Find a Zero:

Which Billion Dollar Company

Will be Bankrupt by 2020
The Answer: Avon Products, Inc.

Catamount Investments
The Economist Case Study Competition
February 2015
Jordan Goldstein
Arran Joyce
Rafe Teer

Contents
I.

Introduction ...............................................................................................................................2

II.

Industry Analysis ........................................................................................................................2

III.

Company Snapshot .................................................................................................................3

IV.

Avon will not become profitable in the United States and Avon.com will flop...........................4

They are missing the main point, a direct selling model is not working in North America. ............4

Attempting to modernize their direct selling model is too little too late, and wont succeed due to
misaligned commissions..................................................................................................................5

V.

They have been facing double digit declines in representatives for some time now.....................6
Overcoming their extreme risk exposure in Latin American markets is no easy task......................7

Brazils economy has been hit hard as oil prices have continued to fall . ......................................7

Venezuela is plagued with political instability and turmoil..........................................................8

VI.

Conclusion ..............................................................................................................................9

Appendix ......................................................................................................................................... 10
Appendix A: Debt.......................................................................................................................... 10
Appendix B: Historical Data ........................................................................................................... 12

I.

Introduction
Avon Products, Inc. (AVP) will file for chapter 11 bankruptcy by the end 2020 and is

highly recommended to be sold short in the meantime. Avon is a global manufacturer and
marketer of beauty and related products founded by David H. McConnell in 1886. The company
was established on the foundation of giving women a chance at financial independence, an idea
that was revolutionary given the time period. However, as women have become more and more
prevalent in the workforce throughout the past 128 years, this vision has become outdated and
irrelevant. Avon has not had a dynamic strategy with the changing environment, resulting in
significant losses YOY in both revenues and net income since 2012. On top of this, they are
located in a highly competitive market with fast changing trends, allowing for tremendous
margins of error.

II.

Industry Analysis
The cosmetic industry can be broken down into two segments; Mature and Emerging

Markets. The mature markets, such as the U.S., have reached a point where growth has flattened
and there is increased competition between the dominant companies such as P&G, Unilever,
LOreal, etc. fighting for new and innovated beauty products. While emerging markets seem to
be where companies are looking for rapid growth and in turn, quick profits.

In 2010, Latin

America became the 4th largest market for cosmetics in the world due to increased GDP and
disposable income. The cosmetics industry is highly correlated to these two factors and
companies must use this knowledge to position themselves for positive growth outcomes. An
aspect that Avon has struggled with in past years and will continue to do so.

III.

Company Snapshot
Avon prides themselves on distinguishing themselves from others in the industry based

on their direct-selling model. For those who are unaware of how this works, Avon employs
representatives that in essence are the CEO of their own business. This means that once a rep,
one purchases the products from Avon directly and then sells them through personal face-to-face
selling, collecting a commission on the sales. This is a system that has been made obsolete in
todays society, due to a dramatic increase in consumer buyer power from technological
improvements. Consumers no longer have to rely on a salesperson to give them details about a
product, they can do that on their own without even leaving the home due to advancements in
online resources. A prime example of this was their attempt to enter China with the direct selling
model but quickly realized that the citizens and government did not take to the idea of door-todoor selling, highlighting the challenges of cross-country integration. Along with this,
consumers can easily execute purchases directly online leaving no need for a middleman. But
with that said, Avon remains to be optimistic about their business model and plans to continue
down the road they are heading. A road that isnt promising with decreasing revenues, bleeding
free cash flow, and a debt to equity ratio of 851.95 as of 2014.
This highly levered position will be the cause of many problems moving forward as Avon
has 5 bonds coming to maturity by the end of 2020, equaling a total of $1.6 billion. For 2014,
Avon had an interest coverage ratio of 2.48 (decreasing from 11.85 in 2010), showing that the
lack of revenue growth YOY is taking a hit on distributing earnings back to common
shareholders since a higher percent is being used for interest expense. Similarly, Avon stopped
paying dividends to its shareholders in 2013 causing (along with decreasing margins) an earnings
per share decrease of -26.5% in 2014. The constant decline in free cash flow will also be
troubling as they will need to sell off assets in order to repay their maturing debt. The only way
3

to avoid becoming a zero will be to make drastic changes to their company model, which they
have openly stated is not going to happen.
Avon will file for chapter 11 bankruptcy due to three main events. (1) Avon will fail to
turn around current conditions in the United States, a market they are entirely opposed to exiting,
(2) their direct selling model is outdated and inappropriate for mature markets, and (3) they will
fail to overcome the volatility and risk exposure in Latin American and emerging markets.

IV.

Avon will not become profitable in the United States and

Avon.com will flop

Avon CEO Sherilyn McCoy has said that North American profitability is her no. 1 priority
and exiting the market is not an option. They have had continued losses since 2012 and believe
they can turn it around by cutting costs, energizing their representative base, and successfully
implementing Avon.com, an online platform with the goal of improving sales. One major issue
here, however, is that you cant continue to cut costs if you want to increase your primary cost
driver. Their plan is essentially to stay the course and try harder.

They are missing the main point, a direct selling model is not working in North
America. In general this sales model does not work well in developed markets and has
more success in developing and emerging markets. This supports Avons heavy presence
in Latin America. Their failures in China are perfect examples of the failure of their
direct selling model. Avon, in referring to China, was quoted saying ... a direct-selling
model in the country is proving tougher than expected. Bribery scandals in the country
have cost the company over $300 million of lawsuits in the past two years.

Today, the average consumer is engulfed in social media and online interactions, people
are no longer comfortable buying beauty products from a stranger knocking on their
door. Avons strategy of continuing to sell products through their direct channel and
ignoring internet sales until a third straight year of losses is going to end poorly for them.
According to IBIS World direct selling in the US is forecasted to shrink at a
rate of 1.2% annually over the next 5 years and only 13% of all personal care
customers purchase their products through direct selling compared to 68%
who buy from mass merchandisersAvon predicts global direct selling to
grow at an annual rate of 4%-5%, however I was unable to confirm their
numbers. Customers no longer order through catalogues. This strategy is
outdated especially in mature markets where women no longer spend their
day at home waiting for the Avon lady to ring their doorbell. - Analyst Joe
Miano. 2012

Attempting to modernize their direct selling model is too little too late, and wont
succeed due to misaligned commissions. Avon has historically had failures
introducing online platforms and their newest endeavor will have the same results. Most
of their past failure has come from the inability to convince their representatives to use
online and mobile resources. This time, however, they are positive they can re-energize
their workforce by selling it to them as two ways to earn and two ways to
sell. Although this sounds great, representatives actually make less commission off of
online sales. Not very much incentive to utilize this tool. Near the end of 3QFY14 they
boasted involvement of around 10% of their representatives with the online and mobile
resources; not a great figure to be boasting about, although given their past failures this
could be considered encouraging for them. Additionally with the introduction of
5

Avon.com they are making no changes to their catalogue distribution, keeping them on a
2-week cycle in the U.S., a costly choice.

They have been facing double digit declines in representatives for some time
now. If direct selling was not an outdated sales model for mature markets, which it is,
they have still had consistently negative results with regards to representative retention, a
key sales driver. At its peak there were around 600,000 Avon Ladies in North
America, now it is down to less than 300,000. As a direct seller that relies on word-ofmouth for consumer awareness this is troubling. What you want to see first and
foremost is the number of reps stabilize Erin Lash, Morningstar Analyst. 2014
showed no signs of reversing this pattern with double-digit quarterly decline in active
representatives.
It doesnt look like 2015 will be any better either. As the North American economy
continues to recover, the creation of full-time jobs is going to decrease the attractiveness
of being an Avon representative. Lower sales followed by representative turnover
followed in turn by less recruiting leads back to lower sales. Their consistent doubledigit decline is difficult to fight, especially in a direct sales business. One could argue
that profitability in 2015 in North America doesnt require rep growth, however 4Q
results have shown that increased average orders will not make up for such large
decreases in reps. In order to recover they need to re-energize reps and attract a younger
audience. Again this is difficult when they are giving their reps a tool to make less
money.

V.

Overcoming their extreme risk exposure in Latin American

markets is no easy task

Avons exposure to the volatility and risk of the emerging markets in Latin America will
result in bankruptcy. Currently, over 70% of Avons total revenue comes from emerging
markets, clearly showing their exposure to risk overseas. Of that, over 50% of revenue comes
from their Latin American markets such as Brazil and Venezuela. With this much exposure to
these markets, Avons success is directly correlated to the economic and politica l policies in
these countries. Currently, these markets have taken huge economic downturns as oil prices
significantly fall and as political instability continues to mount. Avon will not be able to be
profitable in these markets and the value of their equity will eventually be worth zero.

Brazils economy has been hit hard as oil prices have continued to fall. The Brazilian
government has been trying to stimulate the economy by capping oil prices in hopes to
curb inflation. However, as prices of oil continually fall and domestic demand rises, big
oil companies are having to take losses. Consequently, production has flattened to 2M
barrels a day for the last four years. Last year, Petrobras (Brazil's national oil company)
set a goal to be producing 4.2M barrels a day by 2020. With production set to increase by
4.5% in 2015, this goal seems fanciful and unrealistic. With the lack of oil production and
exports, the economy will continue to suffer significantly, directly affecting Avons
ability to capture profitability in this market. Avon has seen a 47.21% decrease in their
net operating cash flow when compared to the same quarter last year. This shows that
Latin America, which constitutes for 50% of their revenue, has not been able to produce
enough income to create year over year profitability for their investors. Avons current
model to capture more revenue is to increase their reps in the emerging markets.
However, there was a 4% decrease in Q3FY14 in Latin American reps. As a result,
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Brazils sales of Beauty products was down 4% while Fashion and Home products were
down 3% representing the overall decrease of 5% in revenue. Avon needs a better model
moving forward in order to try and capture more revenue in their largest market. Solely
relying on representatives will not yield the necessary returns the firm needs to avoid
bankruptcy. Furthermore, if the economy of Brazil continues to suffer due to the
volatility in the oil market, Avon will struggle in their ability to capture more income
from these markets. The firms exposure to their non-market environment in Latin
America poorly positions the firm for future success.

Venezuela is plagued with political instability and turmoil. It represents the other
Latin American country that Avon heavily relies on to create profitability and value for
their shareholders. Alexis Rondon, an official of the Ministry of Social Movements and
Communes, stated earlier this week that the country faces an economic war, warning
the people that a year of struggle lies ahead. As Hugo Chavezs Bolivarian Revolution
lives on, the country faces poor economic conditions as the regime struggles to import
basic necessities and pay its outstanding debts. The country has seen shortages in basic
goods, from milk and flour to soap and toilet paper. Venezuela's suffering is a result of
years of government mismanagement and corruption, and the recent collapse in oil prices,
which accounts for the majority of its exports. During Chavezs reign, the government
received over $800 billion in oil revenue. However, very little of this money found its
way back into the social and economic infrastructure of the country. Rather than saving
windfall oil revenue, the nation issued more debt than any other emerging economy from
2007-2011. The economy has contracted about 4% and inflation has climbed 65% in the
year to November. As oil prices fall around $50 a barrel, Venezuela faces difficulty

generating oil revenue to repay its debts, of which $10.3 billion is due in 2015. The
growing instability of the nation's political and economic policies has directly affected
Avons ability to conduct profitable business in this market. Venezuelas growing
inflation contributes to the growing difference in exchange rates with the US dollar. In
March 2013, the government announced a foreign exchange system (SCIAD I) that
increased government control over the allocation of US dollars in the country. In January
2014, the government extended the program to include certain types of transaction,
including dividends. Consequently, the availability of US dollars under these new
regulations for Avon has been limited. With a fluctuating exchange rate and growing
government regulation on US dollars, Avon is poorly positioned to be profitable in the
future. Furthermore, the government passed a new Law on Fair Pricing in 2014, which
established maximum profit margins for companies in Venezuela. With uncertainty on
how this law may be interpreted and enforced in the future, Avon may be subjected to
new regulation that will further constrain their ability to generate income in this market.

VI.

Conclusion
Avon Products, Inc. will go bankrupt by the end of 2020 due to the points highlighted

above. They have done little to adapt to changing market conditions and expectations in the
industry. Avon has an outdated sales model, high exposure in emerging markets, high debt to
equity, and no plans to save themselves moving forward. All of this adds up to a company that is
a zero. Their only escape plan would have to be a LBO/acquisition, but what company would
want to take over such an outdated business model with a substantial amount of debt. This is
such an unlikely option that any rumors are just that, rumors. Avon will join the many
companies filing for chapter 11 bankruptcy in the next five years.
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Appendix
Appendix A: Debt
Table 1: Capital Structure

Table 2: Debt Comparable

10

Table 3: Interest Coverage Ratio

**Interest coverage ratio has seen steady declines since 2010.

Table 4: AVP 5YR CDS SPREAD

11

Appendix B: Historical Data

Table 5: 10 YR Profitability Data

12

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