In May of this year, global asset management firm KKR (KKR 2.29%) purchased 60% of Coty's (COTY 5.10%) assets. The deal valued Coty -- a global company that develops, manufactures, markets, and distributes fragrances, cosmetics, skincare, nail care, and hair care products -- at $4.3 billion, representing a 34% premium to today's price. With the embattled beauty company's stock trading for 6.5 times last year's earnings and well under 1 times sales, should you join KKR by investing in a Coty comeback? Let's explore.
Deleveraging Coty's stressed financials
Coty has struggled for years with developing its e-commerce capabilities as an effective strategy for a slowdown in brick-and-mortar shopping. Furthermore, it aggressively leveraged its balance sheet to juice growth. That undesirable combination developed long before COVID-19 entered the picture. The pandemic simply added another daunting challenge to endure.
With the stock trading at new lows, KKR took advantage and bought a majority interest in Coty's professional and retail hair businesses for $2.5 billion. It also issued $1 billion in new credit to Coty to fortify its balance sheet at a 9.5% interest rate. With KKR's help, Coty plans to cut its fixed costs by 25% ($600 million) over the next few years. Already, Coty's net debt-to-EBITDA ratio dropped from 5.6 to 4.5 as a direct result of the deal, providing encouraging deleveraging to its stressed financials.
The billions in new liquidity is key for Coty to effectively expand its now more simplified portfolio. KKR purchased the rights to 40 of Coty's 77 brands. Without majority ownership in its hair businesses, CEO Peter Harf plans to use the cash to grow the company's remaining brands, which fall into its Prestige and Mass Beauty business categories.
Coty's Prestige business includes high-margin fragrances and a decent global market share. With KKR's funding and experience, the beauty company should be poised to grow brands like Calvin Klein, Burberry Beauty, and many more.
Forming new partnerships
Excitingly, this year Coty announced a long-term partnership with celebrity Kylie Jenner to build her global brand Kylie Cosmetics within Coty. This segment could boost Prestige sales going forward. Jenner has over 200 million social media followers who generally care about beauty and what she has to say. Coty owns 51% of her brand that generates $630 million in annual, high-margin revenue.
For a short time, Jenner was believed to be the youngest self-made billionaire ever (her total wealth has since fallen below that threshold), and she is now focused on building brands for Coty. It's feasible to think this partnership will continue to be fruitful for both parties, as it had been pre-COVID-19. It is well-suited for direct-to-consumer and digital fulfillments, which will be key as e-commerce continues to grow worldwide.
To deepen Coty Prestige's competitive moat within beauty categories, Harf used a portion of the KKR proceeds to partner with Kylie's half-sister, Kim Kardashian West, earlier this month. Compared to Jenner's 200 million followers, Kardashian West has 300 million. The deal valued her beauty business at $1 billion and gave Coty a 20% stake in it. Kardashian West's brand (called KKW Beauty) doubled from 2018 to 2019 and was on an impressive growth track until COVID-19 arrived.
Stay-at-home orders certainly hurt demand for beauty products, but in terms of celebrity partnerships and brands in the beauty industry, it is hard to do better than Jenner, Kardashian West, and all the labels Coty has to utilize. That bodes well for a sales recovery in the long term.
Time for a Mass Beauty revamp
The other area of focus, Coty's Mass Beauty segment, is also being revamped. It includes popular brands like CoverGirl. Similar to the Prestige segment, mass business will no longer center on wholesale and brick-and-mortar distribution with inherently lower margins. Coty is transforming the business into an omnichannel model to emphasize direct-to-consumer and online sales. This is an ideal move to both streamline the supply chain and expand margins as our world shifts to e-commerce.
Did KKR make Coty worth considering?
While owning this beauty stock has been a challenge for years, the KKR news is encouraging. Coty can now focus on the pieces of its business it does best, while still owning 40% of whatever KKR can do with the professional and retail hair businesses. The balance sheet is far healthier than it had been and prospects are encouraging. For investors willing to stomach a high volatility stock, Coty may be a good longer-term place to look.