By Alex Gavrish, Etalon Investment Research; author of “Wall Street Back To Basics”
L’Oreal announced buyback of an 8% stake from Nestle
On February 11th, 2014 Nestle SA (VTX:NESN) and L’Oreal SA (EPA:OR) (OTCMKTS:LRLCY) announced strategic transaction in which L’Oreal will buy 48.5 million of its own shares which represent 8% of its share capital. Despite a meaningful size of the buyback which is expected to be accretive to L’Oreal, the share price immediately started to move lower and had declined by about 7% since the announcement. This strange fact caught our attention and we decided to take a closer look at the transaction and current valuation of L’Oreal.
Nestle buyback transaction
L’Oreal SA (EPA:OR) (OTCMKTS:LRLCY) will buy 48.5 million of its shares (8% of its share capital). Part of shares will be bought for a cash payment of 3.4 billion euros for 27.3 million shares, reflecting a price of 124.5 euros per share. The second part of the transaction will be done through the disposal by L’Oreal of its 50% stake in Swiss dermatology pharmaceuticals company Galderma (a 50/50 joint venture between L’Oreal and Nestle) for an enterprise value of 3.1 billion euros (an equity value of 2.6 billion euros), and will be paid by Nestle SA (VTX:NESN) in L’Oreal shares (21.2 million shares). Based on the equity value, the share price is 122.64 euros per L’Oreal shares. Overall, the buyback reflects a total payment of 6 billion euros (using equity value for Galderma), 48.5 million shares and purchase price of 123.71 euros per share.
To start with balance sheet and debt, L’Oreal SA (EPA:OR) (OTCMKTS:LRLCY) has almost no short or long-term debt, and as of December 31st 2013 net debt amounts to a net cash holding of 2.2 billion euros and minimal amount of long-term debt. L’Oreal owns an 8.93% stake in Sanofi SA (NYSE:SNY) (EPA:SAN), a large French pharmaceutical company. Based on a recent market price, this stake is valued at about 8.6 billion euros.
As of March 20th, 2014, L’Oreal SA (EPA:OR) (OTCMKTS:LRLCY) had a market capitalization of 70.3 billion euros and an enterprise value of 68.1 billion euros. After adjustment for buyback transaction, market capitalization stands at 64.6 billion while enterprise value is 62.4 billion euros. If we subtract the value of the stake in Sanofi SA (NYSE:SNY) (EPA:SAN), enterprise value stands at 57.3 billion euros. In fiscal 2013 company generated 4.7 billion euros in EBITDA, so the EV/EBITDA multiple is currently x12.2 – a very reasonable valuation for such high-quality company as L’Oreal. In 2014 the company expects to pay a dividend of 2.5 euros per share, which based on a recent share price, equals a 2.2% annual dividend yield.
At current valuation L’Oreal SA (EPA:OR) (OTCMKTS:LRLCY) might be attractive for a long-term oriented investor. It also might be suitable for an income-oriented investor who is looking for additional downside protection. As an illustrative example, you can commit to buy L’Oreal at 110 euros per share by selling a cash-secured put option contract that expires in December 2014, has an exercise price of 110 and is currently selling for a 6.08 euros premium. This would provide you an annualized income yield of 7.8% while also leaving a downside protection of 10% from the current market price as you would have to purchase shares at 110 euros while receiving a premium of 6.08 euros from option sale (making your effective purchase price equal to 103.92 euros per share).