Benefits of Coty’s Merger with Procter & Gamble’s Beauty Brands

The agreement between Procter & Gamble (PG), or P&G, and Coty (COTY) to merge 43 of P&G’s beauty brands with Coty, is expected to immediately improve pro forma profitability for the new entity. Coty’s expected to earn an adjusted operating margin of 12% in fiscal 2015 on a standalone basis. Following the merger, operating margins are expected to rise by 2% to 14% on a pro forma basis.

P&G’s beauty business generated EBITDA (earnings before interest, taxes, depreciation, and amortization) of ~$0.7 billion on sales of $5.9 billion in fiscal 2014, ended June 30, 2014.

Total cost savings and synergies are estimated to be ~$550 million or ~10% of P&G’s Beauty segment sales in fiscal 2014. However, the full impact of these savings wouldn’t be realized until the end of year three.

According to company projections, following the deal’s close, ~$400 million in operating costs wouldn’t be transferred to the new entity. This would result in an immediate upside to profit. As well, annual cost savings of $150 million are anticipated from year three onward. Of these savings, 80% relate to supply chain costs, with the balance emanating from savings in selling, general, and administration expenses, according to Coty CFO Patrice de Talhouët.

In order to realize these cost savings, Coty would need to spend $400 million in capex to build additional capacity. Coty would also incur one-time transaction costs of ~$500 million, to be spent over three years.

Coty estimates an immediate 2% increase in the pro forma operating profit margin to 14% once the deal has closed. Coty also expects to improve its margins by another 1% once the effect of cost savings from the merger is realized. Coty estimates a pro forma margin of 15% from year three onward. In comparison, here’s what operating margins looked like for Coty’s peers over the last twelve months:

• 16% for Estée Lauder (EL)
• 17.3% for L’Oréal (LRLCY) (OR.PA)
• 11.7% for Inter Parfums (IPAR)
• 13.1% for Nu Skin Enterprises (NUS)

Coty, Estée Lauder, and Nu Skin Enterprises are part of the portfolio holdings in the First Trust Consumer Discretionary AlphaDEX Fund (FXD). FXD has 2.2% of its holdings invested in these firms.