Avon Products1 Essay

1526 words - 7 pages

Avon Products

1. Why was Avon restructuring its business in 1988? Did the changes make sense?

In the early 1980s, Avon made several major decisions to diversify its business, first to enter the health care field by acquiring a chemical company, Mallinckrodt, Inc. for $710 million in 1982. Before the acquisition happened, Avon’s beauty products sales and margin had already started to decline due to the decreasing number of housewives. Together with the cash spent on the acquisition, Avon was facing a sudden weakening cash flow position by mid-1982. By August 1982, Avon’s stock price has drop from $30 to $20.375 per share and dividend reduced from $3.00 to $2.00.

Then Avon acquired ...view middle of the document...

05% by 1987.

2. Evaluate Avon’s financial position in mid-1988. Why was Avon reducing its dividend?

Avon conducted a series of acquisitions in the early 1980s, including Mallinckrodt, Inc., Foster Medical Company, Retirement Inns of America and Mediplex Group, in order to diversify its business by entering health care industry. Those acquisitions consumed Avon a great amount of cash initially, causing the company a very low net cash flow during that period.

From the exhibits we could find that the net cash flow for Avon declined steeply in 1982 due to the acquisition of Mallinckrodt, Inc. By reducing the dividend payment to shareholders from $3.00 to $2.00 per share, the cash shortage was temporarily relieved in the next few years before it was faced with another difficult time initiated by declining margin of the health care business and acquisition of beauty businesses. The success of releasing the financial distress the first time gave the Avon board the confidence to solve the same problem again by reducing dividend to maintain a certain cash reserve.

It makes sense for the board to do so, not only because of the consumption of cash for a series of acquisitions and the declining margin, but also because of the increasing debt-to-equity ratio that had exceeded 100% since 1986. A high debt-to-equity ratio can result in volatile earnings due to the additional interest expense. However it’s hard to reduce the debt ratio in a short period of time. Therefore, in order to maintain relatively positive cash flow, the most direct way would be to reduce the dividend payment, which consisted a large portion in cash expenditure.

3. What was the purpose of the exchange offer?

Although the dividend reduction seems like a reasonable solution to cash shortage, Avon should be very careful about announcing it because it will likely lead to a price drop in shares after the announcement. The share price of Avon had been declining since 1978, regardless of the up movement of S&P 500, indicating problems in Avon’s profitability and ability to relieve the financial distress. The board wouldn’t like to stress out the stock price more by announcing a dividend reduction, therefore the company must find another way to solve the cash burden as well as to maintain investor confidence. In addition, 17.6% of the shareholders are still holding Avon for yield purpose instead of price appreciation. If they learned about the dividend cut, they would most likely sell Avon share to purchase other securities that pay high dividends, which will also cause negative impact on Avon’s share price.

The exchange offer to have one new $2.00 PERCS for each share would solve the conflicts of interests of the shareholders. PERCS offers cumulative quarterly dividends of 50 cents ($2.00 a year) accrued from September 1988 to September 1991. Although the company could redeem the preferred share before expiration, the most important redemption will be in September...

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