Thu 01/27/2022 12:14 PM
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Primary Preview Wella:

Buysiders considering the euro tranche of Wella’s $1.95 billion-equivalent term loan B highlighted risks surrounding the company’s retail hair offering, its ability to deliver cost savings and the eye-watering $989 million dividend as concerns. Meanwhile, a margin ratchet, though improved under the current iteration, remained challenging. However, the company’s scale and second position in the global market for professional hair products, its geographic and product diversification as well as its ability to generate free cash flow once one-off carve-out costs have been incurred were seen as positives.

Wella originally planned to raise a $1.8 billion-equivalent term loan B, which included an €800 million euro-denominated portion, but the total amount of the loan was increased to $1.95 billion today, including an increased €925 million euro-denominated portion. The upsizing followed yesterday’s decision to bring the deadline for commitments forward to today from Friday, Jan. 28.

Final terms for the euro portion were tightened today to a margin of Euribor+375 bps from the range of E+375 bps-400 bps previously. The OID was unchanged at 99.75, and there is a 0% floor on the loan portion.

The deal also includes a £550 million sterling-denominated portion and a dollar portion, both of which were pre-placed. The sterling portion carries a margin of S+500 bps. The company also pre-placed a $300 million-equivalent HoldCo PIK and a $300 million RCF.

In addition to funding the dividend, proceeds of the new loan will be used to repay $1.2 billion of existing debt.

In 2020, KKR acquired a controlling 60% stake in Coty’s professional beauty business, Wella, for $4.2 billion, which it increased to 74% since. Following the dividend recap, it will still have $1.607 billion of cash equity in the deal.

Pro forma for the offering, senior secured net leverage and total net leverage (including the HoldCo PIK) will be 4.6x and 5.4x, respectively, based on fiscal 2021 structuring EBITDA of $376 million.

Wella manufactures and sells hair coloring, haircare, nail coloring and hair appliance products. The company generated 54% of fiscal 2021 net revenue from its professional hair segment. It has a number one position in the professional color market with the Wella brand, and a number two position in the professional hair market overall. About 20% of revenue came from the group’s retail hair segment, in which the company is the number two globally in hair color and number three in hair styling. Meanwhile,16% of revenue came from Wella’s beauty appliance brand ghd and 8% from the group’s nail brand OPI.

Wholesalers account for about 34% of the company’s net sales, while salons account for about 30%, consumer retail for 16%, e-commerce for 8%, and other for 12%. The company generates 28% of its overall revenue in North America, 12% in the combined area of Germany, Austria and Switzerland, 11% in the U.K. and Ireland, 6% in Italy, 5% in Japan, 4% in Brazil, and 34% in other regions and countries.

The professional hair segment is very resilient, however, the company’s weaker position in the retail hair sector means there are some risks associated with this part of the business, buysiders said. Competition with L’Oreal is tough, particularly in the retail hair segment, but Wella is well positioned overall, they said.

Wella’s exposure to fast-growing emerging markets (compared with very mature domestic markets) is also limited, which is something the group is seeking to address, especially by expanding in China, one lender said. Online sales also need to increase from the current level of around 8%, he added.

Meanwhile, although ghd has performed well, this may reflect the fact that with hair salons closed during the pandemic, consumers bought more hair appliances (hair dryers, curlers, straighteners, etc.) to use at home. Since this type of equipment typically has a relatively long replacement cycle, sales may not be as strong going forward, the source said.

In its fiscal year to June 2021, the company generated $2.325 billion of revenue. During that period, structuring EBITDA amounted to $376 million, which represents a 16.2% margin. Wella outperformed its fiscal 2021 forecasts, lenders said. The company also outperformed its pro forma EBITDA budget for the November 2021 year-to-date period by $84 million and is expected to exceed the original fiscal 2022 budget by $32 million, sources noted.

Wella seemed to have lost market share between 2016 and 2020, but it is now recovering this with greater focus from KKR compared to under the previous management team at Coty, buysiders said.

The company’s net revenue fell to $2.118 billion in 2020, from $2.414 billion in fiscal 2019, after which it rose to $2.325 billion in 2021 and is expected to reach $2.596 billion in fiscal 2022. Adjusted EBITDA fell to $229 million in 2020, from $358 million in fiscal 2019, before rising to $293 million in 2021 and is expected to hit $375 million in fiscal 2022.

Wella’s core professional hair category is a $12.8 billion market that is well consolidated, with the top three players holding a 35% share. But the hair salon market is highly fragmented, which means that it is harder for smaller brands to gain significant market share since an entrant that wanted to gain significant market share from the traditional big players would need a very extensive sales and training workforce to penetrate the sector, one source said. Salons are also very ‘sticky’ hair color customers because of the technical nature of the product, which results in only about 10% churn per year.

Wella also benefits from a high degree of diversification in each of its segments. In the professional hair segment, the company generates about 27% of its sales in North America, 16% in the combined area of Germany, Austria and Switzerland, 7% in the U.K. and Ireland, 6% in Italy, 6% in Japan, 5% in Brazil, and 33% elsewhere. Within the professional hair category, 60% of sales come from hair color, 29% from haircare, 8% from styling and 3% from other uses. The company has five main professional hair brands, of which Wella is the largest brand, generating about 63% of revenue, while the others each generate between 6% and 7%.

In the retail hair segment, sales are split about 26% from the U.S.,14% from the U.K. and Ireland, 9% from Brazil, 9% from Japan, 7% from Mexico, 5% from Germany, Austria and Switzerland combined, and 29% from other countries. In this segment, sales are also split between channels including supermarket, pharmacy, in-market distributors, export distributors and others. Color accounts for 81% of this segment’s sales, with styling providing the remainder.

The company’s hair appliance brand ghd also has good diversification across geographies, sales channels and types of appliances. And the nail brand OPI generates about 69% of its sales in North America, but has diversified product types.

Wella is aiming to deliver $170 million of cost savings through operational efficiency improvements by fiscal 2025. About 31% of these cost savings had already been implemented in fiscal 2021 and the group expects 85% to be achieved over the next two years, lenders said. However, one buysider questioned whether the group will achieve its ambitious savings target.

Free cash flow is likely to be negative in 2022, and slightly positive in 2023 as the company will only start generating cash once the carve out is complete and all its operational restructuring costs have been incurred, however, the carve out is almost done, another buysider noted. The restructuring costs will last until the end of 2023, with a smaller amount possibly continuing until 2025, he said.

Considering that EBITDA is about 15% of sales, capex requirements are relatively low at about 2.5% of sales, working capital doesn’t require a large build and tax is fairly modest, free cash flow will be adequate, he said. And EBITDA will increase, supporting this, he added.

Beyond 2023 when the majority of restructuring costs are in the past, free cash flow will amount to between a third and 50% of EBITDA, another buysider estimated.

During the period from December 2020 to June 2021, the company generated $142 million of pro forma EBITDA, and $180 million of operating cash flow because of a $38 million change in net working capital. Recurring capex of $22 million resulted in $158 million of free cash flow. However, much of this was used for the $54 million one-off capex related to IT carve-out costs and the $143 million cash impact of one-off expenses related to one-off costs from the separation of the business, including IT costs, separation implementation support, severance/new hire costs, and temporary dual running of finance and human resources functions, which was partly offset by some $46 million of one-off payables, leaving the group with $7 million of free cash flow over the period.

Meanwhile, although the $989 million dividend is certainly hefty, the impact is mitigated by the remaining $1.607 billion of cash equity provided by KKR to date, the fact that leverage is around 4.6x compared with an implied enterprise value of 12-13x, and that the company generates cash in a normal year, one buysider said.

The deal was initially marketed with a margin ratchet with three step downs starting 0.25x inside opening leverage, but this was changed on Monday, Jan. 24 to two step downs starting 0.5x inside opening leverage. While this is an improvement, it still means that the margin on the euro portion of the loan will probably tighten to E+350 bps soon after the six-month margin ratchet holiday, and this margin would not be consistent with the risks related to this credit, one buysider said.

The company and the loan are rated B2/B by Moody’s and S&P, which was surprising, another buysider said, who had expected a higher rating.

Physical bookrunners for the euro portion were Credit Suisse, KCM, and JPMorgan. They were joined as bookrunners on that portion of the loan by ABN Amro, BNP, Credit Agricole, Deutsche Bank, HSBC, ING, Intesa, Mizuho, TD Securities, UniCredit and SMBC.

Credit Suisse was contacted but declined to respond.

The company’s pro forma capital structure is below:



































































































































































Wella AG - Pro Forma as of 01/27/2022


06/30/2021

EBITDA Multiple

(USD in Millions)

Amount

Maturity

Rate

Book


Existing - $300M RCF

-



Existing - Term Loan A (Euro)

-



Existing - Term Loan A (USD)

-



Existing - Term Loan B (Euro)

-



Existing - Term Loan B (USD)

-



Existing - Term Loan B (Sterling)

-



New - $300M RCF due 2028

-

2028


New - Term Loans due 2029 1

1,950.0

2029


Total Senior Secured Debt

1,950.0

5.2x

New - Euro PIK Notes due 2030

300.0

2030


Total PIK Notes

300.0

6.0x

Total Debt

2,250.0

6.0x

Less: Cash and Equivalents

(225.0)

Net Debt

2,025.0

5.4x

Operating Metrics

LTM Reported EBITDA

376.0


Liquidity

RCF Commitments

300.0

Plus: Cash and Equivalents

225.0

Total Liquidity

525.0

Credit Metrics

Gross Leverage

6.0x

Net Leverage

5.4x

Notes:
1. Consists of Euro, Sterling, and USD tranches.
Pro Forma: Capitalization is pro forma for refinancing in January 2022. Reported EBITDA is LTM structuring EBITDA.



– Beatrice Mavroleon
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