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Avon's CDS widens sharply on turnaround, legal cost fears

By Melissa Mott

NEW YORK, Oct 31 (IFR) - The cost of insuring Avon Products debt against default rose to a three-month high on Thursday after the company missed third quarter earnings expectations and warned that it would likely cost more than expected to settle a bribery probe.

The cosmetic seller's five-year credit default swaps widened by 53bp to 210.5bp, making it the worst performing constituent in the investment-grade CDX.IG21 index.

The company reported a 7% drop in third-quarter revenues to USD2.3bn. Beauty sales, and fashion and home sales fell 9% and 7% respectively, while core earnings per share were 14c compared to consensus of 19c.

Its shares also fell sharply, hitting their lowest level since February, on concerns that the company's turnaround plan was not working.

"The third quarter was tough," Sheri McCoy, Chief Executive Officer of Avon Products, Inc said. "However, overall, Avon is headed in the right direction, parts of our business are stabilizing, and we are making progress toward our three-year financial goals."

Also weighing heavily on the company's CDS were fears over the potential cost of a bribery probe.

The company said the size of a penalty that the US Securities and Exchange Commission offered to settle the matter in September was "significantly greater" than Avon's offer to pay USD12m, and would "materially adversely" hurt its financial condition.

The Wall Street Journal has reported that the fine could exceed USD100m.

"We have cash balances. And obviously, we also have a revolving credit facility that we have in place for backup liquidity needs," said McCoy.

The move in the company's CDS was more pronounced than the cash bonds.

That is probably because the issuer's bonds include language which protects bondholders in the event of a downgrade to "junk" by all three major rating agencies.

This change of control language is a proviso which if triggered by a ratings downgrade would require the company to purchase the instruments at 101.

This is a fear since S&P, which rates Avon at BBB-, has a negative outlook on the company.

Fitch downgraded Avon to speculative grade in February, cutting the company's rating by one notch to BB+, citing a confluence of factors including a decline in US revenues, a lack of sustainable operating income growth in key international markets and weakened credit protection measures.

Moody's rate the issuer in investment-grade territory at Baa2.

Avon's 5.00% bond, due in 2023, fell to USD103.25 from Wednesday's USD104.00 close, while the 4.60%, due 2020, dropped to USD103.51 from USD105.94.