Estée Lauder's strategy with Puig doesn't smell as sweet as it looks

By Yawen Chen

LONDON, March 24 (Reuters Breakingviews) - Estée Lauder is testing the waters with Puig Brands, but the prospect of any merger could prove unappealing for shareholders of the larger firm. The U.S. cosmetics group, valued at approximately $30 billion, announced on Monday that it was in merger talks with its Spanish fragrance counterpart, valued at nearly $10 billion. The figures and power dynamics suggest that Estée could end up overpaying.

The strategic logic is clear for the Lauder family, which controls the company and holds over 80% of the voting rights. Estée is heavily reliant on China, where demand has been patchy. Conversely, Puig -- pronounced "pootch" in Catalan -- is a fragrance powerhouse with less exposure to the People's Republic, deriving about three-quarters of its revenue from perfumes, a segment that has proven more resilient. Its operating margins are also higher, according to analyst forecasts compiled by Visible Alpha, standing at around 16% for this calendar year, compared to 11% for Estée.

Puig, also controlled by an eponymous founding family with a stake of over 90% of voting rights, appears to hold the upper hand in negotiations. Firstly, there are other potential bidders, such as L'Oréal, valued at $213 billion, which recently acquired Kering's beauty division. And while Puig's shares have underperformed since its 2024 IPO, the clan has little incentive to sell their 112-year-old group at a significant discount to that level. They may seek to maintain influence over the merged entity, which could mean Estée has to make a very generous offer with a significant stock-based component. Another option is to attempt to extend super-voting shares to the Puig family.

All this points to a poor deal from the perspective of Estée's minority shareholders. Assuming a 20% premium over Puig's Monday closing level, the purchase price, including net debt, would be $13 billion. Jefferies analysts wrote on Tuesday that annual cost and revenue synergies could amount to 6% of Puig's sales, or roughly $380 million. Adding that to Puig's forecast 2029 operating profit based on Visible Alpha estimates and taxing the total at 25%, the return for Estée after three years would be $1.1 billion, or just 8.7% of the hypothetical purchase price in this scenario. That is below the target company's weighted average cost of capital, which Jefferies estimates at 9%.

This is hardly attractive, which perhaps explains the 8% drop in Estée's share price on Monday. There may also be antitrust questions in the U.S. high-end makeup market, according to JP Morgan analysts, as Estée is a leading player and Puig's Charlotte Tilbury is the third-largest brand in that category. Then there are the potential governance risks of having two founding families with significant stakes.

In short, Estée may gain greater weight in the fragrance sector and a highly valuable asset, but at a price that leaves little room for value creation. And the minority shareholders of the larger company can do little about it, given the control exercised by the Lauder family. Puig shares soared 13% on Tuesday. As with many deals in the luxury sector, most of the value in this case may accrue to the sellers.

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CONTEXT

Estée Lauder and Puig Brands announced on March 23 that they were in talks regarding a potential merger, confirming an earlier report by the Financial Times.

The two companies have discussed a combination that would include a mix of cash and stock, the Wall Street Journal reported on March 23, citing people familiar with the matter.

Estée Lauder shares closed down 7.7% on March 23. Puig shares were up 12.7% at 1354 GMT on March 24.

(Editing by Liam Proud; production by Shrabani Chakraborty; Spanish editing by Jorge Ollero Castela)