Natura is Reported to be Considering Divesting Avon International

According to the Financial Times, Brazilian beauty giant Natura, which has already sold its Aesop and The Body Shop brands this year, is considering selling off most of its international business for the Avon brand. Natura had high hopes for the beauty brand, which started with a direct-selling model, after acquiring Avon in 2019. However, Avon’s performance has been underwhelming for three consecutive years post-acquisition. With the continuous sale of Aesop and The Body Shop this year, Natura aims to focus on its domestic market in Brazil and the South American region.

Avon International has experienced net revenues declining for nine consecutive quarters

In 2019, Natura acquired the entire equity of Avon at a ratio of 0.3 shares of Natura stock for each share of Avon stock. Based on the transaction price, the current market value of Avon stands at approximately $2 billion, marking a 28% premium compared to the closing price on May 21. Additionally, Natura is set to pay about $530 million to holders of Avon’s Class C preferred shares. According to Natura, including Avon’s debt, the total value of this transaction amounts to $3.7 billion.

However, the acquisition of Avon did not yield impressive results for Natura. In 2020, Avon’s net revenue only grew by 2.9% year-on-year but declined by 18% when calculated at fixed exchange rates. In 2021, Avon’s net revenue dropped by 6.09%. In 2022, Avon’s net revenue declined again, falling by 9.9% at fixed rates and by 22.9% when calculated in reported currency.

Looking at its quarterly performance, Avon’s results have taken a nosedive. In the first two quarters of 2021, Avon managed to maintain year-on-year net revenue growth of 11.4% and 33.6%, respectively. However, from then until the third quarter of 2023, Avon experienced declining net revenue for nine consecutive quarters. Seven of these quarters saw double-digit declines, with three quarters dropping by over 20%.

In the latest financial report for the third quarter of 2023, Avon’s net revenue for the first three quarters of this year amounted to 4.573 billion Brazilian reals. In contrast, in the first year post-acquisition by Natura in 2020, Avon’s net revenue stood at 9.097 billion Brazilian reals. Since being acquired by Natura, Avon’s net revenue has almost halved.

Natura attributes Avon’s performance decline in 2022 primarily to global economic downturns and supply chain issues arising from the Russia-Ukraine conflict. However, according to a recent report by Standard & Poor’s Global Ratings, Natura’s profits from Avon have decreased over time. “Avon continues to underperform in the third year of the turnaround since its acquisition. The benefits of commercial, administrative, and systems synergies have been weaker than expected, raising concerns about the long-term viability of Avon’s brands and business model,” written by S&P Global Rating’s analysts Flavia M Bedran and Luciano D Gremone.

Most significantly, Avon, which Natura had high hopes for post-acquisition, did not bring about the desired transformation in Natura’s performance. In 2020, Natura’s net revenue was 36.922 billion Brazilian reals, marking a 12.1% year-on-year increase. However, in 2022, Natura’s net revenue decreased slightly by nearly 600 million Brazilian reals to 36.35 billion Brazilian reals compared to 2020. For the first three quarters of this year, Natura’s net revenue amounted to 22.611 billion Brazilian reals, reflecting a 6.3% year-on-year decrease.

Simultaneously, starting from the first quarter of 2022, Natura began experiencing consecutive losses. By the first half of this year, the Brazilian beauty giant had encountered six consecutive quarters of losses. Natura attributes these losses primarily to increased costs due to supply chain issues from the Russia-Ukraine conflict and a rise in short-term debt pressures. The underperformance of Avon’s performance might be a reason for Natura’s consideration of selling it.

To strengthen and deleverage its balance sheet

Moving into 2023, Natura has initiated a gradual divestment of its significant assets. In April, Natura signed an agreement with L’Oréal to sell its Australian luxury brand, which had shown promising performance in recent years. The transaction, completed in early September, saw Natura receiving $2.5 billion in cash, marking the first profitable quarter after six consecutive quarters of losses.

Furthermore, in November, Natura sold another significant brand, The Body Shop, to the investment firm Aurelius Group for £207 million.

The revelation of Natura’s intention to sell Avon’s international operations marks the third attempt within a year by this Brazilian beauty giant to divest crucial assets. These moves are a continuation of the debt issues stemming from the acquisition of Avon in 2019, where the total transaction amounted to $3.7 billion, including Avon’s debt.

The Avon acquisition’s debt issue has affected Natura since 2022. By the end of the first quarter of 2022, Natura’s current assets amounted to 14.749 billion Brazilian reals, while current liabilities stood at 14.286 billion Brazilian reals, resulting in a current ratio of just 1.03, signaling a sudden spike in short-term debt pressure. As of June this year, Natura maintained a high current ratio of 1.36, alleviating some short-term debt pressures but still facing considerable strain. Concurrently, as of June this year, Natura’s total liabilities reached 30 billion Brazilian reals, with total assets at 50.594 billion Brazilian reals. The high debt-to-asset ratio increases financing costs and annual interest expenses, impacting the company’s profitability and resulting in six consecutive quarters of losses for Natura.

In April this year, the global credit rating agency Moody’s reduced the overall bond rating of Natura &Co Holding S.A to Ba3 and altered the outlook from stable to negative.

In this context, despite the positive cash flow from the sale of Aesop, which led to a positive cash flow for Natura in the third quarter, the company still faces tight cash flow and debt. Consequently, in the third quarter, Natura continued seeking asset sales to alleviate the issues arising from its balance sheet.

Fábio Barbosa, Chief Executive Officer of Natura &Co, said: “The divestment of Aēsop marks a new development cycle for Natura &Co &Co. With a strengthened financial structure and a deleveraged balance sheet, Natura &Co, exercising strict financial discipline, will be able to sharpen its focus on its strategic priorities, notably our investment plan in Latin America.”

In reality, the sale of Aesop was a reluctant move for Natura because Aesop had been the company’s standout performer in recent years. In 2022, at fixed exchange rates, Aesop achieved a remarkable 21% year-on-year increase in net revenue, reaching 2.72 billion Brazilian reals. By the second quarter of 2023, Aesop’s net revenue amounted to 759 million Brazilian reals, showing a 14.2% year-on-year growth in reported currency and remaining the only brand experiencing growth. The capital gained from successfully selling Aesop in the third quarter allowed Natura to “prepay more than half of the debt by the end of the quarter,” said Natura CEO Fábio Barbosa. This necessity to divest from Aesop was also due to this pressing financial situation.

However, the sale of The Body Shop was a strategic move as evidenced by its performance in the third quarter, which was the weakest among Natura’s brands. Over the past year, The Body Shop closed as many as 111 stores, with a 5.0% decline in retail sales in its core distribution channels. The rationale for selling Avon aligns with that of selling The Body Shop. Previously, Natura achieved rapid growth through a series of significant acquisitions, but both The Body Shop and Avon, despite high expectations, eventually faced profitability challenges. Consequently, Natura seeks to divest these assets to deleverage, strengthen its balance sheet, and restore profitability.

Fabio Barbosa, CEO of Natura, mentioned, “With a renewed focus, reduced debt, and a more streamlined approach, Natura & Co. will now direct its full attention to its primary expertise in direct sales in Latin America. Simultaneously, it will further optimize Avon International’s presence and invest in initiatives and innovations that have a positive impact on both people and the environment.”

The direct selling model in the beauty industry is gradually declining

The underwhelming performance of Avon highlights the gradual decline of the direct selling model, which it represents, in the beauty industry. Despite pioneering the cosmetics direct sales model, Avon has lost market share to more savvy competitors with the rise of social media and digitalization.

Taking China as an example, in the 1990s, the cosmetics market was still in its nascent stage. Avon entered the Chinese market through direct selling.

In 1998, China implemented a ban on direct selling, forcing Avon to sell products through physical stores named “Beauty Boutiques.” Avon adopted a retail model, establishing outlets nationwide. Throughout Avon’s century-long history, direct selling has been its key strategy to stay at the forefront of the cosmetics market.

The ban on direct selling compelled Avon, originally founded on this model, to alter its traditional sales channels and adopt a model of operating through stores and sales representatives. It wasn’t until 2006 that Avon became the first company to obtain a direct selling license, initiating a transition towards a “boutique stores + direct selling” hybrid model.

Reportedly, in terms of management, Avon enforced progressively increasing sales targets for distributors monthly, without providing any safeguards in return or exchange policies. Due to varying quality among distributors nationwide, some resorted to selling products at lower prices to meet sales targets, leading to market price confusion. The primary issues faced by distributors were product mix-ups and price discrepancies. Even in today’s age of e-commerce, establishing a unified pricing system across online and offline platforms remains a challenge.

Though the ban on direct selling was lifted in 2001, Avon received its direct selling license in 2006. However, the Avon management at the time wavered between adhering to direct selling or operating through a “boutique stores + direct selling” hybrid model. Subsequently, Avon’s performance took a significant downturn.

In 2019, Avon ceased its direct selling operations in China and sold its Guangzhou factory to The Face Shop for $44 million. Additionally, Avon divested the majority of its stakes in Japanese and American businesses and exited markets such as South Korea, Vietnam, and Ireland.

Beyond regulatory challenges, the rise of new retail and e-commerce has dealt the most significant blow to the direct selling model. Especially post-pandemic, consumers have increasingly relied on online shopping. They now have more convenient access to compare a wide array of products and leverage emerging AI technologies for enhanced consumer experiences, rendering the traditional advantages of direct selling obsolete.

According to a McKinsey report, between 2015 and 2022, e-commerce in the beauty industry nearly quadrupled, now occupying over 20% of the market share, with substantial room for further growth.

McKinsey highlighted several factors driving the growth of e-commerce in the beauty industry: the widened beauty product range by online giants such as Amazon in the US and Tmall in China; enhanced digital capabilities among direct-to-consumer brands; the rising importance of online platforms for omnichannel retailers; and the surge of social selling methods, notably livestreaming, in Asia.

McKinsey stated that e-commerce is projected to maintain its rapid growth as the swiftest sales channel in the beauty products channel, estimated at a 12% annual increase from 2022 to 2027. However, traditional channels like specialty retail, grocery retail, and drugstores are anticipated to experience heightened growth after the pandemic, influenced by consumers’ inclination towards omnichannel experiences, driven in part by their ongoing interest in exploring and testing products in physical stores. Department stores are forecasted to continue losing global market share.

As of 2023, direct selling remains the primary sales method for both Avon and Natura. The company directly employs sales representatives to sell products, facilitating direct interaction with consumers to understand their needs promptly. This approach helps in crafting better products or delivering more personalized services based on these insights.