Business Case Studies & Business Publications

The Leverage of L’Oréal

Schill, Michael J....

Case

The Leverage of L’Oréal

Schill, Michael J.; Zouita, Kods

F-2109 | | 20 pages Case

Collection: Darden School of Business

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This case examines the question of financial leverage for French beauty and personal care company L’Oréal S.A. (L’Oréal) in October 2021. With an historical aversion to debt and a highly profitable business, L’Oréal management is considering a debt-financed stock buyback program. At the time, L’Oréal is controlled by the combined ownership of two important shareholders: Françoise Bettencourt Meyers, the richest woman in the world, and Nestlé S.A. (Nestlé), the Swiss multinational food and beverage conglomerate. The recapitalization proposal would reduce the tax liability of both L’Oréal and Bettencourt Meyers (France maintains the world’s highest corporate tax rate), enhance Bettencourt Meyers’s company control, allow Nestlé to reduce its position in L’Oréal (Nestlé would provide the shares to be repurchased), and allow L’Oréal to opportunistically take advantage of the historically low interest rates prevailing at the end of the COVID-19 pandemic. The case is intended to introduce students to the Modigliani-Miller capital structure irrelevance propositions and the concept of debt tax shields. At the University of Virginia Darden School of Business, it is taught in the first-year core finance class; it would also be suitable in a module introducing the value implications of debt financing.

The case serves to motivate the following teaching objectives: (1) Introduce the Modigliani-Miller intuition of capital structure irrelevance. (2) Establish how the cost of equity is affected by capital structure decisions, by defining financial risk and introducing the levered-beta capital asset pricing model (CAPM) equation. (3) Discuss interest tax deductibility and the valuation tax shields. (4) Explore the importance of debt capacity in a growing business.