Ham & Eggs – our view of the proposed merger of Luxottica and Essilor

Luxottica is a new addition to the Global Leaders portfolio.

Italian sunglasses & frames maker Luxottica and French optical lens maker Essilor have announced a €46bn “merger of equals”. When it is completed, it will represent one of the largest cross-border deals attempted by European companies, and the news was well-received by the market. The stock of both companies rose +8% and +12%, respectively, on the day of the announcement.

The marriage makes strategic sense, considering the highly complementary nature of the two businesses, which are already leaders in their respective fields. Luxottica is known for their strong brand portfolio: 7 proprietary brands including Ray-Ban and Oakley, and over 20 licensed designer brands incl. D&G, Bulgari, Chanel. They also have a notable retail presence including Sunglass Hut, LensCrafters, Sears Optical, among others. Its size dwarfs the next largest competitor Safilo (also Italian) by almost 6 times. Essilor, who controls over a quarter of the global lens market, also houses over 13 brands including Essilor, Varilux and Crizal.

In recent years, the two companies have been tentatively treading onto each other’s turf, evidenced by Luxottica developing lens finishing techniques in-house and Essilor acquiring sunglass maker Costa and moving into online spectacle lens retailing. The merger, should it go through, will diffuse the escalating tension between the two and instead create the world’s largest integrated eyewear entity with a pro-forma revenue of over €15bn and operations in over 150 countries. Together, they will dominate the €90bn eyewear industry with an estimated 15% market share.

This is a textbook example of vertical integration. The merger will strengthen the competitive positions for both companies, and offer their customers more integrated eyecare solutions. As Essilor is a supplier to Luxottica, it will create ample opportunities to streamline and optimise operations from production to distribution. We can expect joint R&D efforts, cross-selling potential, an improved product mix, and closer consumer engagement. Essilor will be able to leverage Luxottica’s extensive retail channels (of which it had a minimal exposure), and vice versa with Luxottica building their presence online. Essilor is expected play a larger role in Luxottica’s supply chain, increasing from the current ~30% level to supply ~90% of Luxottica’s lenses. The companies forecasted a target of €400-600mn in synergies over the medium term, of which around half will come from revenue synergies, a third from supply chain benefits and the rest from cost.

The new entity “EssilorLuxottica” will be based in France (thereby enjoying a lower overall tax rate), with Leonardo Del Vecchio (founder of Luxottica) taking the roles of the Executive Chairman and CEO, and Hubert Sagnières (CEO of Essilor) serving as Executive Vice-Chairman & Deputy CEO with equal powers. Following the transaction, Delfin, the holding company of Del Vecchio, will contribute its entire 62% stake in Luxottica for Essilor shares. He will remain the largest shareholder of the new entity with 31-38% shareholding, with voting rights capped at 31%. This resolves the succession issue that has been plaguing Luxottica, for some time now, given the 20 years’ age gap between Del Vecchio (aged 81) and Sagnières (aged 61).

The regulatory risk of anti-trust actions is not a major concern as the deal is vertical, so the scope of customer choice remains largely unchanged, and while 15% market share is a large number for a single entity, the combined entity will still operate in a fragmented market with many smaller, regional and unbranded players. Further, as neither company demands exclusivity from their distributors, which should not compromise distributors’ ability to sell to other providers.

Luxottica was approved as a Cerno Global Leader in 2015 and we have now initiated an investment. Our assessment is that the potential for the joint entity is much greater than on a standalone basis, provided the deal proceeds to its expected conclusion which we expect in the second half of this year. Their competitors, specifically lens maker Hoya and Carl Zeiss, have reasons to worry, as well as smaller independent optical retailers, as their supplier just became their direct competitor.

 

By | 2017-10-17T10:34:40+00:00 January 26th, 2017|Cerno Capital, Cerno Capital Posts, Cerno Capital Posts, Cerno Global Leaders, Strategy|

About the Author:

Fay Ren works within the investment group and has specific responsibility for quantitative measurement of sector, style, portfolio and asset class returns. She undertakes asset class studies and coordinates the firm’s top-down symposia at which asset class settings are determined. She also undertakes security analysis in conjunction with the Portfolio Managers. Fay joined the firm from Imperial College London where she completed a BSc in Mathematics and a Masters in Applied Mathematics.