Features Skin Deep Cosmetics Go Medical Valeant Pharmaceuticals International, Inc. and other pharma companies are quickly snatching up professional beauty-care products, as a means of gaining more direct access to consumers. Brands that promise skin repair and rejuvenation are tapping into online portals, including Dermstore.com, QVC, and HSN. They are also in retail outlets and drugstores that provide on-site services to shoppers, including Sephora, Duane Reade's Look Boutique and CVS’ Beauty 360. The migration from the medical to the consumer channel has gained the attention of middle-market dealmakers, and industry observers say the trend will continue for years to come. “Large pharmaceutical companies are looking to diversify broadly into the consumer sector over time,” says Brian Krumrei, who is a managing director at the San Francisco-based private equity firm TSG Consumer Partners. Jeff Menashe, CEO of the San Francisco -based boutique investment banking firm, Demeter Group, says deals are going to be primarily in skin care, hair care, and color cosmetics. “The reasons behind that is the size of the market, the competitiveness within each one of those categories, and the proposition that beauty-care brands offer a therapeutic element.” Pharma and premium beauty-care brands are following the footsteps of consumers, who continue to look for alternatives to prescription skin-care products. “Consumers want the same products available in other channels,” says Krumrei. Buyers now have the option to shop at drugstores, such as Duane Reade Inc., where they can pick up premium beauty products at its Look Boutique. CVS Caremark Corporation (NYSE: CVS) offers a similar service through Beauty 360. “Consumers increasingly want convenience. That demand is actually driving the trend in that scene,” Krumrei noted. So far, strategic buyers are leading the way. Valeant Pharmaceuticals International, Inc., (NYSE: VRX), which specializes in neurology and dermatology, is on an acquisition spree that straddles its consumer set as well as the pharma side of the business. The Ontario-based company has an over-the-counter (OTC) division that includes skin care and hair care assets. In May, it added the OTC acne treatment, AcneFree, to its consumer portfolio. Valeant bought the brand from the Irvine, Calif.,-based skin, body, and hair care products manufacturer, University Medical Pharmaceuticals Corp., for approximately $64 million. “There has always been an overlap between pharma and consumer brands,” says Steve Davis, managing director of Intrepid Investment Bankers LLC. He pointed out that the overlap has traditionally been in the personal-care, food and nutrition spaces. “You are starting to see it expand more into the beauty-care market. As it relates to M&A, I do think you will see the migration in both directions,” he says. Beauty-care companies have already begun to acquire businesses that have a science or medical-based component. Most of them are gaining access into the traditional doctor and derma channels. With a market capitalization of nearly $14 billion, Valeant has more than enough clout to make its own professional beauty and skin-care products, but it has to stay ahead of the game, given the competitive landscape. Menashe estimates the professional color cosmetic market as a $200 million industry, professional skin care at $985 million, and professional hair care at about $2 billion. “The competitiveness in each of those categories correlates strongly toward their size,” says Menashe. The main attraction to the beauty-care industry, for both pharmaceutical and consumer product giants, is that it is positioned in multiple channels, including dermatology offices and medi spas. It is a competency in a category that pharmaceutical companies, like Valeant, are familiar with, given that it reduces the reliance on third party distributors. Although strategic suitors are at the forefront, private equity buyers aren't that far behind. Catterton Partners, North Castle Partners, LLC, TSG Consumer Partners, LLC, and VMG Equity Partners are the top four firms that have made investments in the beauty-care category. VMG Equity agreed to merge its science-based mineral makeup company Colorescience with the professional skin care company SkinMedica, Inc. in January. The Carlsbad, Calif.,-based company sells both prescription and non-prescription products to doctors who specialize in aesthetics. The addition of Colorscience, which is headquartered in Dana Point, Calif., and created by Bare Escentuals founder Diane Ranger (see page 34), enables consumers to preserve and improve their skin after using SkinMedica products, according to the company. SkinMedica has its sights set on an initial public offering, says Menashe, who advised Colorscience on the merger. “This deal was about strengthening and building their exit through a potential IPO. It gives them the ability to tell a story to the public markets of having a duality of being both a life science and a consumer-facing business.” While SkinMedica prepares for an ultimate IPO, there are at least two dozen professional skin-care brands that are considered to be targets. Menashe says most of them are generating $40 million to $100 million in annual revenues. “There is certainly a wave of prospects behind them, but they are just smaller companies,” he says, explaining that the smaller targets may be in categories that are making some noise but are still considerably new. Depending on a number of factors, valuations of professional beauty-care companies are within the range of 2.5 to 3 times revenue, or an Ebitda as high as 11 to 14 times. According to industry research from Demeter Group, M&A volume in the _ beauty-care space in-I creased 4.5 percent in | 2011, but the size of transactions shrank 11.3 percent. The decline in deal size is not alarming, however, given that there were a number of relatively large transactions that took place in 2010. “It's just part of the cycle, where deal volume fluctuates up and down, year to year,” says Krumrei. In 2010, there were several announced transactions that were responsible for more than $5 billion worth of deals. Tokyo-based cosmetic and pharmaceutical business Shiseido Co. was part of the rotation, when it bought Bare Escentuals in an all-cash transaction valued at $1.8 billion. Unilever spent $3.7 billion for the hair-care assets of Alberto Culver Company. Coty Inc., paid a reported $1 billion for the nail care company OPI Products Inc. Most of the action on the higher end of the middle market has since calmed down. However, industry dealmakers expect things to shake up for the median range of the middle market in the second half of 2012. Rumor Mill Castanea Partners- In February, it was reported that Deutsche Bank sent out the books on Castanea's color cosmetic brand, Urban Decay, to strategic suitors. Catterton Partners-Around the same time, word got out that Catterton's cosmeceutical skincare company, Stri-Vectin, retained Goldman Sachs to explore a sale. Murad Inc.- Founded in 1989 by Dr. Howard Murad, the El Segundo, Calif.,-based skin care products manufacturer has been in the rumor mill as an acquisition target for years. In 2007, it was reported that Estee Lauder Companies (NYSE: EL) danced around the idea of acquiring the business, but Murad is still privately owned. The company's line includes cleansers, toners, hydration and skin protection products, which are sold through the company's website, infomercials, beauty retail stores, salons, and spas. TSG Consumer Partners has a diverse collection of beauty-care investments under its belt, including Perricone MD, Pevonia and Sexy Hair. It is rumored that the firm is contemplating combining its beauty brands into one company and taking it public or pursuing other alternatives. TSG managing director Brian Krumrei declined to comment. Potential Targets Glominerals- Founded in 1997 under the name Caleel + Hayden, the Denver-based company offers hair care, skin care, and mineral-based cosmetics products. In 2006, North Castle Partners bought a controlling stake in the business, for an undisclosed amount. The investment currently sits within the firm's third fund. Iredale Mineral Cosmetics- Founded in 1994 by Jane Iredale, the Great Barrington, Mass.,-based company was the first to supply a mineral makeup line with skin care benefits to the aesthetic industry. Living Proof- Founded in 2005 under the name Andora, the Cambridge, Mass.,-based company produces and markets women hair care products. It offers everything from shampoos, conditioners, hairsprays, and styling creams. Peter Thomas Roth Labs, LLC- Founded in 1993, the Moonachie, N.J.,-based skin care company produces a full line of products including cleansers, products for men, eye and lip care, hair and body care, as well as anti-aging products, acne care and shaving products, all of which are sold online and in select retail stores. Yes To Carrots- Founded in 2007, the San Francisco-based natural hair and skin care products, which is made from organic fruits and vegetables, received a $14 million investment from San Francisco Equity Partners in 2008. Industry reports cited that the company expected to pull in $40 million to $60 million in sales for 2011. Meet Innovator Diane Ranger The pioneer of mineral makeup is Colorscience founder Diane Ranger, whose initial idea back in 1976 manifested into Bare Escentuals. In 2004, Berkshire Partners bought a 16 percent stake in the San Francisco-based company. The rumor mill speculated that Estee Lauder Companies (NYSE: EL) was thinking about buying a piece of the business until it realized that the products were mainly sold on television shopping networks and not in department stores. Selling products on QVC wasn't a problem for Berkshire Partners, and the firm helped to take its mineral makeup investment public. On September 29, 2006, Bare Escentuals started to trade shares at $22 apiece on the NYSE under the ticker symbol BARE. Priced at the top of its range, the company raised more than $350 million. Bare Escentuals continued to sell its products through infomercials and QVC but it kicked up its distribution efforts by opening boutiques and tapping into retail stores. Bare Escentuals also ventured abroad and its international sales generated 11.9 percent of sales for 2008. The company reported that it brought in $556 million in sales during that time. The company's success started to attract the attention of cosmetic giants. Although Estee Lauder was known to be the big time strategic acquirer, it was the Japanese skincare brand Shiseido Co. Ltd. that rose to the occasion. By January 2010, Shiseido struck a deal to acquire Bare Escentuals’ shares at $18.20 apiece. The all-cash transaction was valued at $1.8 billion.