Coty Inc disclosed on Monday that it had offered $10 billion for Avon Products Inc but the larger company, which is grappling with sliding sales and a bribery probe, rejected the bid as too low and "opportunistic".
Combining Coty, maker of Stetson aftershave and Beyoncé fragrances, with Avon, the world's largest direct seller of cosmetics, would give Coty less reliance on fragrances and a bigger share of growing overseas markets.
Investors sent Avon's stock soaring as high as $23.38 on Monday after news of Coty's offer. The shares closed up 17.3 percent at $22.70.
Coty Chairman Bart Becht said in an interview that Coty and Avon started talking a few months ago about a merger that would have had Avon buying Coty in exchange for shares.
He said when no offer came from Avon, Coty made a verbal offer, followed by three letters last month to Avon Chief Executive Andrea Jung.
"Their board fully acknowledges the financial and strategic rationale, so it is something that should happen," Becht said.
Avon declined to address Becht's comments.
"We would think they would be very open to a takeover," Barclays analyst Lauren Lieberman wrote in a note to clients, referring to Avon's shareholders.
Caris & Co raised its price target to $28, saying the bid reaffirmed the value of Avon's international presence.
Avon, known for its iconic "Ding Dong, Avon Calling" commercials of the 1950s and 1960s, said in its most recent annual report, released in February, that developing markets accounted for more than two-thirds of its sales.
Coty said in a statement on Monday that it made its offer public after unsuccessfully trying to engage Avon in merger talks. It said it had no intention of making a hostile bid.
"We hope by having made public our offer ... that their shareholders will talk to their board and that the board will start engaging with us," Becht said.
The company said it was willing raise its bid, provided it was given access to Avon's financial records to decide whether a higher offer was warranted.
Such due diligence would take about a month or so, Becht said.
Less than an hour after Coty went public with its unsolicited bid, Avon issued a statement saying the $23.25 per share offer "substantially undervalues" the company. It is a 20 percent premium over Friday's closing price of $19.36 and a dollar higher than a previous offer.
Michael Bigger, founder of trading firm Bigger Capital, called the offer "too cheap."
Investors and analysts predicted that Coty would again raise its price, following the classic playbook in dealmaking.
Avon, which is searching for a replacement for Jung, said a new CEO would create "greater opportunity" to increase its value.
"The new CEO should have time to develop a strategy and make that transparent to the market before Avon should ever be dealing with a buyout offer," said Shawn Gault, portfolio manager at Kempner Capital Management Inc, which holds 218,135 Avon shares, according to Reuters data.
There are few other companies for which buying Avon would make sense, analysts said.
Sanford C. Bernstein & Co analyst Ali Dibadj said that with the exception of perhaps another direct seller, there are few potential suitors for Avon.
Avon said in December that Jung, who has been CEO since 1999, would step down. Jung will stay on as executive chairman after her successor takes the helm.
The company has had declining sales in markets like the United States, Brazil and Russia. Its famous army of "Avon ladies" sales representatives is shrinking because of uncompetitive commissions and stiff competition.
Avon has been bedeviled by heavy competition from drugstores in the United States, aggressive pricing by rivals in Eastern Europe and inadequate ordering systems that have frustrated representatives in Brazil, its biggest market.
Coty, a fast-growing privately held company that is majority-owned by German group Joh. A Benckiser GmbH, is confident it can line up the necessary financing to pull off the acquisition of a company with sales nearly three times greater than its own and retain its investment grade debt rating.
Late on Monday, Standard and Poor's Ratings Service said that it had put Avon's ratings, including its 'BBB' corporate credit rating and 'A-2' short-term rating, on CreditWatch with negative implications.
S&P said one of the reasons for its action was that it believed if a deal was reached, it would include "meaningful additional debt".
BDT & Co LLC, founded by former Goldman Sachs Group Inc partner and longtime Warren Buffett confidant Byron Trott, is arranging equity financing, while J.P. Morgan Securities LLC is working on the debt financing, Coty said in its statement.
As of Friday, Avon was worth about $8.3 billion, down from an all-time peak of $21.8 billion in June 2004.
More cosmetics, emerging markets
Fragrances accounted for 57 percent of Coty's $4.1 billion in sales in its year ended June 2011. The bulk of its sales come from Europe and North America, and it has largely missed out on China's ravenous demand for Western brands. Still, overall revenue was up 17 percent last fiscal year.
In addition to expanding its cosmetics market, Coty said Avon's direct sales model would help Coty's beauty brands.
Becht said Coty would retain some of Avon's senior executives who have expertise in direct selling.
Coty has grown substantially through deals aimed at diversification. In 2010, it acquired Philosophy Inc, a maker of personal-care products, from buyout firm Carlyle Group for $1 billion. It also bought a majority stake in Chinese skin-care company TJoy Holdings Ltd, with its distribution network and infrastructure that would help Coty's other products in that market.
Avon's sales have plummeted in the last few years in China, where it got a direct selling license in 2006.
Avon has been conducting an internal probe into whether it broke the Foreign Corrupt Practices Act to get that license. The U.S. government announced its own investigation last year.
Late on Monday, Avon said that it had elected Douglas R. Conant to its board of directors, effective immediately, replacing Paul Pressler. Conant is the former CEO of Campbell's Soup Co.