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Deal creates global leader in fast-growing eyewear industry

Italy’s Luxottica and France’s Essilor have agreed a €50bn merger deal, one of the largest ever European cross-border transactions, creating a global leader in the fast-growing eyewear industry, according to people with direct knowledge of the event.

The deal, which is due to be announced before the market opens on Monday, sees Luxottica, the world leading consumer eyewear group and owner of Ray-Ban, Oakley and Sunglass Hut, merging with Essilor, the world leading manufacturer of lenses.

Leonardo Del Vecchio, Luxottica’s 81-year-old billionaire founder and Italy’s richest man, will become the largest single shareholder in the merged group and will control 31 per cent of voting rights, said one person informed about the terms of the deal.

Mr Del Vecchio and Essilor’s chairman and chief executive Hubert Sagnieres, 60, will equally share executive powers. Mr Del Vecchio will become executive chairman of the merged group and Mr Sagnieres will become executive vice-chairman. The merged group will be listed in Paris, said a banker familiar with the matter.

The long-mooted deal will create a group with a combined market value of about €50bn, combined sales of about €14bn and staff of 130,000.

It is set to rewrite the dynamics of the €90bn eyewear industry, one of the fastest-growing consumer sectors.

The main factor driving change is demographic shifts, especially in Asia. Of the 7.3bn people in the world today, 63 per cent are considered to be in need of vision correction, but only 1.9bn have purchased glasses, contact lenses or surgery. More than 2.5bn are still in need, particularly in Asia, Africa and Latin America, according to industry data.

Meanwhile, the risks of damage from increasingly potent sunshine, UV and blue light are pushing sunglasses from being considered a “nice to have” item to a “must have” among emerging middle classes.

The longer-term outlook for the industry is “optimistic” with a compound annual growth rate of 2.5 per cent forecast for 2015 to 2020, says May Ling Tham, head of personal accessories and eyewear research at Euromonitor.

Leonardo Del Vecchio

A deal has been mooted since Mr Del Vecchio who, as an orphan, spent part of his childhood in a poorhouse but who is now worth €20bn, returned to the front line of Luxottica three years ago promising he was back to do deals. He had relinquished executive powers for the previous decade.

Essilor and Luxottica considered a deal three years ago when French-Canadian Mr Sagnieres approached Luxottica to do a deal, say people involved in the talks.

The French group, which then was focused mostly on healthcare, saw a combination as a way to get access to consumers but failed to get the support of Mr Del Vecchio.

Essilor has since undertaken a restructuring to turn it into a more consumer-facing company providing a better fit with Luxottica, said people close to the transaction.

Meanwhile, Luxottica since Mr Del Vecchio’s return has been plagued by analyst concerns about governance and succession, which have hit its shares. Three chief executives have left the group during the past two years.

Analysts have long suggested a merger with Essilor would provide a succession plan for the group, given the 20-year age gap between Mr Del Vecchio and Mr Sagnieres.

Luca Solca, managing director at Exane BNP Paribas, said the deal “would be excellent news for both stocks”.

“It creates significant synergies, both in revenues and costs; it defuses the risk of heightened competition between the two and it removes uncertainty on succession at Luxottica,” he said.

The appetite of rich Muscovites for expensive timepieces has diminished

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At the Moscow Watch Expo in mid-October, the centrepiece of Russian brand Slava’s stand was a large watch with “USSR” written on the face. It was an updated version of the Soviet watch worn by agents belonging to Smersh, Stalin’s counter-intelligence agency. (“Smersh” is an acronym for “death to spies” in Russian.)

This watch was made to commemorate the 70th anniversary of Victory Day — the Soviet Union’s defeat of Nazi Germany in 1945 — and the company talked proudly and without irony about the updated version.

Russian watches like Slava are not as popular among the national elite as they used to be. Its membership has lately turned to Swiss models; witness scandals with President Vladimir Putin’s spokesman Dmitry Peskov and Patriarch Kirill, head of the Russian Orthodox church, wearing watches (Richard Mille and Breguet, respectively) that their salaries would suggest they could not afford. But since sanctions and a currency slide hit, even Swiss watches are falling out of favour.

According to the Federation of the Swiss Watch Industry, imports of Swiss watches to Russia between January and November 2016 fell by 46 per cent to SFr140.5m ($136.9m) compared with the same period in 2014, far greater than the 13.3 per cent global slide. By another measure, of the 446 foreign brands available on the Russian market during 2012-14, 204 have stopped exporting to Russia in the past year, according to Time Seller, a Russian watch association.

The collapse of the rouble, following the oil price, has played its part. On January 1 2014, $1 bought Rb35.18; in January 2016, the rouble hit a historical low against the dollar of Rb85.97. On the first day of this year, it had moderately recovered to Rb60.66. “The mood is still negative,” says Dmitry Krylov, watch expert at the Fashion Consulting Group and general director of Chasovshik.ru, a pawnshop which specialises in Swiss watches. “People are worried and are reluctant to spend money, even if their savings are in hard currency,” he says.

Before the crisis, and before western sanctions against politically-connected Russians in response to the invasion of Crimea, the wealthy would buy watches two or three times a year, according to Mr Krylov. As Anna Lebsak-Kleymans, the general director of the Fashion Consulting Group, puts it, now there is “a trend for rational investment purchases — where less is more”.

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Experts who attended the watch fair say traditional buyers of expensive brands — oligarchs and politicians — have stopped buying in bulk, but not for lack of money. “Officials have almost stopped wearing expensive watches, because excessive consumption which previously was meant to impress other people is now taboo,” says Vyacheslav Medvedev, the general director of horological publisher Watch Media.

While some brands in Russia have lost part of their local clientele, others have enjoyed greater demand from tourists because of the rouble’s fall. Mercury Group, which is among the top three importers of Swiss watches to Russia, according to an industry expert, has previously said that it has not raised its prices, in order to retain clients.

Tourist interest during the days of currency devaluation reached well outside Moscow to the regions. According to Konstantin Sobko, owner of the Brizo jewellery and watch shop in Samara (1,000km to the south-east of Moscow), sales almost doubled in 2014-15 because of new customers.

Mikhail Kasparov, general director of ProTime Rus, the distributor for Frederique Constant, Maurice Lacroix and Escada watches, says in some shops half of all sales are to Asian customers, attracted to Russian shops by the fall in the value of the currency. One expert at the watch show recalls how he saw a Chinese tourist buy Longines watches in a luxurious department store on Red Square and resell them immediately outside to other tourists.

Shopping in Russia has also become cheaper because, after Russia joined the World Trade Organisation, duty for watches was lowered from 20 per cent to 7 per cent, explains Mr Kasparov. This hit locally produced watches, especially those at the cheaper end.

Guillaume Alix, chief executive of Groupe Montaigne, which owns watch retailer De Bon Ton, explains that “not all brands have decided to change their prices — only those who have subsidiaries here. If they are on the stock exchange, they need to change the price immediately. Distributors, on the other hand, could decide whether or not to raise prices” because, he says, they still bought at the old prices.

For some companies Russia remains a lucrative market, despite its sanctions and economic problems. In 2016 Rolex opened a boutique in the centre of Moscow. Omega launched its third shop in the Russian capital in November last year. Breitling opened its first monobrand shop in the capital in 2014. That said, new stores are planned years in advance.

The mood among the considerable crowds at the opening day of the expo was upbeat but, warns Mr Medvedev, who has been organising the event since 2011, it may be too soon to celebrate. “We used to have the fair in a bigger venue but this year we have seen the market fall. There are no miracles here.”

As another expert who attended the fair jokes: “2017 will certainly be worse than 2016. But better than 2018.”

Weekly Update

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Macro :

- U.K. to Leave Europe’s Single Market Under Brexit: Sunday Times

- El-Erian Says Markets Getting Impatient With Trump Rally

- Le Pen Win Would Be Disaster for France, EU, Schulz Tells Pais

- Swiss Econ Min Says Franc Shock May Hit Companies W/ Delay: NZZ

- Trump Says Will Be Flexible in Relations With China, Russia: WSJ

- EU’s Brexit Negotiator Seeks ‘Special’ London Deal: Guardian

- Italy Says Germany Insistence on Fiat Chrysler Incomprehensible

- EU's Chief Brexit negotiator Barnier: EU needs special vigilance in allowing UK financial firms access to the EU because of potential financial stability risks 

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Revlon’s Beautiful Outlook

The stock could be worth more than twice its current price, even if top shareholder Ron Perelman doesn’t relinquish control.

Beauty-products giant Revlon is the ugly duckling of the beauty space in the eyes of investors. The stock has long traded at a deep discount to rivals.

At a recent $32.00, Revlon shares (ticker: REV) go for an enterprise value of nearly nine times 2017 estimated earnings before interest, taxes, depreciation, and amortization. That compares with 13 to 15 times Ebitda for peers Coty (COTY), Estée Lauder (EL), and L’Oréal (LRLCY).

The reasons for the discount are well known. Billionaire Ron Perelman owns 77.5% of Revlon through his holding company, MacAndrews & Forbes. He has controlled the business since 1985, and is Revlon’s chairman. His control leaves a relatively small public float, limiting the stock’s liquidity, and Perelman has a reputation for being unfriendly to minority shareholders.

Despite those issues, Revlon is a first-class franchise, with familiar brands, including Revlon, Almay, and Mitchum, among others. The stock has rewarded shareholders handsomely over the past few years, and could continue to do so. Barron’s wrote a bullish story on Revlon in June 2013, when the stock was about $20.

One top holder, Chris Mittleman, chief investment officer of Mittleman Brothers, thinks Revlon can command a multiple more in line with its peers’. He thinks the stock is worth $76—an enterprise value of 13.5 times his 2017 Ebitda estimate of $500 million. While the discount may persist as long as Perelman controls the company, Mittleman contends “that doesn’t mean the stock can’t rise dramatically while maintaining the discount.”

In the past six years, Revlon has grown revenue 51% and Ebitda 60%, by making market-share gains and acquisitions. In September, Revlon paid $900 million for cosmetics maker Elizabeth Arden, which has struggled in recent years as its celebrity fragrances have become less popular with consumers. The deal is expected to generate substantial synergies, and could turn out to be opportunistic.

Fabian Garcia, formerly the chief operating officer of Colgate-Palmolive (CL), was appointed CEO in April. His leadership appears to bode well for Revlon’s future.

No Wall Street analysts publish estimates for the company, another likely contributor to its discount to peers. For 2016, not including Elizabeth Arden, Revlon has guided for $410 million in Ebitda on $2 billion in sales. The combined companies will generate $3 billion in sales.

Mittleman expects free cash flow of $115 million, or $2.20 a share, in 2017. Not including restructuring charges, he estimates $175 million in free cash flow.

Founded 80 years ago by Charles Revson, New York–based Revlon sells cosmetics, hair-care products, and fragrances through mass channels, such as drugstores and supermarkets, and on the Internet. The company has leading positions in lipstick, lip liner, eyeliner, and other categories, such as nail polish.

Including Elizabeth Arden, its sales are split geographically, with 60% from North America, and the remainder from international markets.

Over the past 10 years or so, global beauty sales have been growing at a roughly 5% annual clip. Mass-market cosmetics such as Revlon’s, which are sold in retailers like Wal-Mart Stores (WMT) and in drugstores, have been slower-growing, compared with the “prestige” brands sold at Sephora and in department stores.

ELIZABETH ARDEN, which has a stable of prestige brands, including Juicy Couture and John Varvatos designer fragrances, could help spur organic growth at Revlon. As of late, Elizabeth Arden has shown signs of turning around. In the September quarter, the business registered its seventh quarter of net sales growth, helped by new products and a focus on revitalizing its existing brands. Arden’s Ebitda margins are considerably lower than the 19% margins that Revlon enjoyed in 2016. With the companies combined, the figure could slip to just over 17% this year. But in time, as Arden is fully integrated, profitability should pick up.

Initially, management identified $140 million in cost synergies, but in a filing released this month, Revlon said it expected that the synergies would exceed that. On the revenue side, Elizabeth Arden has a strong presence in the fast-growing Chinese market, which could aid Revlon. Both companies have sizable overlap in their customer base, so there are cross-selling opportunities.

Revlon’s highly recession-resistant business generates stable cash flows. The balance sheet, with $2.7 billion in net debt, is highly leveraged, but that level looks manageable.

Perelman, 74, isn’t getting any younger. A year ago, he announced “strategic alternatives” for Revlon, leading many to speculate that a sale might be in the works. Instead, the Arden acquisition followed, and the speculation has been tamped down.

But the potential still exists. Unilever (ULVR.UK) has long been thought of as an acquirer, going back to the late 1990s. Several acquisition-oriented Asian companies, such as Shiseido (4911.Japan) and LG Household & Health Care (51900.Korea), could be potential suitors. In 2014, LG expressed interest in acquiring Elizabeth Arden.

Still, it’s important to keep in mind that, if the past few years are any guide, a sale isn’t necessary for Revlon’s stock to rise.