200 1.7 Index
Irving Trust Company 0 1,136,781 1.6 Mixed
Lord Abbett & Company 0 1,090,200 1.5 Yield
Bankers Trust NY Corp. 211,025 934,856 1.3 Index
Dreyfus Corporation 0 884,700 1.2 Mixed
Capital Research & Mgmt. 0 800,000 1.1 Mixed
Center Bancorporation 0 770,783 1.1 Mixed
Amsouth Bancorporation 0 764,343 1.1 Mixed
College Retire. Equities -165,700 712,000 1.0 Index
Dean Witter Reynolds Int. 0 700,090 1.0 Mixed
Mellon Bank Corporation 0 699,693 1.0 Index
Eaton Vance Management 0 650,000 .9 Mixed
E.I. du Pont de Nemours 382,600 598,760 .8 Mixed
General Electric Master Ret. 0 596,800 .8 Mixed
Hagler Mastrovita & Hewitt -175,600 520,300 .7 Mixed
California Public Empl. Ref. 0 499,000 .7 Index
American National B&T 0 494,275 .7 Index
Chase Manhattan Corp. 12,400 489,695 .7 Mixed
Total +440,825 33,160,217 46.5%
Yield 17.6%
Turnaround 5.1
Mixed 15.3
Index 8.5
46.5%
Source: 13-F filings with the Securities and Exchange Commission.
Avon Products, Inc. 289-049
9
Exhibit 6 Chicago Board Option Exchange, Listed Options Trading, Closing Prices, June 1, 1988
Calls Puts
Strike Price June July October Strike Price June July October
$ 22 ½ $ 2 r $ 3 1/8 $ 22 1/2 $ 3/16 r $ 1 1/16
$ 25 $ 7/16 $ 7/8 $ 11 13/16 $ 25 r $ 1 7/8 $ 2 1/2
$ 30 r $ 1/4 $ 9/16 $ 30 r r r
r - not traded that day.
The closing price for Avon Products common stock on June 1, 1988, was $24 1/8.
Note: An option is a contract giving the holder the right, but not the obligation, to buy or sell a given asset at a specified price (the
exercise price or strike price) on or before a given date (the exercise date or expiration date). A call option gives the holder
the right to buy, while a put option gives the holder the right to sell. The right is valuable, and options on many stocks are
traded on organized exchanges. Exchange-listed options like these expire on the Saturday after the third Friday of the
month indicated. A contract represents an option on 100 shares. The entries in the table give the prices (sometimes called
option premia) of the options themselves, per share of Avon stock. Thus, on June 25 call option contract gives the holder
the right to buy 100 shares of Avon stock for $25 per share on or before Saturday, June 18, 1988. Such a contract traded
on June 1 for $43.75, which is $7/16 x 100. Tables like this one for most exchange-listed options appear daily in financial
publications, including The Wall Street Journal and the business section of the New York Times.