Patrice Müller, partner at Ipolitis & Hubertus, delves beyond global economic uncertainties to suggest that 2012 will be a year of real opportunities in luxury M&A.;
Another in our series of conversations where we explore and discuss the future of the luxury industry. We spoke with Patrice Müller, partner at Ipolitis & Hubertus, a strategic and mergers & acquisitions firm based in Geneva, specialising in the global luxury goods industry. Sister company, Swiss Fiduciary Capital Pte, focuses on the increasingly active Asian market, from its base in Singapore.
When you consider the M&A; activity in our industry post 2009, Ipolitis & Hubertus seems ahead of its time launching in 1999, focusing exclusively on luxury, across watches, jewellery, accessories, leather goods, fashion, wine and spirits. The boutique firm conducts transactions on behalf of small and medium enterprises, from family businesses to private consortiums, independent brands and some private groups. Dedicated to SME companies, partner Patrice Müller jovially explains that Ipolitis doesn’t work with the big ones “firstly because they don’t need us!”
“Generally have their own M&A; team internally,” he goes onto explain, “and if they enlist external assistance it tends to be that of large investment banks with worldwide coverage, so it doesn’t make sense to compete. That said, we have a very global understanding of what’s happening with the big players.”
“ There are concerns about growth in Asia, volatility in major currencies & important structural changes concerning distribution ”
There is much discussion regarding general economic uncertainty, but which specific factors do you believe are the most threatening to the luxury sector?
The global economy today even for small companies is very uncertain. I don’t want to talk too much about the crisis, everybody knows there is a crisis. Nobody knows what will happen in the future, so it’s a very short vision. Luxury is currently performing well, for how long no-one knows, but I still believe there are growth opportunities in this sector.
Obviously there is uncertainty surrounding the U.S. and European debt crisis, but there are also concerns about the sustainability of development in Asia. For the last two, three, even five to eight years, Asia has developed at very high percentages of growth but people are starting to believe this will be reduced. Not necessarily much – Asia is still likely to grow in 2012 – but not at the same pace that we have had in the past.
On a more global scale there is a big volatility in the major currencies, which luxury brands based in Europe and the United States will need to manage in markets like Japan, China and even the UK. Finally, the luxury industry has also undergone a series of important structural changes, especially concerning distribution, and this will have a large impact on M&A; in 2012.
“ To cover the world, you presently need around 400 boutiques. This means 40 to 60 just to cover China ”
We have all witnessed extreme structural change in the last decade, but how specifically is this going to affect financing going forward?
Talking about luxury goods, 80% of the value of a product is spent on its distribution costs, the cost of production is relatively low. And now there has been a change where we have big groups with a high volume of products sold, often across many brands, who have the financial capacity to develop their own monobrand boutique network worldwide, either directly owned or licensed.
This represents a huge investment. For each boutique you could spend between two and eight million, and then you have to create an inventory and then you start to sell. Return on investment can be up to five, seven or eight years – if you succeed. Just to cover the world for a watch or jewellery brand, you need around 400 boutiques. If you want to cover China, you need between 40 and 60 boutiques just to cover China, in relation to the purchasing power of Chinese in the future. So it’s a big investment and only the big groups have the financial power to fund this type of distribution.
Artisans at the Hermès leather workshop. Patrice identified exotic skins as one of the many components creating bottlenecks in the production of luxury goods.
For medium luxury companies this is an issue because they are not big enough to cover the world. So some of them they take risks, by investing in the same business model as a big group for this they need financing. Other medium companies choose not to open their own monobrand boutiques and instead launch two or three flagships worldwide. Otherwise they stay in the multibrand retail network because they don’t need as much financing to develop.
But for small luxury brands, they cannot open their own boutiques and they do not have access to the big markets. There is also pressure from powerful groups preventing them from having access to the multibrand retailers. So there are increasing barriers to entry in distribution, and for these small companies, even if the luxury goods market is growing and the groups are moving very swiftly, these small brands are really suffering. Some of them are for sale and others are looking for financing.
So the M&A; situation for all three levels is going to be different. And for two or three sectors, when we talk about structural changes to the industry, we have some production issues that are also creating changes.
“ Small luxury brands cannot open their own boutiques and they do not have access to the big markets ”
Perhaps Swiss timepiece production? And the impact Swatch Group’s limitation of components will have on the market, as also the expertise shortage leftover from the GFC?
Exactly. In the Swiss luxury watch sector today, there is a significant bottle neck in the production of components which will eventually create a global structural change in Swiss watch production. The same potentially in leather goods, with exotic skins there are also some bottlenecks and access to these key components will become more and more difficult. This will lead to a new structure of production in each sector. We know that manufacturers are already looking for alternatives and solutions.
And we now have groups that are leveraging bottlenecks in the supply chain in order to increase their market share. Some are trying to make the supply of key components much more difficult to their competitors. This is across timepieces, leather goods and sometimes even the production of wines and spirits. So we don’t just have distribution structural changes but also in some sectors, very important changes in production. When you combine these two elements and uncertainties of the global economy, you have a real change in the list of the players.
“ There is a significant bottle neck in the production of components which will create a global structural change in Swiss watch production ”
So where does this leave us in terms of M&A.; Conglomerates are becoming more powerful, small brands are suffering but you are still confident about real opportunities in 2012…
We do still have various types of opportunities in 2012. We have big luxury groups that in the past three years have accumulated a lot of cash for many reasons. They didn’t know what would happen after 2008, particularly what would happen to revenue so they stockpiled cash. Not necessarily for investment but to ensure they could survive a dip in sales. But as we know luxury is performing extremely well, and they now have huge amounts of cash – I would estimate it to be several months’ worth of sales.
So if an interesting opportunity arises on the market, they are very well placed to carry out transactions – like we saw last year with LVMH and Hermès. These groups are not seeking opportunities but keeping an eagle eye on markets. If they find an attractive opportunity they have the financial reserves and power to move forward, so I don’t think we will see as many transactions as in 2011, but they could be much bigger financially.
Medium brands present a different issue. There are still many medium luxury brands – still sizeable, up to half a billion even – you have Valentino, you have Versace, and no one knows what will be the future of these brands. No one knows how well these brands will be managed, if they are profitable or if they will become profitable. Some sizeable brands already launched an IPO to raise capital, mostly in Hong Kong because it’s a quicker and provides closer access to China’s market.
But in 2012 it will be more difficult to get financing through IPO’s because it’s a slight slowdown, even in China. In the case of Chow Tai Fook, they didn’t reach the maximum price expected, but the minimum and not for 100% of the shares. So as IPO’s cool off, brands must look to other players for finance, as they need financing to survive the crisis if they have a reduction in sales or to continue their business development, particularly entering new markets with growing opportunities.
Swatch’s decision to reduce its component supply to competitors will also create global structural change in Swiss watch production (Photo: NY Times)
And where geographically do you believe the biggest opportunities lie in terms of growth?
Even if Asia does slowdown a little, it will remain a key market and key region for growth opportunities. But there is also Latin America, which is not a major market currently but growth is strong, has been strong and will remain strong. I do not believe it will be much affected by the current macroeconomic situation.
I also feel that the United States will start to recover in 2012. The luxury market is obviously performing well, but the general financial market is also beginning to stabilise in various regions of the United States. This is a very positive element. There were also many jobs created last year and the trend is going positively. When people they have security in their home and they feel positively about their ability to find employment, they are more keen to invest and to purchase. So we feel that after three difficult years in the United States, the markets could begin to recover.
And even inside Europe there are economies still performing well. Even if some markets are under significant pressure, you still have some growth opportunities within Europe.
“ Even if Asia does slowdown a little, it will remain a key market and key region for growth opportunities ”
There is much talk about an Asian slowdown in spending and consumption, but Chinese investors are playing a much bigger part in luxury M&A.; Do you think this will continue or they will be spooked by a potential European recession?
Investors globally are freezing investments due to macroeconomic uncertainty, as they become more worried and more prudent. Generally it is institutional and financial investors that are prudent as they cannot accept any other type of return than a financial return, which is not the case with an industrial investor, who can create synergies and with the synergies can recover more quickly his investment.
But we are seeing some investors, particularly Asian investors, waiting and scanning the market to see when the European crisis and the debt crisis will stabilise. As long as these investors believe that the price or the situation can worsen they will wait. When they believe they are reaching the bottom, then they will start to invest. So we know at the moment that many Asian groups are actively looking for transactions in luxury, and that big groups are also scanning the luxury market in Asia.
What is interesting is that Asian investors are not just waiting for Europeans, they are also looking now at Asian luxury investment opportunities. They do not necessarily want to wait for Europe, so they are looking for opportunities in the local market to develop their own luxury brands and invest in Asian luxury brands. And the awareness of creating Asian luxury brands in Asia is increasing, especially when it comes to fashion, jewellery, art & silk.
And even from a European and American point of view, there are less and less transcontinental transactions. When there is a crisis investors start to look around and see what they can do in the local area – they don’t want to accumulate risk. So investment becomes more and more local.