JUST ONE QUICK QUESTION ASKED AT BOTTOM!!!

As an institutional investor holding Avon stock, should you just sell the common stock and ignore the offer all together?

Mr. Waldron felt that at the same time that Avon was reorganizing its business, it should also reconsider its financial policies, including its dividend policy. The company was about to begin the last phase of its exit from the health care business with the sale of Mediplex and Retirement Inns. In addition, Mr. Waldron and the board agreed that Avon should redouble its commitment to its core beauty products business, whose recent results were encouraging. Among other things, this implied that Avon would continue to invest significant additional capital in that business. In December 1987, Avon raised additional capital by selling 40% of the common stock of its wholly-owned Japanese subsidiary, Avon Products Company Limited, in a public offering in Japan that raised $218 million. The price was over six times book value and around 50 times earnings. Avon booked an after-tax gain of $121.1 million, or $1.72 per share, on the sale. The board also felt that Avon should conserve cash flow by reducing its dividend from $2.00 to $1.00 per share, but Mr. Waldron worried about the consequences of simply cutting Avon's dividend. Avon had maintained its dividend at $2.00 per share per year since the dividend cut in August 1982. Although that reduction had not resulted in any sudden drop in Avon's stock price, Avon's stock had been falling for some time in advance of the cut. This time might be different. Avon's 1987 annual report had stated that the firm expected to maintain the current annual $2.00 dividend, and Avon's stock price had remained fairly steady during 1988. Exhibit 5 lists the 25 largest institutional holders of Avon stock. Many of those investors might sell their Avon shares quickly if Avon simply reduced its dividend. As Mr. Waldron put it, "For five years I had been telling them that we weren't going to cut the dividend, and for five years they had been telling me they didn't believe me." Some investors had stated that they held Avon stock because it paid a high dividend. Avon's board asked its financial advisor, Morgan Stanley and Co., what steps the company could take to avoid having the dividend reduction drive down the stock price. The exchange offer was one element of the solution. Morgan Stanley proposed that Avon offer to exchange one share of a new $2.00 preferred equity-redemption cumulative stock (PERCS) for each of up to 18 million of Avon's 7.17 million outstanding common shares. The new preferred would pay, on the same dividend dates as its common stock, cumulative quarterly dividends of 50 cents ($2.00 a year) accrued from September 1, 1988 to September 1, 1991. Although the company would be able to redeem the preferred shares at any time before September 1, 1991, according to a declining schedule, the important provisions concerned mandatory redemption of the PERCS shares in September 1, 1991. On that date the PERCS shares would expire. Their holders would receive one common share for every PERCS share if the price of the common stock was less than or equal to $31.50, or $31.50 worth of common stock per PERCS share if the common stock was above that price. As was usual with preferred stock, Avon would not be able to pay its common dividend at any time its preferred dividend was in arrears. In addition, this preferred stock included a restriction providing that Avon could never pay a common dividend of $1.50 or more per share per year unless it first redeemed the preferred. Mr. Waldron felt confident that the financial markets would understand the new security. Third-party issuers had successfully marketed at least one product similar to the PERCS, Americus Trust PRIME units. An Americus Trust was a corporation whose sole asset was common stock of a particular company. The basic idea was that shareholders of that company placed their shares in the trust, which issued two units, called a PRIME and a SCORE, against each share. The PRIME units received all the dividends the stock earned; the SCORE units received no dividends. At a predetermined terminal date, the trust would liquidate the shares it held. The PRIME holders would receive the value of the shares up to a certain predetermined level, and the SCORE holders would receive any excess. The PERCS might appeal to investors who would buy PRIMEs. Mr. Waldron realized that he would need to convince his colleagues on the board that the terms of the offer would be fair to all the company's shareholders and also appealing to those who especially desired high dividends. Avon's stock closed at $24.125 per share on June 1, 1988. Exhibit 6 gives the June 1 closing prices of options on Avon's stock which were listed on the Chicago Board Options Exchange Mr. Waldron felt that at the same time that Avon was reorganizing its business, it should also reconsider its financial policies, including its dividend policy. The company was about to begin the last phase of its exit from the health care business with the sale of Mediplex and Retirement Inns. In addition, Mr. Waldron and the board agreed that Avon should redouble its commitment to its core beauty products business, whose recent results were encouraging. Among other things, this implied that Avon would continue to invest significant additional capital in that business. In December 1987, Avon raised additional capital by selling 40% of the common stock of its wholly-owned Japanese subsidiary, Avon Products Company Limited, in a public offering in Japan that raised $218 million. The price was over six times book value and around 50 times earnings. Avon booked an after-tax gain of $121.1 million, or $1.72 per share, on the sale. The board also felt that Avon should conserve cash flow by reducing its dividend from $2.00 to $1.00 per share, but Mr. Waldron worried about the consequences of simply cutting Avon's dividend. Avon had maintained its dividend at $2.00 per share per year since the dividend cut in August 1982. Although that reduction had not resulted in any sudden drop in Avon's stock price, Avon's stock had been falling for some time in advance of the cut. This time might be different. Avon's 1987 annual report had stated that the firm expected to maintain the current annual $2.00 dividend, and Avon's stock price had remained fairly steady during 1988. Exhibit 5 lists the 25 largest institutional holders of Avon stock. Many of those investors might sell their Avon shares quickly if Avon simply reduced its dividend. As Mr. Waldron put it, "For five years I had been telling them that we weren't going to cut the dividend, and for five years they had been telling me they didn't believe me." Some investors had stated that they held Avon stock because it paid a high dividend. Avon's board asked its financial advisor, Morgan Stanley and Co., what steps the company could take to avoid having the dividend reduction drive down the stock price. The exchange offer was one element of the solution. Morgan Stanley proposed that Avon offer to exchange one share of a new $2.00 preferred equity-redemption cumulative stock (PERCS) for each of up to 18 million of Avon's 7.17 million outstanding common shares. The new preferred would pay, on the same dividend dates as its common stock, cumulative quarterly dividends of 50 cents ($2.00 a year) accrued from September 1, 1988 to September 1, 1991. Although the company would be able to redeem the preferred shares at any time before September 1, 1991, according to a declining schedule, the important provisions concerned mandatory redemption of the PERCS shares in September 1, 1991. On that date the PERCS shares would expire. Their holders would receive one common share for every PERCS share if the price of the common stock was less than or equal to $31.50, or $31.50 worth of common stock per PERCS share if the common stock was above that price. As was usual with preferred stock, Avon would not be able to pay its common dividend at any time its preferred dividend was in arrears. In addition, this preferred stock included a restriction providing that Avon could never pay a common dividend of $1.50 or more per share per year unless it first redeemed the preferred. Mr. Waldron felt confident that the financial markets would understand the new security. Third-party issuers had successfully marketed at least one product similar to the PERCS, Americus Trust PRIME units. An Americus Trust was a corporation whose sole asset was common stock of a particular company. The basic idea was that shareholders of that company placed their shares in the trust, which issued two units, called a PRIME and a SCORE, against each share. The PRIME units received all the dividends the stock earned; the SCORE units received no dividends. At a predetermined terminal date, the trust would liquidate the shares it held. The PRIME holders would receive the value of the shares up to a certain predetermined level, and the SCORE holders would receive any excess. The PERCS might appeal to investors who would buy PRIMEs. Mr. Waldron realized that he would need to convince his colleagues on the board that the terms of the offer would be fair to all the company's shareholders and also appealing to those who especially desired high dividends. Avon's stock closed at $24.125 per share on June 1, 1988. Exhibit 6 gives the June 1 closing prices of options on Avon's stock which were listed on the Chicago Board Options Exchange