L’Occitane en Provence

1. You have been hired as an investment banker by L’Occitane. Should L’Occitane do

an initial public offering (IPO)? What are the benefits to the firm of doing so? Costs
and disadvantages? Try to give as much empirical evidence as possible to back up
your answers.

Yes, L’Occitane should consider doing an initial public offering for the following reasons :
● There is a considerable underlying growth potential : IPO is only rewarding for firms
who are able to grow fast and who have a large market in front of them. L’Occitane is in
● a constant growth that’s why it needs additional funds. Besides, there is significant
growth potential from sales in emerging countries where the market is not mature yet.
● There is not a big concentration in the business model of L’Occitane. Indeed , the firm
does depend neither on a dominant distributor nor on a narrow number of customers.
Advantages:
- providing new capital for the firm (source: case)
Equity market would be a larger resource for L’Occitane than Geiger’s account (Geiger
financed L’Occitane by its own capital)
Main part of the firm is financed by debt but debt is a limited resource (too high debt
becomes risky for bankers). On 31 Dec 2009, Debt/Equity = 60.71%
- Exit for initial investors: founders and other pre-IPO investors could sell some of their
shares in the IPO (case)
- Diversification of funding sources allows more financial flexibility (case)
- Raise prestige and recognition of the firm (case) : increase public awareness of the
company which may lead to new opportunities and new businesses (internet)
- Enhance credibility because of information disclosure (internet)
- Provide a currency for acquisition and for employee stock option plans (case)
Could be an advantage when Geiger sought M&A opportunities
- Monitoring by the stock market (lower monitoring costs) (course)
- Improved access to debt markets (course)
see leverage above
- The capital does not have to be repaid and does not involve an interest charge (//Debt)
(internet)
- Attract better management talent + Incentive to perform well (internet)
Offering shares of stock and stock options as part of compensation may enable to attract
better management talent and to provide them with an incentive to perform well.
Employees who become part-owners through a stock plan may be motivated by sharing
in the company’s success.

Costs and disadvantages:

- Underwriting fees (case)
 Typically 7% of the value of shares sold in the US
- Legal, accounting and marketing costs (case)
For example, cost to convert accounts that haven’t used IFRS Standards or to report
semi-annually (HKEx) -> Improve accounting systems and add staff
- Expenses for auditing, reporting and compliance with exchange regulations (case)
- Requirement of substantial management time (case)
- Put the company under public scrutiny(case)
- Could decrease the control of the owners (case)
By diluting the holdings of the company's original owners, going public also gives
management less control over day-to-day operations. Large shareholders may seek
representation on the board and a say in how the company is run. If enough shareholders
become disgruntled with the company's stock value or future plans, they can stage a
takeover and oust management. The dilution of ownership also reduces management's
flexibility. It is not possible to make decisions as quickly and efficiently when the board
must approve all decisions. (internet)
This could also trigger a potential shift in strategy and vision. For instance, Levi
Strauss, a 6th generation family business from the USA, went through a painful
experience some years ago. In 1971 the family sold shares to the public. The family
business went from a highly focused strategy –one main product – to a diversified offer
of varied apparel, one-product strategies being considered too risky by financial markets.
The diversification strategy proved unsuccessful and the family decided to buy back all
the shares to regain control in 1985, buying back the shares at a price of $50 per share
(Source: The New York Times).
- Could make the firm more susceptible to (hostile) takeover bids (case):
In early November 2010, the family controlling Hermès, the French luxury goods
company, woke up one day to find that LVMH, a key competitor, had acquired 17% of
the shares in their family company. The family was quick to react and publicly asked Mr
Arnault to back off from what they saw as an unfriendly move (Source: Reuters,
November 3, 2010)
- Underpricing (case)
- Information and disclosure requirements (course)
Conflicts and problems may arise when everyone from competitors to employees know
all about the inner workings of the company (profits, etc)
- Pressure of the market which may cause company to focus more on short-term results
rather than long-term growth, hard to maintain long-term strategy (internet)
- Costs associated with handling shareholder relations (internet)

“The aftermath of an IPO: what families in business ought to know before they go public”,
Tharawat magazine
http://www.tharawat-magazine.com/en/family-business-articles/finance/1568-the-aftermath-of-
an-ipo-what-families-in-business-ought-to-know-before-they-go-public

2. You have been hired as an investment banker by a large U.S. institutional investor
who is considering purchasing L’Occitane stock. Provide an analysis of i) France as
an investment destination, ii) key success factors, and iii) L’Occitane’s strengths and
weaknesses.
i) Invest in France for an American
http://www.state.gov/documents/organization/227346.pdf

Advantages:
- stable and reliably safe business climate
- significant resources to attracting foreign investment, through policy incentives,
marketing, its overseas trade promotion offices, and investor support mechanisms
- Well-educated population, excellent universities and a talented workforce
- Modern business culture
- Sophisticated financial markets
- World-class infrastructure and efficient intermodal connections
- Transparent and stable regulatory and legal environment
- The Eurozone facilitates the movement of people, services, goods and capital -> invest in
France enable to open up European market
- No restriction on the repatriation of capital, no restrictions on transfers of profits,
interests, royalties or service fees
- The United States and France have a bilateral tax treaty -> avoid double taxation and tax
evasion.
- Strong intellectual property protections
- Easier to trade across barriers than in the US (US:16th country, France:10th
http://www.doingbusiness.org/rankings)

Disadvantages:
- Complex investment climate
- Low GDP growth, high unemployment, strict European Union macroeconomic
surveillance
- Lack of clarity in the government’s agenda
- Red tape and burdensome regulations
- Lack of predictability in legislation
- Growing complexity of labor legislation
- High cost of labor + rigid labor market
- occasional strong negative reactions towards foreign investors planning to restructure,
downsize or close
- Significant role of French unions (said “outsized” in the article) -> common strikes

ii) Key success factors :

Key success factors for the french cosmetics industry:

 - image of chic and elegance
- quality of the products manufactured in France
- ability to build a strong brand image via marketing

iii) L’Occitane

Strengths:
- High profitability and revenue , according to the analysts predictions , the ebit margin
would evolve around a steady 18,9% between 2012 and 2015.
- Well developed channels of sale and distribution. L’Occitane has over 1500 stores by
2009.
- High growth margin , according to the analyst prediction
- Present internationally and existence of an important market where to expand.

Weaknesses:
- The market of naturally based cosmetic products is booming and very competitive.
- Tax structure in France.

3. a. Evaluate the pros and cons of each stock market for L’Occitane. In case of an
IPO, which stock market would you recommend? Why? What considerations
should determine the location choice?
I added requirements to make the location choice easier

Paris Bourse (Euronext)

Pros Cons

- Headquarter in France - Decreasing number of IPO in Paris

- France = sixth largest national market
for beauty and personal-care products
industry (+ Germany 5th)
- Competitors in the same sector :
L’Oreal -> L’Occitane would not
provide additional diversification for
investors and investors may prefer
L’Oréal because of a lower risk.
- the lowest first day stock returns
among the 5 Stock Exchanges
Requirements:
- Minimum market capitalization of €150 million : OK (according to analysts, p.8,
between €1.5 and €1.8 billion)
- IFRS accounting rules

London Stock Exchange

Pros Cons

- fifth largest stock exchange in 2009 - drop of the number of IPOs due to
- UK = seventh largest national market financial crisis -> perhaps not the best
for beauty and personal-care products place to find capital
industry
Requirements:
- IFRS

NY Stock Exchange
Pros Cons

- largest and most prestigious stock - decrease in IPO activity (Exhibit 8)

exchange - Competitors in the same sector : Avon,
- US is the world’s largest national Estee Lauder, Herbalife
market for beauty and personal-care - expensive
products industry
Requirements:
- Over $10 million aggregate pre-tax income for the last three years OK*
- IFRS

*
Year Average exchange Pre-tax income in Pre-tax income in
rate (dollar per euro dollar
euro)

2007 1.3415 45,325,000 60,803,488

2008 1.5067 65,271,000 98,343,816

2009 1.3552 76,311,000 103,416,667

Nasdaq (USA)
Pros Cons

- cost effectiveness and liquidity - low number of foreign companies

- US is the world’s largest national
market for beauty and personal-care
products
Requirements
- EITHER aggregate pre-tax earnings for the last 3 years over 11 million and positive
earnings for each year OK
- OR positive CF in the last 3 years (pb: cash and cash equivalents in BS went from 56 M€
in 2007 to 27 M€ in 2009), over $550 million market capitalization and over $110 million
revenue in the previous year
- OR over $850 million market cap and over $90 revenue in the previous year OK
- AND IFRS

Hong Kong Stock Exchange

Pros Cons

- third largest stock exchange in Asia - Competitors in the same sector :

- L’Occitane has high forecasted sales Bawang International
growth in Asia, especially in China - small amount of foreign companies
- China is the fourth largest national listed: the market is not mature enough
market for beauty and personal-care
products
- L’Occitane launched stores in HK
since 1995, the brand awareness is
very high, investors are willing to buy
shares.
- largest capital returns through IPOs,
31.5 billion compared to NYE’s 15.8
billion in 2009
- Large increase in IPOs -> dynamic
market
Requirements:
- over HK$200 million market capitalization (-> 18,796,992€, with 1€ = HK$10.64) OK
- Report semi-annually

Conclusion:
All requirements concerning results are reached, so L’Occitane can list everywhere.
but the most suitable listing place is Hong Kong Stock Exchange. The brand awareness is very
high, capital returns through IPO are highest, stronger resistance against financial crisis, Chinese
Investment Corporation(chinese sovereign wealth fund) has big appetite for L’Occitane shares
 + most active stock exchange for IPO deals in 2009 + top market in terms of capital raised
by IPO in 2009
+ HKEx accelerated efforts to attract companies outside of China: L’Occitane would be the
1st French company to go public in HK

IPO destination guide, EY:

http://www.ey.com/Publication/vwLUAssets/IPO_Destination_Guide_v2/$FILE/IPO%20brochu
re%20with%20Metin%20C.pdf

Factors that require careful examination include:

- motivations and goals of your strategy
- factors that are relevant to valuation
- shareholder preferences
- initial and ongoing costs

b. What type of listing is suitable for L’Occitane to pursue? Direct IPO domestically
or internationally, or through an ADR program? If through ADR, which type of
ADR program?
IPO internationally seems to be a good opportunity for L’Occitane. Indeed, you can expect a
listing abroad to attract consumers’ attention to your company’s products (indeed a director of
l’Occitane mentioned that listing in HK would further increase the brand awareness in the APAC
area) and media presence. This can facilitate access to new markets and benefit your business
operations.
+ markets in Europe still look sluggish: uncertain future of the euro and the sovereign debt

…it should also pursue a public issue ADR program. Reason:

➔ sales in US counts largest proportion of total sales, indicating plenty of American
investors probably attracted to buy ADR especially they can realize dividends and capital
gains in US dollars.
➔ ADR can help hedge different stock markets risks to reduce volatility of company’s
value.
➔ a public issue ADR type can be listed on several exchanges, raising a lot of capitals for
L'Occitane. Although it should abide by the most stringent regulations of SEC, its credit
reliability can be guaranteed among investors.

3 levels of ADR program:

- Level 1 : OTC
- Level 2: listed on an exchange or quoted on Nasdaq
- Level 3: this is when an issuer floats a public offering of ADRs on a U.S. exchange.
Level 3 ADRs are able to raise capital and gain substantial visibility in the U.S. financial
markets.

4. What is the right cost of capital for the various equity issuing options (i.e., US,
France, UK, HK)? Measure and explain the cost of capital for each equity option.
Do your results affect your choice of place to issue? You can use the data provided
in the case and also search for additional relevant data to justify the calculations.

Please check my answer as we use calculations for question 5 + I used only data provided

𝜷e = (1+(1-Tc)(D/E))𝜷u
Re = Rf + β(Rm – Rf + CRP) CAPM formula with CRP
RWACC = (D/(D+E))*Rd(1-Tc) + (E/(D+E))*Re WACC formula
with: 𝜷e : beta of equity
𝜷u : unlevered beta = 1.03
Tc : corporate tax rate = 23% Same??
 D : Debt = 75,137 (I took only LT debt)
E : Equity = 407,163 - 96,149 - 123,755 = 187,259
Re : cost of equity
Rd : cost of debt = 6%
Rf : risk free rate : I took 10 year bond ???? 5 year-bond, risk free rate for US
2009 was set at 2.25%, near 5 year-bond(wharton research)
Rm – Rf : market risk premium
CRP : Country risk spread (compared with US)

𝜷e = (1+(1-Tc)(D/E))𝜷u = (1+(1-23%)(75,137/187,259))*1.03 = 1.348

Re = RWACC =

US 3.84% + 1.348*(5.30%+0) (D/(D+E))*6%*(1-23%) + (E/(D+E))*10.98%

= 10.98% = 9.16%

Hong-Kong 2.78% + 1.348*(6.70%+0.68%) (D/(D+E))*6%*(1-23%) + (E/(D+E))*12.73%

= 12.73% = 10.41%

London 4.01% + 1.348*(5.60% + 0.17%) (D/(D+E))*6%*(1-23%) + (E/(D+E))*11.79%

= 11.79% = 9.74%

France 3.60% + 1.348*(5.60% + 0.9%) (D/(D+E))*6%*(1-23%) + (E/(D+E))*12.36%

= 12.36% = 10.14%

Add comments on the above findings:

Higher cost of capital in HK due to a higher market risk premium (for emerging markets, it’s no
surprise). But still very close to France.

5. What is the value of L’Occitane en Provence’s equity?

a. Conduct a DCF using the assumptions of equity analysts given out in the last
paragraph of the case.

FCFF= EBIT(1-tax rate)+ Depreciation- FCinv-WCinv

( in thousands of euros)

year 2010 2011 2012 2013 2014 2015 terminal value

FCFF 64,774.75 87,969.57r 106,561.4 113,309.81 126,985.13 140,662.4 1,793,446.24

9 5
 WACC:10%(discount rate)
growth rate:2%(prudent method)
L

Firm’s value =1,605,607,648.42 euro

firm Value = NFD + equity - minority interests

Equity = FV - NFD + minority interests = 1,605,607.65 - (33,831 + 75,137 - 27,279) + 2,004 =
1,525,922.65 (in thousand of €)

b. Conduct a sensitivity analysis of the DCF that varies the L’Occitane cost of
capital and the perpetuity growth rate (based on your answers to question 4 and
other possible values).
sensitivity analysis: WACC
 y’=

at a certain growth rate level, the bigger WACC, the less sensitive the firm’s value is

sensitivity analysis: Growth rate

y’=2*(3E+08)x+2E+06, at the same discount rate, the bigger growth rate, more sensitive firm’s
value is
 6. Now imagine you are L’Occitane’s investment banker, and you need to
recommend an issue price for its shares. What would be a reasonable price? Please
go beyond DCF and also analyze other prices based on trading and transaction
multiples.

=> equity value

1,525,922,650/1,500,000,000= 1.02€ per share

Valuation method used: comparables

assume 1.5 billion shares outstanding after IPO, there is no preferred equity

➔ net income multiples:26x (average of exhibit 9)

59,384,000*26/1,500,000,000=1.03€ per share

➔ leverage at market:8%
total debt(2009):133,793,000(short-term & long-term borrowings)
existed shares:87,561,000(shares capital & paid-in capital)

x=1,441,059,000
price=1,441,059,000/1,500,000,000=0.96

➔ EBITDA multiples:12x
http://www.intrepidib.com/media/40148/beauty_care_m_a_reoport_june_
2013.pdf
share price=141,401,000*12/1,500,000,000=1.13€
7. Now imagine that you are the investment banker of the large U.S. institutional
investor. Would you take into account any corporate governance considerations to
determine the price at which you would buy? If so, which and how would they
change the price ? Please justify numerically as much as possible.

Corporate governance issues can positively or negatively affect the value of a company
and as a consequence the price of the share. An investor is willing to buy shares at a high
price if the firm is well managed. Moreover, if the firm has no corporate governance
issues, the value of the firm is expected to grow or at least not to suffer from a decrease in
share price because of corporate governance problems.
If the firm is poorly managed, if the legal environment is unsafe, it can affect the share
price.
http://www.academia.edu/4177600/Relationship_between_Corporate_Governance_Score
_and_Stock_Prices_Evidence_from_KSE-_30_Index_Companies

Corporate Governance Score

this study concludes that better governed firms have higher stock prices and vice versa.
This is due to the fact that better managed firms will perform better and as result stock prices will
increase.
There is a positive relationship between corporate governance score and stock prices of the
company. Stock price and corporate governance score have a high correlation (0.7)

http://people.stern.nyu.edu/adamodar/pdfiles/articles/corpgovstockprice.pdf

Shareholder rights vary across firms. Using the incidence of 24 governance rules,
we construct a “Governance Index” to proxy for the level of shareholder rights at about
1500 large firms during the 1990s. An investment strategy that bought firms in the lowest
decile of the index (strongest rights) and sold firms in the highest decile of the index
(weakest rights) would have earned abnormal returns of 8.5 percent per year during the
sample period. We find that firms with stronger shareholder rights had higher firm value,
higher profits, higher sales growth, lower capital expenditures, and made fewer corporate
acquisitions.

This paper examines the association of corporate governance variables and IPO pricing.

Results show that managerial ownership is positively related to both offer price and

market price premium, which is consistent with a high level of managerial ownership

reducing agency costs leading to a closer alignment of interests between managers and

shareholders. High blockholder ownership is positively related to offer price premium

but not market price premium which implies that underwriters, but not investors, perceive

that the quality of the IPO is associated with blockholder ownership. Board size is

negatively associated with both measures of IPO pricing, suggesting that smaller boards

are better. The other conventional corporate governance variables are not significant.

Family ownership and family management are negatively related to both offer price and

market price premium, which is consistent with the suggestion that the lack of separation

of ownership and management causes family-controlled firms to suffer from cloudy

financial vision, resulting in a negative relationship with pricing. However, family

chairman is positively associated with offer price premium which implies that

underwriters view family leadership on the board as beneficial. The other family

governance variables are not significant. None of the board expertise variables examined

are significantly related to IPO pricing.