Shares of Puig PUIGb.MC, owner of fragrance brands Jean Paul Gaultier and Rabanne surged 16% on Tuesday, on track for their best trading day on record after the Spanish beauty group and Estee Lauder EL.N said on Monday they were in talks over a potential merger.

A deal would create a $40 billion luxury beauty group with a strong foothold in the global fragrance industry, which is facing a slowdown in demand with consumer sentiment further shaken by inflation concerns due to the Middle East conflict.

More than 70% of Puig's revenues come from perfume lines.

The combination would come just months after French beauty giant L'Oreal bought the beauty assets of Gucci-owner Kering, with some analysts saying the growth difficulties in the global beauty industry could fuel a wave of consolidation.

"Growth is shrinking, uncertainty is on the rise due to geopolitics and the Chinese market. Competition meanwhile is getting more intense, so consolidation and size is an answer if you want to win in this context," said Stefan Bauknecht, portfolio manager at Deutsche Bank's DWS.

CHALLENGE TO L'OREAL'S LUXE?

Financial details of the planned Puig and Estee Lauder deal were not disclosed, but analysts said the transaction could come with a chunky premium to Puig's valuation if the family-controlled Spanish company gives up its independence after more than a century, boosting its shares.

It would end Puig's two-year era as a listed business. Its shares have constantly declined since its market debut, and are trading roughly 30% below their value in May 2024, the time of the IPO.

Some analysts say the planned deal could come as a distraction for Estee Lauder, which is undergoing a turnaround after years of sluggish sales.

"Estee is in the middle of a multi-year turnaround, which requires management to focus on brand investments, innovation and in-market execution after years of sales declines," Morningstar analyst Dan Su said in a note.

Estee Lauder's New York-listed shares closed 7.7% lower on Monday.

Analysts said the combined business, which would span brands like Estee Lauder's Clinique cosmetics and Puig's Rabanne perfumes, would have revenues of just over 20 billion euros, topping the 15.6 billion euros at L'Oreal's Luxe division, which sells products under brands like Armani and Yves Saint Laurent.

Xavier Brun, portfolio manager at Trea Asset Management in Barcelona, said the fact Puig owns its fragrance brands, rather than just licences, is an advantage. "Carolina Herrera, Paco Rabanne and Jean Paul Gaultier are each close to a billion in sales, they're world-recognised, so you can leverage that, plus they bought Charlotte Tilbury which is expanding."

-Reporting by Gemma Guasch in Gdansk; Editing by Milla Nissi-Prussak and Emelia Sithole-Matarise/Reuters