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Revenue growth at Bare Escentuals (BARE) has slowed sharply this year, crawling to a 3% rate in Q3. Nonetheless, we expect the top and bottom lines to grow in 2009. We do have some concerns regarding the long-term growth of the minerals-based cosmetics category, and we are unsure whether the company can maintain EBIT margin around 30%. However, the adverse implications of these long-term issues should not be overweighted in light of continued growth and a valuation of less than 5x 2009E earnings. Bare shares may be too cheap to ignore.

BUSINESS OVERVIEW

Bare Escentuals is a prestige beauty brand and a leader in mineral-based cosmetics. It makes branded cosmetics, skin care and body care and professional skin care. Distribution consists of infomercials, home shopping TV, specialty beauty retailers, Bare boutiques, spas and salons, and online.

SELECTED OPERATING DATA

FYE December 31

2005

2006

2007

YTD

9/30/08

% of revenue by distribution channel and segment:

Retail – infomercial

37%

33%

25%

19%

Retail – boutiques

14%

14%

17%

20%

Total retail

51%

47%

41%

39%

Wholesale – premium

19%

28%

32%

32%

Wholesale – shopping TV

15%

13%

12%

12%

Wholesale – spas and salons

9%

8%

11%

12%

Wholesale – international

6%

4%

3%

4%

Total wholesale

49%

53%

59%

61%

Revenue growth by distribution channel and segment:

Retail – infomercial

77%

33%

-2%

-18%

Retail – boutiques

51%

58%

53%

39%

Total retail growth

69%

40%

14%

4%

Wholesale – premium

253%

121%

49%

11%

Wholesale – shopping TV

39%

31%

22%

22%

Wholesale – spas and salons

27%

38%

71%

26%

Wholesale – international

71%

11%

7%

29%

Total wholesale growth

84%

65%

43%

17%

Total revenue growth

83%

52%

30%

12%

Gross margin by distribution channel:

Retail

77%

80%

80%

80%

Wholesale

65%

64%

65%

67%

Total gross margin

71%

72%

71%

72%

EBIT margin by distribution channel and corporate overhead:

Retail

31%

36%

35%

33%

Wholesale

57%

60%

59%

61%

Corporate

-14%

-13%

-16%

-18%

Total EBIT margin

30%

35%

33%

32%

% of revenue by geography:

U.S.

94%

96%

92%

88%

International

6%

4%

8%

12%

Revenue concentration by major customer:1

Customer A

15%

13%

12%

12%

Customer B

<10%

13%

13%

12%

Customer C

<10%

14%

16%

15%

1 Top three customers are QVC, Sephora, Ulta.

INVESTMENT HIGHLIGHTS

  • 74% of target consumers are aware of mineral makeup, but only 23% of those have tried it. 45% of consumers say they are likely to try mineral makeup in the next year, according to Bare.

  • bareMinerals core foundation products offer healthy, lightweight alternative to conventional liquid- or cream-based cosmetics while providing light to maximum coverage for all skin types.

  • 12% share of $3.6 billion U.S. facial makeup market. Bare continues to gain share.

  • Large opportunity in “extension” markets, with only 2% share of $4.9 billion U.S. color market and 1% share of $7.8 billion U.S. skin care market.

  • To grow distribution to 786 U.S. doors by yearend 2008, up from 559 in 2007 (potential of 2,300).

  • International only 8% of revenue, but Bare is pursuing growth in Europe, Japan, and Canada.

  • Bare Escentuals was the top-selling cosmetics brand at specialty retailers Sephora and Ulta in 2005, 2006 and 2007. The company has strong brand awareness and consumer loyalty.

  • No-celebrity marketing lowers cost. Bare spends 7-8% of sales on ads and promotion, while L’Oreal and Estee Lauder spend ~30% and ~25% each.

  • Guidance for 10% revenue and EPS growth in 2008, with guidance lowered from 20-25% to 15-20% in July and to 10% in late October.

INVESTMENT RISKS & CONCERNS

  • Are mineral-based cosmetics a fad? Bare’s explosive growth in an emerging category suggests that the company has benefited from the “in” factor.

  • Aggressive long-term growth targets. Even if Bare performs well, it may not meet its long-term targets of 20-25% sales and 25% EPS growth.

  • Management turnover in several high-level positions may heighten growth and execution risks.

COMPARABLE PUBLIC COMPANY ANALYSIS

($mn)

MV

EV

EV/Rev

P/TB

08 P/E

09 P/E

AVP

9,605

11,048

1.0x

13.8x

11x

11x

EL

5,884

6,987

.9x

3.4x

13x

12x

RDEN

390

816

.7x

3.4x

9x

8x

REV

424

1,691

1.2x

n/m

10x

8x

BARE

407

629

1.1x

n/m

4x

4x

MAJOR HOLDERS

CEO Leslie Blodget 6% │ Other insiders 7% │ Berkshire Partners 20% │ Capital World 10% │ Wellington 8% │ Artisan 5% │ Thornburg 5%

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Source: Bare Escentuals: Expectations Ratcheted Down Too Much