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A N A LY S I S iStock 458591871 The battle for “bling” could be heating up Kaitlin Byrne PORTFOLIO MANAGER i KEY TAKE-AWAYS T owards the end of 2019, the world’s high-end jewellery investors were given a reason to be excited about the coming year with the announcement The combination of Tiffany and of the proposed buyout of Tiffany & Co, LVMH could create even stronger the US’s number-one jewellery brand, competition for Richemont and other by European luxury group LVMH. What top global jewellery brands, given kind of shake-up could materialise in the two companies’ complementary this exclusive market of historic brands, market presence. and what innovations could it spur in The merged LVMH-Tiffany group the competition for the wallets of the will overtake the more successful rich and famous? Here we take a look Richemont in size, and key will be at what the transaction could mean Prudential Investment Managers © whether LVMH is able to turn around for the global jewellery market and for Tiffany’s slumping revenues. investors in LVMH and Richemont, one of South Africa’s larger listed global corporates and a keen competitor of LVMH and Tiffany. Consider this QUARTER 01 2020 Page 1
A N A LY S I S The battle for “bling” could be heating up As equity analysts, we are able to at a lower margin than jewellery, have a glimpse into the world of the margin they earn from jewellery branded jewellery because three of alone is even higher. the globe’s most popular jewellery brands are all currently owned by Yet Richemont’s overall success has publicly listed companies – Cartier masked some difficult periods. The (owned by Richemont), and Tiffany group used to be more famously and Bvlgari (owned by LVMH). Apart known for its numerous luxury watch from these three large brands and a brands including Cartier, IWC and few other big branded names, the Panerai, which, along with the rest of jewellery market globally is highly the global watch market, experienced fragmented. This market includes a major expansion until 2013. At engagement rings, high-end jewellery this point, the Chinese government and jewellery collections along a wide clamped down on “gifting” in the range of price points, and usually public sector, resulting in pressure on excludes luxury watches. However, watch sales. After years of high growth, here we include them as key parts of the sudden slowdown in sales resulted the businesses. in an oversupply in the market that is taking years to correct. As investors Richemont has pulled ahead in focused on the declining watch margins recent years within Richemont and the continuous Richemont, which owns Cartier buybacks of stock from wholesalers to (jewellery and watches) and Van Cleef reduce the excess watch stocks, global & Arpels within its jewellery Maison, jewellery sales continued to rise. And is a good example of a company because jewellery has margins nearly which has made a major success of double those of watches, jewellery its jewellery brands and managed to continue to grow these year after became by far the largest source of year – across revenue and operating the group’s operating profit. profits. In fact, they have managed to Graph 1 shows this change in the expand the margins in their jewellery composition of Richemont’s operating division from 20% to 30%. And because profit over nearly 25 years, with its Prudential Investment Managers © this figure includes Cartier watches jewellery business now accounting Consider this QUARTER 01 2020 Page 2
A N A LY S I S The battle for “bling” could be heating up for the majority of the value of the growth within the jewellery business. company. At the same time, Graph 3 Prudential’s portfolios have benefitted details the strong revenue growth and from this overweight position, as the high margins Richemont has generated share delivered a 20.1% return in 2019. from its jewellery business relative to LVMH in recent years. Has LVMH simply been lucky? LVMH, which is predominantly known Prudential has held an overweight for its leather bags and clothing (Louis position in Richemont over the last few Vuitton, Christian Dior) as well as its years as we felt the value of its strong champagne (Moet & Chandon) and jewellery business and brands was not cognac (Hennessy), has been selling fully appreciated by the market, as watches and jewellery since the mid- concerns around the declining watch 1990s, but watches and jewellery make business masked the compounding up only 9% of LVMH’s total revenue. Graph 1: Richemont operating profit* shows strong growth (Euro millions) 3 000 2 500 2 000 1 500 1 000 500 0 -500 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Jewellery OP Leather and accessories OP Head office and unallocated costs OP Watches OP YNAP OP Operating profit Writing instruments, leather, clothing OP *Split of Richemont’s operating profit between the different divisions. Richemont includes Cartier Watches within its jewellery Prudential Investment Managers © division, therefore pure jewellery profit excluding all watches is slightly less than shown above. SOURCE: Prudential & Company reports Consider this QUARTER 01 2020 Page 3
A N A LY S I S The battle for “bling” could be heating up Investor interest in LVMH’s jewellery Tiffany’s revenue growth has been really only gained traction post its pedestrian, and stifled by shareholders acquisition of Bvlgari in 2011, when who have focused on cash flows. This it demonstrated its ability to double has restricted its ability to invest for Bulgari’s revenue and expand margins long-term growth. from an estimated 9% to 24%. The key question is whether LVMH really Following the news of the acquisition, has found the secret to creating a there was mixed reaction and highly profitable jewellery business, speculation by the market as to why or whether it was exceptionally lucky LVMH would go after a company such in its timing of the acquisition, which as Tiffany, especially given its high followed on the heels of the Global proportion of engagement jewellery Financial Crisis (GFC) -- hence Bvlgari’s (almost one-third of its product mix), margins had plummeted and then which is considered to be a fairly low- benefitted from the good growth in growth market segment. Equally, the jewellery market post 2011. Tiffany does not craft “distinguishable” jewellery pieces, a key selling point The answer is probably somewhere in which rivals Bvlgari and Cartier have between the two. We would suggest kept core to their brands. that the company’s ability to make a success of Tiffany & Co, their largest acquisition to date, will get us closer Table 1: Global iconic jewellery to the real answer. LVMH announced houses the planned US$16.9 billion purchase (some R236 billion) in late 2019, and is Jewellery Brand Parent Founded acquiring Tiffany at margins that are Cartier Richemont 1847 fairly close to their long-term average. Van Cleef & Arpels Richemont 1906 Buccellati Richemont 1919 “Tiffany’s revenue growth has Bvlgari LVMH 1884 been pedestrian, and stifled by Chaumet LVMH 1780 shareholders who have focused Fred LVMH 1936 on cash flows” Prudential Investment Managers © Tiffany Tiffany & Co 1837 SOURCE: Company Reports Consider this QUARTER 01 2020 Page 4
A N A LY S I S The battle for “bling” could be heating up What’s the deal? the company. Over the past few years, Tiffany has generated between As detailed in Table 2, LVMH US$500-700 million free cash flow (FCF) has made an all-cash offer every year after all capital investments to acquire Tiffany for a total for a 3.5% FCF yield. This indicates value of $16.9bn and an equity value that for LVMH to generate a decent of $16.2bn, equivalent to US$135 per return on their investment, they will share, a 50% premium to the share need to ensure that Tiffany returns to price at which Tiffany was trading prior revenue growth and margins can be to the offer. Based on Tiffany’s 2018 improved further, to realise at least results, the multiple paid is a 16.6x 5% growth per annum in order to EV/EBITDA, and a 3.8x EV/Sales, which get to an 8.5% return (3.5% free cash is comparable to its previous Bvlgari flow yield + 5% cash flow growth). and Christian Dior acquisitions on an EV/Sales basis, but seemingly cheaper Given the number of successful deals than their Bvlgari acquisition on an that LVMH has done over the years, EV/EBITDA basis. However, the latter especially its turnaround of Bvlgari, is due to the depressed margins in the market is clearly optimistic that Bvlgari at the time of that acquisition LVMH can work its magic on Tiffany compared to Tiffany’s more normalised margins now. in the same way. The share price of Tiffany has shot up some 46% The deal will take LVMH from a since the deal was announced, while net debt/EBITDA of 0.5x to around LVMH’s share price has gained 16%. 1.6x, which is still a fairly low debt The transaction is expected to close level, posing little financial risk to in mid-2020. Table 2: Recent LVMH Deal Multiples Enterprise Year Acquisition EV/ EBITDA EV/Sales Value Acquired Tiffany & Co $16.9bn 16.6x 3.8x 2020 Bvlgari $5.2bn 22x 3.6x 2011 Christian Dior Couture (Leather & fashion) $7bn 15.6x 3.5x 2017 Prudential Investment Managers © SOURCE: Prudential and company reports Consider this QUARTER 01 2020 Page 5
A N A LY S I S The battle for “bling” could be heating up Graph 2: Tiffany and LVMH revenue split by geography Tiffany Total Revenue LVMH Watches & Jewellery Revenue Other Europe 2% Other markets 11% 15% Rest of Asia 35% France 6% Japan 15% Americas 44% Rest of Europe Asia-Pacific 23% 28% Japan United States 12% 9% SOURCE: Prudential & Refinitiv, LVMH website Why would LVMH spend such a huge attractive jewellery designs is also sum to acquire Tiffany rather than important, they can be easily replicated, expanding their own jewellery lines and new designs can be introduced organically? First, LVMH has always by competitors. Meanwhile, a strong acquired brands and is essentially a brand name and what that brand conglomerate of numerous acquisitions. represents keeps consumers from The brands they have purchased in the switching out of the brand, creating past, including Tiffany, were in fact a high barrier to entry. founded a few hundred years ago -- this type of history simply cannot be Tiffany: An iconic US brand replicated. Just for interest, we have Tiffany has always had an exceptionally strong brand in the US, being the listed the founding dates of some country’s number-one preferred of the world’s best known jewellery jewellery brand. The company was brands in Table 1. Maintaining or established in 1837 by Charles Lewis improving on the brands’ strength is Tiffany and is known for its diamond the number-one priority for luxury Prudential Investment Managers © rings and iconic Blue Box, which has goods companies. Although having been used since Tiffany first started Consider this QUARTER 01 2020 Page 6
A N A LY S I S The battle for “bling” could be heating up Graph 3: Richemont overtakes LVMH in most key financial measures Combined revenue (Euro millions) 5 000 40% 4 500 35% 4 000 30% 3 500 25% 3 000 2 500 20% 2 000 15% 1 500 10% 1 000 5% 500 0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 LVMH watches and jewellery TIF revenue Richemont Jewellery (excl Cartier watches) LVMH watches and jewellery margin TIF revenue margin Richemont Jewellery (excl Cartier watches) SOURCE: Prudential and company reports selling its diamond rings in 1886. Over in the US has remained largely stable, the past few years their presence while its Asia-Pacific numbers have and brand image in China has been grown by 23%, indicating Tiffany’s growing strongly, elevating it now to strong focus on the higher-growth the number-two preferred brand in Asian market. LVMH has an even bigger China after Cartier, according to an reach, with 428 watch and jewellery HSBC survey. This is Tiffany’s largest stores globally. Tiffany management attraction for LVMH -- its strong brand believes that being within the LVMH name and history. stable will allow them to leverage off LVMH’s expertise in the very important The second attractive attribute that Asian market. In the same way, LVMH Tiffany has is its broad retail footprint. can leverage off Tiffany’s experience It has 321 company-operated stores in the American market. As shown in globally, 93 of which are in the United Graph 2, the United States accounts States, its home market, and 90 in Asia for only 9% of LVMH’s jewellery sales, Pacific, the fastest-growing region. Prudential Investment Managers © compared to Tiffany’s 44% in the Over the past five years, its store count Americas region. Consider this QUARTER 01 2020 Page 7
A N A LY S I S The battle for “bling” could be heating up Turning around subdued revenue Within LVMH, jewellery and watch growth sales currently make up 9% of LVMH’s One big challenge for LVMH as a revenue, but once the transaction is new parent company will be tackling completed, this will almost double in Tiffany’s sluggish revenue growth euro terms to 16% of group revenue. over the last five years, which has Once combined, LVMH’s jewellery allowed Richemont to overtake it, division revenue will exceed that of as shown in Graph 3. In 2017 Tiffany Richemont. tried to revive growth itself through a transformation strategy that included Looking ahead, Richemont will be renewing its product offerings and closely watching developments at in-store presentations; strengthening the bigger, combined LVMH-Tiffany. its brand message and committing to The threat posed to Richemont will higher investment spending. In not be significant if LVMH can return resisting the buyout, the company Tiffany to growth and, in so doing, is tacitly admitting that it has not take market share from Richemont, achieved its goals, and is therefore after years of market share loss by leaving it to LVMH to work its magic. Tiffany. The increasingly competitive LVMH’s acquisition of Tiffany, currently environment may in turn prompt a standalone listed company, will Richemont to boost investment in its result in Tiffany’s financial results own brands. Consumers are likely to being reported within the larger LVMH be the real winners of any heightened group, therefore allowing LVMH to rivalry, given that it could very well increase investment into the brand, spur the creation of many new and but without the same degree of wonderous pieces of jewellery to investor scrutiny or publicly available ignite the consumer imagination and financial information as currently. add bling to any occasion. Kaitlin joined Prudential in 2015 as an Equity Analyst and was appointed as joint-Portfolio Manager of the Prudential Dividend Maximiser Fund in January 2020. Prior to joining Prudential, Kaitlin completed her articles at Ernst & Young, where she was responsible for auditing companies in the Finance, Gaming and Leisure, Real Estate and Manufacturing sectors. With five years’ industry experience, Kaitlin holds a Bachelor of Accountancy degree from Stellenbosch University Prudential Investment Managers © and is a qualified CA (SA) as well as a CFA charterholder. Consider this QUARTER 01 2020 Page 8
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