Everything You Need to Know About Luxottica and Essilor's $50 Billion Merger
Take two leading companies in the eyewear industry, combine them, and what do you get? In this case, say hello to EssilorLuxottica.
In this episode of Industry Focus: Consumer Goods, Vincent Shen and Asit Sharma dig into the details behind this mega-deal. They explain how the R&D-focused Essilor (NASDAQOTH: ESLOY)beautifully complements the fashion-focused Luxottica (NYSE: LUX) as they seek to combine a lens specialist with some of the most popular frames in the world. The cast also considers some of the other major risks and considerations for investors in either company.
A full transcript follows the video.
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This podcast was recorded on Jan. 24, 2017.
Vincent Shen:Welcome to Industry Focus, thepodcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen,and it's Tuesday, January 24th. Today, we'll be talking about arecently announced $50 billion deal that willcreate a truly dominant entity in the eyewear industry. If westill have a little bit of time afterwards, we'llpreview some upcoming earnings in the consumer and retail sector. Joining me viaSkype to cover these topics is none other than senior Fool.com contributor Asit Sharma. How's it going, bud?
Asit Sharma: It'sgoing well, Vince, how are you doing?
Shen:I'm doing very well.I'm very excited about our topics for today. This is really a crazy deal. I'm also excited to have you on,I think this is our first show together for 2017, right?
Sharma:It is.I'd like to follow up really quickly withsomething we talked about at our year-end lookback. We were talking aboutNew Year's resolutions. Listeners, I have a new motto for this year. You may know this,it's attributed to Horace: "Never a day without a line." So, for you writers out there, if you want to write, write every day. If you have a hobby, a foreign language, whatever it is, your investments you want to improve,make sure you get at least one touch every day. We'll make it together.
Shen: Alright. Thanks a lot, Asit, forsharing that. Is that part of your resolutions for 2017?I'm not sure if you made any.
Sharma:That'sthe only one I have that's still standing. How about you, real quick?
Shen: For me? We had anepisode about this. Sarah, who'son the editorial team with me for technology and consumer goods, we covered our goals andaspirations for 2017. For me, it'sa little bit of decluttering andorganizing my life, innot just my living space, buthopefully moving on from that point tomore financial stuff, things with family, taking a step-by-stepapproach with it. But overall,I would say the theme, one word, decluttering.
Sharma:Awesome.
Shen: So, the big topic for todayis the recent deal announced betweenLuxotticaandEssilor.This $50 billion deal is with two companies that, in my opinion, very much lead their respective spaces within the world of eyewear. Asit,please bear with me, I'm going to try and set the stage herefor these two companies, who they are, and thenI'll let you dive into some specifics behind the deal. But for listeners who might not be as familiar with these names --we don't cover them that often on the show,and they're based in Europe -- so ourlisteners can get a good idea of thescale of their operations,which I think is very important,and how they will come together.
The first,Essilor, theirhistory. Aninvestor overviewdescribes a company based in France, has a nearly 170 year history as Essel, one of the two companies that merged to form the current company, was originally founded in 1849. It has about 60,000 employees in over 60 countries. Products aredistributed to over 100 countries; 32 production plants, 490prescription labs,16 distribution centers. I think all and all,what you need to know is that they make over 500 million lensesannually. Their products get distributed through eyecare professionals, online channels. It is a leader in its space, has 40% market share forprescription lenses, 15% market share for both sunglasses and reading glasses, and that does not even include some of the opticalequipment and instruments they also produce. For those of youlistening who do have prescription lenses,you might recognize some of the names in their portfolio, which includes Transitions,Varilux. Thecompany trades on the Euronext Exchange with about a $25 billion market cap and $7.7 billion in revenue for the trailing 12 months.
Luxottica, which is the other company that is in this transaction, this is one that,I've spoken to a lot of people about this company, mostly asconsumers, they don't know it,but when I mention some of their in-house brandsand the many others they license with,people know exactly what I'm talking about. Luxottica is based in Italy, founded in 1961 byLeonardo Del Vecchio, who is now the second richest man in Italy. He's amajority shareholder in the company with anapproximately 62% ownership stake through his family holding company calledDelfin.Luxottica has 79,000 employees. Theirmanufacturing operations are based in Italy, China, U.S., Brazil, and India. Theirhome country of Italy makes up just over 40% of that output. Eighteen distribution centers give the company a network that covers more than 150 countries. They also have, besides producing these glasses, a retail network of 7,400 stores of chains that many of you willrecognize, including LensCrafters,Pearle Vision, Sunglass Hut. They'realso behind EyeMed, which is a major U.S. vision benefits provider. Theirbrand portfolio includes Ray-Ban, Oakley, Oliver Peoples, and then theylicense major brands like a Burberry,Chanel, DKNY,Ralph Lauren. So,Luxottica is the largest eyewearcompany in the world. It's market cap is about $26 billion, with $9.9 billion of revenue for the trailing 12 months. Once they come together,they will still very much be the largest eyewear company in the world.
But,these two companies are going to come together,I think their new headquarters is going to be based in Paris. What else do you thinkour listeners need to know about the deal?
Sharma:Thefirst thing ourlisteners need to know about this deal is, is it a complementary deal? Orare these companies just overlapping each other? Many times, when two giants merge,Wall Street loves it initially, there's a pop in both stocks. And thatcertainly was the case here. I thinkEssilor popped about 13% the day this deal wasannounced, which was last Monday, andLuxottica shares popped about 8%. That's the initialexcitement that manifests itself when two really big companies announce that they're going to merge operations. But longer-term, this can work to the disadvantage of both companies. If you merge up and start to dominate an industry so much, the statistics which pertain to growth, you inform those statistics. Growingfaster than the industry becomes difficult when you are the industry.
What'sdifferent about this deal is that these are two very complementary products.Essilor as a lensmaker sees itselfvery much as a health vision company. Oddly enough,Luxottica,although we know them for brands like Oakley and Ray-Ban, they also see themselves as a health vision company. When you think about sunglasses, they provideprotection against UV light, and alsoa new phenomenon that's blue light, the light from all our devices, especially at light, which tends todeteriorate our eyesight and overall health quality. So, thesecompanies see themselves asmerging up as a giant health vision company. AndI think that's important because they will be able to, together, co-marketproducts. They also have some synergies in their supply chains. So,that's the first thing you want to answer when you look at a merger like this --is this just pooling a lot of assets together that won't grow faster than the industry in the long-run? Or does this have the potential for gains down the road? This deal certainly does.
Shen:I think what you describedin terms of what might be considered the mission statement for these two companies, health vision companies, is really important. Long-term,I think the combined entity, which is going to be namedEssilorLuxottica,it's a very strong position to benefit from some global tailwinds aroundhealthcare for your vision, which includes, there's an aging population, there's growing needs for eyewear and health of your vision in emerging markets. And,I think both companies have been touting this number,basically an estimate that 2.5 billion people worldwide still grapple with visionproblems of some kind, and their products,be it the lenses or the sunglasses or whatever it is, can come together and help address this issue, certainly a huge market.
Overall,for this combined entity,it will generate half of its revenue in the U.S., withEurope accounting for about one quarter andAfrica, Asia, and the Middle East making up the remainder. Definitely a lot ofopportunities, I think, for the company, not only in its more entrenched markets like the U.S. but in emerging markets as well.
Sharma: That's true. Andwhat's really interesting in terms of how that market looks on paper,Luxottica has great brand presence in the U.S. and Europe as a maker of frames. So,if you take the demographics you were talking about, Vince,as people age in developed countries, theyalso have that disposable income to buy high-end frames, vanity frames, really.Essilor is very well-placed inemerging markets where there's a growing need for people to have corrected lenses and corrected vision. In placeslike the Middle East and Africa and Asia, that's really a limitless market for this combined company,which is something that I'm very excited aboutwhen you look at them together.
Some of theother things about this deal that are attractive from a financial standpoint are just the synergies involved. Since they don't have a lot of overlap, the companies can really dig into each others' strengths. I think they're shooting for a combined400 to 600 million of cost savings annually. That translates to about $430 to $640 million per year on an annual run rate of about $16 billion. It's quite a savings just in the near-term. Another thing from a financial standpoint, which I really love, is that the combined EBITDA of this company -- that is earnings before interest, taxes,depreciation and amortization -- is going to be about $3.7 billion on that run rate that I was just speaking on. You may wonder, is this EBITDAsupported by a lot of debt?
Oftentimes, the reason big companies merge is they'revery leveraged on their balance sheet, andwhen you combine, you have the abilityto refinance. Butneither one of these companies is that leveraged. In fact, their combined pro formabalance sheet is going to show a net debt to EBITDA ratio of under one time. What that means is,if you take the relationship between debt on the books and earnings in one year, they're about equal. Andthat's a great position to be in. So,another reason to really be interestedin this combined company.
I do have one complaint, though.I don't like this name.EssilorLuxottica. You know? That is really hard to pronounce. But, I'll return to that. Let'stalk about some risks we might see in the deal. Do you want me to jump in with once, Vince, or do you want to grab thefirst risk that you see?
Shen:Before I get to the risks, which we can have as some of our takeaways for this topic,I think it's important to note that for the deal itself,with the combined entity, you'vementioned some of the numbers behind it. 140,000 employees,annual revenue of over $16 billion, EBITDA of nearly $4 billion. The name, whichyou are not quite happy with, I think makes sense in this case, since a lot of people were considering this a merger of equals. And even the management structure reflects that. Del Vecchio will serve asexecutive chairman and CEO of the company, while Essilor CEOHubert Sagnires will hold the title ofexecutive vice-chairman anddeputy CEO of the new entity. And they'resupposed to have equal powers. How that will work in terms of this co-CEO, co-leader structure, we'll see.I think some people have some concerns about that. But the board itself will have 16 members -- that will also see an equal split ofnominations from the two companies. And this is an all-share deal.Luxottica shareholders will exchange their holdings forEssilor shares based on a ratio of 0.461Essilor shares per one Luxottica share. Of course, Del Vecchio, his majority stake inLuxottica, which is about 62%, will need to go first, followed by theremaining outstanding sharesat the same exchange ratio. Once the deal closes, Del Vecchio will own between 31% to 38% of the new entity. The deal isexpected to close by the end of the year, of course.
This will segue nicely into our risk factors. Being a cross-border dealbetween Italy and France, and also such a large deal,despite the fact that you could say that one focuses on frames and one focuses on lenses, two very distinct parts of the supply chain in that industry,there could still be significant scrutinyjust with the size and the fact that they have, in recent years, beenencroaching a little bit into each other's expertise area.In terms of other risks, or other things that give you pause about the deal,what do you have on your mind, Asit?
Sharma: I think, for me, that split of this down-the-middle merger of equals structure, thatbothers me a little bit. AndI want to point out one more thing,given the excellent rundown of the deal specifics. Del Vecchio'svoting interests are going to be limited to 31%. He can buy up to 38% of the shares, but they'retaking a lot of care to make sure that both parties come to the table and are dead equal. This board arrangement, eight board members for each company, is one example. The name, I'll return to that, EssilorLuxottica,because neither side really wants to give up their traditional name. Both are very long-lived companies. These types of deals go great when the money is plenty and revenues are increasing. As we've seen in the U.S., whenthings start to go downhill,Chipotlewas a much-discussed example from last year, as wasWhole Foods, these types of equalarrangements. In these cases, we're talking about dual CEO structures. But in terms of board structures, as well, the same pertains. When things start to go south, revenues decrease, or profits decline, then two sides which are split down the middle have a hard timegetting to the difficult decisions. So,that always bothers me a little bit.
The other risk which isn't as evident but leaps out to me is that,culturally, these are slightly different companies.Essilor is more of a scientific-leaning company in that it does high-end ophthalmic lenses.Luxottica, whichI think you pointed out, Vince, is sort of moving into that territory itself. ButLuxottica is more of a brand company, more of a vanity company. Although, yes, its eyeglasses are vision-centric, health-centric, they really have made their margin on upscale brands, especially in the U.S. and Europe, so they're slightly different cultures here. I do like the way that the press releases have gone. They seem both to be rallying around this point of vision healthcare companies. But still, there's just a little bit of cultural difference, again, with the traditional Franco-Italian history between those two countries, which is sometimes very friendly and has sometimes been antagonistic, may also come into play here. But we see that a lot in the E.U.
Shen: Yeah. And on that note,I think it should be noted that atLuxottica, with Del Vecchio currently heading up the management team there, this isactually after stepping back into a more executive role in 2014, as chairman,he was looking for a CEO. He has gone through threein the past two years or so,and there was definitely a lot of investor concernabout what the succession plan is going to look like. Del Vecchio had stated thathe does not want anybody from his family to take over thisleadership position at the company. So figuring out that succession plan, what happens with his holdings and his heirs, wasdefinitely a point of concern with investors for Del Vecchio himself. This deal withEssilor seemed like a very clean, tidy way of having that come together, especially with the dual-CEO structure. Just aninteresting point there. Also, the fact that,this is not the first timethese companies had consider doing such a deal. They werein negotiations back in 2013. I think that fell through due to somegovernanceissues and concerns that they're now able to tie up with the board structure and theleadership structure that we described. Overall,I think this is definitely an example,as you mentioned, Asit,of a deal where it's really easy to imaginethe benefits of the two companies coming together,bring together those frames and lenses under one roof. Overall,I think both stocks recentlyhave actually seen some downward pressure, definitely saw a bump,as you described,after the announcement of the deal. But,together, and with both of their very well-known and revered operations within the industry,bringing those together will be very interesting to watch going forward. Any other takeaways from you before we move on?
Sharma: Yeah, one brief last point on Del Vecchio. He's now 81 years old andreally comes out of this tradition of publicly traded companiesin Europe that have a strong family presence and very strong-willed. So this dual-CEOstructure is probably a good thing, andLuxottica shareholders can breathe a little sigh of relief. Vince, if he calls you upasking you to run the combined company,turn it down, man. You'll beback at the Motley Fool in like two months,not because you're not capable, but he's been going through CEOs at quite a clip. (laughs) Stay with us.
Shen: So, again, the deal isexpected to close by the end of this year.I should note thatwith this part of the discussion around management, Del Vecchio isexpected to hold his position with the new entity for about three years, and then he will step down, unless shareholders vote to keep him. Butthat point, he will be a ripe old 84. So,it'll be interesting to seehow the integration works out, and what opportunities this massive company willpursue once the deal closes.
But as we runinto the last few minutes of the show here,I want to cover at least one bit of an earnings preview coming this week. It's fora company that we're all familiar with,Starbucks(NASDAQ: SBUX). They'rereleasing their fiscal 2017 first quarter results after the close on Thursday. Asit,what will you be watching and looking for in the report?
Sharma: Vince,I spend a lot of my working hoursduring the year looking at Starbucks and its component parts.I know you do as well. And many of our listeners spend a lot of timetrying to analyze this company as well, because they're invested. So rather than look at any one piece,what I'm really interested in for this earnings report are two numbers -- 5% and10%. 5%, I'd like to see the U.S. comparable sales run again above 5%, whichhas been a benchmark for Starbucks for many quarters, and they stumbled on that last year. Out of the last three quarters,I think they only hit that benchmark one time. So I'd love to see that number come back above 5%.
The other number thatI'm looking at is 10% overall revenue growth. Taken together, these two numbers are part of Starbucks'structural framework of their business model. So,if we have one without the other,it's a signal that perhaps the company is slimming down a bit. This isgoing to be the first quarter of their fiscal 2017 year, and itincludes the very busy holiday season, which istraditionally a strong quarter for Starbucks. So,I want to see these two numbers pop above their benchmarks and from there, work backwards to the component parts. How about you?
Shen: Yeah,I think those two numbers that you mentioned are really key. Keep in mind that thecompany has very ambitious plans over the next five years, including anexpansion of 12,000 locations,so the company would have a total network approaching 40,000 stores. Part of their goals also in financials is to deliver 10% annual sales growth -- so,one of those two numbers that you had mentioned -- and then, annual EPS growth of 15% to 20%. But I think something else in terms of recent news for this company that a lot of people have been watching is the fact thatHoward Schultz will be stepping away from the CEO position this spring. How did you feel when you heard that news? Any concerns there? Or do you think this is a well-oiled machine situation? The CEO Kevin Johnson stepping in, he's already managing the day to day operations as it is. What do you think?
Sharma:I hate to use a tired metaphor, andsome metaphors, we just have to pull them out and beat them back to death, butI think it's a glass half full, half emptysituation. Howard Schultz has built a machine,in terms of what this company can produce in its earnings per share every quarter. It's a verystructuralized company. He'simplemented many technological changes, and he's hired greatpeople in the management team. But what we lose withHoward Schultz moving more toward a brand-type ofposition with Starbucks and out of the CEO chair is that strong sense of vision, the idea to take big bets and go onknowledge, instinct, data, andjump into a market or technology.
We saw withSteve Jobs thatApplehasn't been the same company since he's left,although on an execution basis they're still very strong. The glass being half full here for me is to see if Kevin Johnson, who is actually, not unlike Tim Cook, an operations guy, if he can bring his really goodoperational executional ability and build his own layer of vision to keep pushing the company. Let'sremember, Starbucks is no longer a small company -- it'schallengingMcDonald'sas the biggest quick service player on the block. So to keep growing,it needs at least two things. It can't stumble on execution, but it needs vision. And we sawHoward Schultz bring in the whole ideaof premiumization in its Roastery concept, and just moving all of us who arededicated Starbucks fans up this value chain of coffee, and raising the bar on what youraverage person is drinking. So I think prospects are good for Starbucks,but I want to see some ideation --to use a fancy word --I want to see some innovationcoming pretty quickly from Kevin Johnson. How about you?
Shen:I think it's really important,and it's reassuring, at least, to see thatHoward Schultz is maintaining his presence within the company,more as aculture and brand ambassador, sure, but still there. I think he will be equally nervous, frankly, about the transition, and how things goin the coming years, having had this experience, what was it, 10, 15 years ago? Andhaving to come back, hopefully avoiding that this time, of course. But what you mention, I think we should give Johnson a chance and see how things turn out. But he's being handed the reins of a very effective,profitable, and growing machine that has a five-year plan already laid out. The blueprint is there. It comes down to the execution.I definitely think the current CEO is somebody that can drive that through.
Thank you very much, Asit, forjoining me today. It was great to have you on,and I look forward to seeing you in the coming weeks.
Thatwraps up our discussion. You can reach out to us and the rest of the Industry Focus crew viaTwitter@MFIndustryFocus, or send us any questions via email to industryfocus@fool.com. Don't forget to check outwww.fool.com/podcastsfor our other awesome shows. People on the program may own companies discussed on the show,and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Thanks for listening and Fool on!
John Mackey, CEO of Whole Foods Market, is a member of The Motley Fools board of directors. Asit Sharma has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple, Chipotle Mexican Grill, Starbucks, and Whole Foods Market. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool has a disclosure policy.