AVON PRODUCTS AVP (March 2018's)
January 20, 2016 - 6:36pm EST by
Orion
2016 2017
Price: 85.00 EPS 0 0
Shares Out. (in M): 250 P/E 0 0
Market Cap (in $M): 1,057 P/FCF 0 0
Net Debt (in $M): 1,726 EBIT 0 0
TEV ($): 2,783 TEV/EBIT 0 0

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  • Private Equity (PE)
  • Undervalued Bond
 

Description

 

Aviclara wrote a negative post on AVP common stock on 1/6/16.  I recommend readers look to that note for further background.  I generally agree with his/her note, but I do believe AVP’s 2018 bonds look attractive and don’t think the two recommendations are mutually exclusive.

 

Recommendation: Buy AVP March 2018 Notes (054303AU6) and a smaller position in July 2018’s (054303AR3)

 

What’s Happened:

  • 12/17/2015 Avon announced that they signed a definitive agreement with Cerberus for a capital infusion.  

  • AVP NA will be separated into a privately owned entity, Cerberus will own 80.1%, AVP will own 19.9%.  $230 million of long-term liabilities (mainly pensions) will be passed onto AVP NA, along with $100 million in cash from AVP.  For this business, Cerberus will pay $170 million to AVP NA (not AVP).

  • In addition to the North American business transaction, AVP will receive $435 million from the issuance of convertible perpetual preferred securities to Cerberus.  They have a 5% coupon, and can be converted at $5.00 per share (forced conversion at $10).  The coupon is deferrable through the first seven years (or subject to penalty interest thereafter).  The company can elect to pay the coupon in cash, non-convertible/non-voting Series D preferred stock, or common stock.

Use of Proceeds:

  • In the press release announcing the agreement, Avon stated the following: of the proceeds, “$250 million may be used to opportunistically reduce debt”.

  • During the conference call associated with this transaction, James Scully, CFO stated the following: “The way I was thinking about it, that you look at the 2018 maturities, we have $500 million of maturities there.  To be able to take care of one tranche with this infusion of capital would be important.”

Post Deal Liquidity:

 

2018 Bonds:

  • 054303AU6- $250 million outstanding, 5.75% coupon, currently trading around $85.

  • 054303AR3- $250 million outstanding, 4.20% coupon, currently trading around $75.

Thesis:

    Why even pay down debt?  The company has a fair amount of cash and liquidity (though major reinvestment is required).  The company recently (June 2015) obtained a secured revolver, which has looser covenants than their previous unsecured revolver.  The company may potentially breach the covenants at some point in 2016.  The major friction point is the Leverage Ratio.  The financial ratio schedules are as follows:

 

 

I think $460 million in EBITDA in 2016 is a moderately bullish estimate.  Using this EBITDA and the current debt outstanding ($2.3 billion as of Q3 2015), by YE 2016 the leverage ratio would be greater than 5.0x.

 

Since it is a gross leverage ratio they are under pressure to pay down some debt.

 

    I believe that AVP is going to likely tender, and/or, possibly redeem one of these securities.  If they are going to redeem, the March bonds would be preferred, since they carry a higher coupon and mature 4.5 months earlier (though slightly more expensive to buy using make-whole premium).  If they were to tender for the some of the bonds, my conviction declines on which 2018 maturity they choose.  The July bonds trade at a higher yield-to-maturity and it would be advantageous for AVP to buy this maturity if they are time agnostic…but AVP doesn’t have this luxury.  There is a non-zero probability that AVP buys the July bonds, in my opinion.  

 

AVP could buy the bonds in the open market, but, this is difficult given the liquidity of the issues and the timeline.

 

The Risk/Reward-

 

March 2018’s-

 

The most likely scenario is a 5pt tender (estimate), in my opinion:

 



Assuming the bond is redeemed @ the make whole price on 4/1, this would be the expected return:

 

 

I use the 2019’s for downside expectations which currently yield around 18%.  A lower yield is likely appropriate for the shortest maturity, so I will use 17%.   This is the downside return scenario for the  March 2018’s, if on 4/1 the deal falls through or they buy the  July 2018’s instead:

 

July 2018’s-

 

 



 

Obviously my downside scenarios are based on the March 2019’s as of today…..while the yield on those has been anything but consistent:



Nonetheless, I think the risk/reward is favorable.  I have a position with 75% March bonds and 25% July bonds.

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Debt paydown post Cerberus deal (expected before May)
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    Description

     

    Aviclara wrote a negative post on AVP common stock on 1/6/16.  I recommend readers look to that note for further background.  I generally agree with his/her note, but I do believe AVP’s 2018 bonds look attractive and don’t think the two recommendations are mutually exclusive.

     

    Recommendation: Buy AVP March 2018 Notes (054303AU6) and a smaller position in July 2018’s (054303AR3)

     

    What’s Happened:

    Use of Proceeds:

    Post Deal Liquidity:

     

    2018 Bonds:

    Thesis:

        Why even pay down debt?  The company has a fair amount of cash and liquidity (though major reinvestment is required).  The company recently (June 2015) obtained a secured revolver, which has looser covenants than their previous unsecured revolver.  The company may potentially breach the covenants at some point in 2016.  The major friction point is the Leverage Ratio.  The financial ratio schedules are as follows:

     

     

    I think $460 million in EBITDA in 2016 is a moderately bullish estimate.  Using this EBITDA and the current debt outstanding ($2.3 billion as of Q3 2015), by YE 2016 the leverage ratio would be greater than 5.0x.

     

    Since it is a gross leverage ratio they are under pressure to pay down some debt.

     

        I believe that AVP is going to likely tender, and/or, possibly redeem one of these securities.  If they are going to redeem, the March bonds would be preferred, since they carry a higher coupon and mature 4.5 months earlier (though slightly more expensive to buy using make-whole premium).  If they were to tender for the some of the bonds, my conviction declines on which 2018 maturity they choose.  The July bonds trade at a higher yield-to-maturity and it would be advantageous for AVP to buy this maturity if they are time agnostic…but AVP doesn’t have this luxury.  There is a non-zero probability that AVP buys the July bonds, in my opinion.  

     

    AVP could buy the bonds in the open market, but, this is difficult given the liquidity of the issues and the timeline.

     

    The Risk/Reward-

     

    March 2018’s-

     

    The most likely scenario is a 5pt tender (estimate), in my opinion:

     



    Assuming the bond is redeemed @ the make whole price on 4/1, this would be the expected return:

     

     

    I use the 2019’s for downside expectations which currently yield around 18%.  A lower yield is likely appropriate for the shortest maturity, so I will use 17%.   This is the downside return scenario for the  March 2018’s, if on 4/1 the deal falls through or they buy the  July 2018’s instead:

     

    July 2018’s-

     

     



     

    Obviously my downside scenarios are based on the March 2019’s as of today…..while the yield on those has been anything but consistent:



    Nonetheless, I think the risk/reward is favorable.  I have a position with 75% March bonds and 25% July bonds.

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Messages


    SubjectSecured debt capacity for an exchange?
    Entry01/21/2016 11:28 AM
    MemberRSJ

    Thanks for the write-up. How much secured debt capacity does the company have? Any specific carveouts in the bond indenture? I am curious whether the company has considered a 1st/1.5/2nd lien exchange to clean up the capital structure - that would be another way to reduce gross leverage instead of calling the March 2018s in April and paying the make-whole.


    SubjectRe: Secured debt capacity for an exchange?
    Entry01/21/2016 06:32 PM
    MemberOrion

    Hi RSJ,

    Both 2018 bonds have negative pledges equal to 20% of net tangible assets, which should allow up to $600 million-ish in secured debt.  There is also a first-lien debt cap in the revolver, but this would be less restrictive than the clause in the bond indentures (at least by my read).

    I don't think an exchange would be enough to reduce gross leverage, in my opinion.

     


    SubjectRe: Investor day
    Entry01/21/2016 06:33 PM
    MemberOrion

    I am not, nor have I listened to the replay yet. 


    SubjectUpdated thoughts?
    Entry02/17/2016 10:06 PM
    Membergrizzlybear

    Orion or anyone -- any updated thoughts here on either the credit or the equity?  

    The equity is up quite significantly in the last few days after a seemingly disappointing earnings result.  

    Thanks in advance.  


    SubjectThoughts here?
    Entry04/26/2016 09:13 AM
    Memberpuppyeh

    Hi Orion - I bought some of the July'18s a couple of months back, partly on the strength of this argument - thank you for sharing. This has worked out very nicely, even though the company has been strangely reticent in putting the Cerberus proceeds to work yet.

    What do you think the playbook is now? It seems all the arguments re the need to reduce gross leverage still apply; this would be even more the case if/when the USD rallies back in the event of faster-than-expected rate rises (as seems to be more likely with markets stabilizing globally).

    Surely the case for near-par tenders is stronger now? Why do you think the company is waiting before doing something to clean up the 18s?

    thanks


    SubjectRe: Thoughts here?
    Entry04/26/2016 03:46 PM
    MemberOrion

    I am going to wait for commentary on the 5/5 call before making any decisions.  My best guess at the time of the post was we would have heard something by now.  

    I am interested to see the financials in Q1 to see if they have been buying debt in the open market.  

    I plan on keeping this position on a short leash.  The risk/reward is less favorable here, and I share your concerns about dollar resurgence.   


    SubjectRe: Thoughts here?
    Entry05/06/2016 09:41 AM
    MemberOrion

    Avon stated on the call that they:"plan to repay $250 mil in debt in 2016".

    I really don't know what they are waiting for, if anyone else knows, or has any clue, I would be interested in your thoughts/opinion.

    I am increasingly confident that the March bonds will be targeted (either make whole, or tender/open market), given the yield differential has tightened.  I would be interested in peoples thoughts on that issue as well.

    Thanks.

     

     


    SubjectRe: Author Exit Recommendation
    Entry05/12/2016 08:56 AM
    MemberOrion

    I am moving on here.  Management is planning on retiring $250 mil of 2018 maturities this year, but not stating how, or which maturity. 

    Given the risk/reward, I am moving capital elsewhere.

    March 2018's TR- +13% since post.

    July 2018's TR- +21%

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