WHARTON PRIVATE EQUITY & VENTURE CAPITAL Volume 1 / Issue 13 THE BODY SHOP NEARS ONE BILLION EURO VALUE
IN THIS ISSUE: 1. The Body Shop Nears 1Bill Euro Valuation 2. Driverless Cars: Intel’s Big Bet 3. Dupont Divests to Satisfy Regulators 4. Office Suppliers Feeling Homesick
Author Ty Zhang Class of 2020 taizhang@wharton.upenn.edu
Buyout shops across Europe and the United States have their eyes set on a possible acquisition of The Body Shop, a business that L’Oreal (OREP.PA) originally acquired in 2006 but a business that L’Oreal now hopes to unload in the wake of years of weakening sales and severe margin compression. Original a pioneer in the field of ethically sourced cosmetics, increasing competition as well as a shift in consumer sentiment towards natural and oil-based cosmetics has meant that The Body Shop have found itself with a decreasing topline and slowing consumer demand. These factors, as well as margin cannibalization within L’Oreal’s numerous product lines, have turned The Body Shop from a former industry leader into an undesirable business that L’Oreal is eager to take private. Earlier in March, L’Oreal sent out information packages to many bidders, hoping to attract the highest valuation possible. According to internal reports, L’Oreal is hoping for a valuation upwards of $1 billion euros. However, internal sources to major bidders such as Bain Capital, BC Partners, CVC and Advent report that very few investors value the business any higher than $700 million pounds, and many have readjusted estimates downwards after L’Oreal reported an earnings miss for The Body Shop in Q4 2016. Non-GAAP operating profits fell from $54.8 million euros to $33.8 million euros while GAAP revenues dropped to $920.8 million euros in 2016 from $967.2 million in 2015. A drastic decline in revenues and increasingly constrained cash flow have caused multiple buyout firms to discount The Body Shop at increasingly high rates. This made it difficult for buyout firms to meet L’Oreal’s price expectations for the terms of acquisitions. Even bigger private equity shops, like giants KKR and PAI Partners, have also expressed interest in buying out The Body Shop, but at even more discounted prices. A possible alternative avenue for L’Oreal to unload The Body Shop comes in the form of Chinese investors who have signaled interest in purchasing at a high valuation. This is because of the unique structure of the Chinese cosmetics markets, which is still primarily saturated by synthetic and unethical products. The Body Shop represents a golden opportunity for Chinese private equity shops to bring a tested, western brand that has the best odds of penetrating the Chinese markets with environmentallyconscious cosmetics. Compared to developing a brand within the Chinese market and going through the costly process of educating the Chinese consumer about buying socially responsible cosmetics, the opportunity to leverage The Body Shop’s existing high bottom-line margins and brand power in China is an attractive one. When The Body Shop was founded in 1976 with a strong stance against animal testing that quickly differentiated itself from the largely impartial synthetic cosmetics market. Thus, American
investors are concerned about a possible deal between Chinese investors and The Body Shop. Due to China’s storied history with animal abuse and animal testing, such a deal would be a blatant violation and turnaround of The Body Shop’s founding principles, and a deal with China could potentially mean giving up American business to penetrate the Chinese market. The turnaround work needed to revamp The Body Shop’s brand recognition over its competitors
within the saturated domestic market is a huge obstacle to any potential buyout deal from any private equity shop. Therefore, it is ideal for L’Oreal to consider alternate avenues for a deal, such as with Chinese shops eager to penetrate a quickly emerging market with highly profitable Western products with huge mark-ups. L’Oreal’s decision, as well as whatever price target they set, is ultimately vital to the survival of a former pioneer in the cosmetics industry that has long lost its luster in an increasingly crowded and valuable space.
DRIVERLESS CARS: INTEL’S BIG BET Intel made waves last week when it announced a deal to purchase autonomous vehicle technology company Mobileye for $63.54 a share, valuing the Israeli firm at $15.3B. The offer represents at 34.5% premium on Mobileye's $47.27 stock price at close of the market on March 10. The acquisition would put Intel directly amid the race to debut driverless vehicles on a commercial scale, one that includes industry rivals Nvidia and Qualcomm.
Author Armghan Ahmad Class of 2019 armghana@wharton.upenn.edu
The stakes are enormous. A 2016 Goldman Sachs prediction forecasts the market for driver assistance and autonomous vehicles growing from $3 billion to $96 billion within the decade, and to $290 billion in 2035. Intel and Mobileye are already collaborating with German car manufacturer BMW on an initiative to launch a fleet of around 40 self-driving test vehicles on roads by late 2017. Mobileye’s portfolio includes cameras, sensor chips, incar networking, machine learning, cloud software, and roadway mapping—all tools that would complement Intel’s core competency of data processing and intelligent computing. Intel CEO Brian Krzanich, when speaking of the acquisition, likened Mobileye to the “eyes of the autonomous car” with the “intelligent brain that actually drives the car." Both parties are optimistic about the deal; Mobileye will be given a significant amount of autonomy and the two companies have very similar cultures and practices. It is important to note the price tag Intel has agreed to; Mobileye had a net income of just $108.3 million. At the price tag of $15.3B, this means Intel valued Mobileye at 141 times earnings. By way of comparison, the S&P 500 is currently trading at about 26 times earnings, which itself is above its historic average. Perhaps the best way to characterize Intel’s move is a bold, all-in bet on the future of the autonomous vehicle industry and Intel’s role as a major supplier to the market. One interesting point is that Intel’s acquisition is very far outside its core business—something that has not always worked out well for them. In 2012, Intel purchased security software company McAfee for $7.7 billion, which eventually fizzled out to perform below expectations before being spun off for $4.5 billion last year. But considering future expectations on self-driving cars and the company’s history, Intel’s move is understandable. Intel failed to capitalize on the once-in-a-generation growth opportunity that came with the rise of smartphones and tablets; executives are likely anxious not to miss their chance this time around. The autonomous driving industry presently seems to be one of the largest avenues of growth in technology, and everyone is scrambling not to get left behind. Last October, chipmaker Qualcomm announced a $47 billion deal to acquire NXP—the largest automotive chip manufacturer—that will likely be approved by shareholders in 2017. Tesla has already debuted its semiautonomous driving system, Google’s vehicles have been driving cross country since 2010, and Uber has been rolling out autonomous rideshares in Pittsburgh and Arizona (after the California DMV disallowed on the lack of a special permit). Traditional auto manufacturers are also getting in on the action; Ford has made $1 billion investment in Pittsburgh-based Argo AI and GM announced last month that it would be rolling out a fleet of 40 selfdriving Chevy Bolt vehicles. It is safe to say that the space is getting increasingly crowded. Now it is just a question of who can make the first real large-scale move.
DUPONT DIVESTS TO SATISFY EU REGULATORS
Author Jose Roberto Delgado Class of 2019 delgj@wharton.upenn.edu
Dow Chemical and DuPont, two of the largest and oldest companies in the American chemical industry, have been in merger talks since early December 2015. Their merger would fuse the two industrial giants into a single entity worth over $130 billion, which would serve as a vehicle for producing $3 billion of synergies. They then would split up into three separate businesses to better position themselves in their respective industries. DuPont was founded in 1802 in Delaware as a gunpowder manufacturer and has since expanded its portfolio to include electronics and communication, advanced materials such as Kevlar and Teflon, safety and protection, and agriculture. Its agriculture business has also been involved in innovative corn seed technology. Dow Chemical was founded in 1897 in Michigan as a bleach producer and has since generated an array of plastics and agricultural chemicals. Dow’s portfolio consists of both specialty and basic chemicals, but the company has recently focused more on the higherpriced specialty chemicals. Over the last several years, both Dow and DuPont have been fighting against sinking commodity prices and a strengthening U.S. dollar that has put pressure on their bottom lines. The trio of companies they would produce post-merger would allow them to better tackle the challenges to come. Management’s overall plan is to approach each spinoff with unique strategies to reduce costs, improve profitability, and accelerate growth. The first spinoff will be a materials-science company and will retain the Dow name. This company will be the world’s largest packaging material supplier and the second-largest in the performance materials product segment. By implementing Dow’s low-cost feedstock platform, the company will significantly increase its margins and productivity, allowing it to better compete with BASF, the world’s largest materials company. The agriculture spinoff will become the world’s largest chemical company in the seed and crop protection industry, taking 17% of the pesticide market, 41% of the US corn seed market, and 38% of the US soybean market. The specialty product spinoff will focus primarily on high-margin specialty products in high growth sectors such as electronics, semiconductor materials, and solar photovoltaic materials. However, the merger talks between Dow and Dupont have received severe scrutiny from fearful farm groups and antitrust regulators. ChemChina and Syngenta are currently awaiting regulators’ approval of their merger; so are Bayer and Monsanto. This consolidation among these six global companies that sell crop seeds and pesticides would result in three global powerhouses controlling about 60% of the seed industry and about 65% of the agrichemical industry. The European Commission’s primary concern has been that the $130 billion Dow-DuPont merger would result in little incentive to produce new herbicides and pesticides, damaging innovation in new products and reducing price competition by stripping farmers of their bargaining power. In response, Dupont said this Friday, March 31st, that it would sell part its crop protection unit, which produces herbicides and insecticides, to FMC and buy nearly all of FMC’s health and nutrition business. FMC will pay DuPont $1.2 billion cash and allow DuPont to retain $425 million in working
capital due to the difference in the asset values, providing DuPont with just over $1.6B in the end. Although this is the third time the merger’s closing has been delayed, Dupont’s asset swap with FMC would finally win the European Union’s approval for its merger. DuPont CEO Edward Breen said, “We are far down the road in our conversations with the other regulators,” but that any further asset sales enforced by
regulatory bodies in the United States, Brazil, China, Australia, and Canada would be “very small” relative to this crop protection divestiture, which “satisfied the bulk” of solutions needed to win consent from governments around the world. The Dow-DuPont merger is now expected to close in August of this year, followed by its break up into three within 18 months of the deal close.
Figure 1: Major Industries and Players
Figure 2: Pre-and Post-Merger Industry Composition
OFFICE SUPPLIERS FEELING HOMESICK The two largest retailers of office supplies and small business solutions, Staples and Office Depot, have recently begun the discontinuation of their international operations, narrowing in on only North America operations.
Author Sadhvi Venkatramani Class of 2019 sadhviv@wharton.upenn.edu
Staples announced as of December 2016 that it would sell a controlling portion of its European division to the private equity firm, Cerberus Capital Management. Cerberus specializes in distressed investing and has over $30 billion in assets, with retail deals in companies such as Safeway and Avon. This particular investment would be for roughly 53 million U.S. dollars or 50 million euros, in exchange for a 15 percent stake in Staples’ European Division. Staples’ European division includes all retail stores, contract, and online businesses. Specifically, Staples’ European division spans 16 countries and generates revenue of about 1.7 billion euros annually. Cerberus sees opportunity in Europe through expansion of Staples’ sales force and is considering further diversification outside of the core office supplies business. In the United Kingdom, specifically, Staples plans to sell its retail business to Hilco Capital, a distressed investing and turnaround firm who had recently completed another retail deal with Poundland. Staples was not the first to begin cutting down international operations. In October of 2016, Office Depot announced the complete sell-off of its European division to the Europe-based firm, Aurelius Group, closing the deal in January of 2017. Office Depot’s European division includes 6,000 employees across 14 countries and with revenues of $2.8 billion. Other international segments of Office Depot include Australia, New Zealand, South Korea, and China, all retail divisions of which Office Depot has begun detaching itself from. These segments make up about $600 million of sales and are unprofitable operations for Office Depot, generating an operating loss of $10 million in second quarter of 2016, as compared to the operating income of $2 million in 2015 second quarter. Retail has steadily comprised of about 40 percent of Office Depot’s total sales over the last 5 years, while Business Solutions has grown from 29 percent to 40 percent and International has correspondingly shrunk from 30 percent to 19 percent. However, as of 2016, Office Depot officially discontinued international operations, thereby currently only having two operating segments – North American Retail and Business Solutions. Both these sell-offs and company-slimming strategies come following the failed merger between Staples and Office Depot in May of 2016, primarily due to the lack of significant other competition in the space and creating antitrust worries. Staples holds 37.2 percent of market share in the office supply space, while Office Depot holds 36.3 percent. Both companies have taken measures to cut costs and find better ways to stay competitive in a shifting retail environment. Both have also promised upwards of hundreds in store closures and stricter cost cutting measures over the coming years. Given the relatively smaller size of the international divisions, along with unprofitability, focusing on North American segments appears to be the optimal choice for these top-line growth struggling retailers. International operations for these retailers have been challenging due to negative effects of foreign currency conversion, continued sales decline, lower gross margins, and navigation in the more fragmented European markets.
Once again, the recent trends in retail are exemplified, with traditional businesses struggling in an evolving and volatile consumer environment. Competition from online players, most notably Amazon, threatens these two companies’ retail and business divisions, while discount and diversified players like Walmart and Target
also pose a threat. The futures of these specialty retailers are uncertain, but the sell-off of international divisions could be taken as either a signal of long-term efficiency improvements within the companies, or of a potential takeover opportunity over their North American divisions as well – or both.
Figure 3: Retail Sector versus Office Supply Industry Costs
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