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Luxottica: How vertical integration has made it the world leader in eyewear

Luxottica with revenues of €8.8 billion clearly emerged as the market leader in Televisory’s earlier analysis through a blog on the eyewear industry. In addition, it emphasised on the operational and financial position of the selected key players.

In this blog, Televisory analysed Luxottica’s vertically integrated business model, that enabled it to acquire more than 50% of the market share. The company not only designs and manufactures frames, but can bolster sales through its strong distribution channels. Luxottica owns 50 wholesale subsidiaries and 7,265 retail stores across the world. It has further improved its reach through the use of e-commerce lately.

Luxottica soon after its inception realised the need to save costs on the supply chain and reached customers directly through the process of vertical integration. It forayed into the wholesale business with the acquisition of Scarrone in 1974. Secondly, its advent into the international market began in the 1980s by means of partnerships, joint ventures and acquisitions of various foreign wholesalers (Avant-Garde Optics in the USA and Mirari in Japan). Simultaneously, it understood the importance of high-end technology to design its frames and thus, acquired La Meccanoptica Leonardo to gain access to a flexible hinge patent. In 1995, it took the major leap by acquiring LensCrafters to become the first eyewear manufacturer to enter the retail segment. It has since then been pursuing acquisitions in the retail market incessantly. It also ensured that its product portfolio is consistently in sync with contemporary fashion trends by acquiring brands such as Vogue, Ray-Ban, Persol, etc. The figure below depicts the Luxottica’s strategy with regard to vertical acquisitions throughout the globe. It has made only a few horizontal acquisitions and thus, evaded the anti-trust restrictions.

Over the years, Luxottica also signed license agreements to manufacture and distribute designer eyewear for Giorgio Armani, Prada, Ralph Lauren, Burberry, DKNY, Michael Kors, Dolce & Gabbana, Tiffany & Co., Versace, etc. Moreover, producing for third parties allowed Luxottica to capitalise through economies of scale with significant and advanced manufacturing capabilities. It had to pay only a royalty fee for these licenses and thus was able to earn more revenue with very few additional costs. Luxottica did not restrict its vertical integration model to only Europe, it extended it to North America, Latin America and Asia Pacific. In fact, North America was its major revenue contributor (close to 40% in 2015). The table below summarises the key benefits of major acquisitions for Luxottica.

But all these acquisitions came at a certain cost and were not always instantly earnings-accretive. For instance, if we observe the net income profile of Luxottica since 1990, it suffered its 1st major decline in 2003 due to the acquisition costs of €254 million associated with OPSM. In another instance, there was a peak in its revenues in 2007-08 as financial results of Oakley, which had revenue of over €500 million was included in the above fiscal year. However, the net income dropped due to costs associated with the merger (Oakley was acquired for €1.6 billion). It faced a dip in its revenues again in 2009 due to structural and economic reformations across the world.as it covers a large geography, its revenues are susceptible to currency risk. The depreciation of the US dollar was a primary contributor to the fall in its revenue in 2003.

Luxottica has been prudent on funding its acquisitions. The firm maintains sufficient liquidity levels and primarily depends upon internal funding and debt facilities for expansion purposes. It also keeps on selling smaller subsidiaries to earn returns and uphold the stability of its financial structure. Its debts mainly comprise of senior unsecured guaranteed notes and revolving credit facilities. It repaid a long-term debt of €527 million in 2015 which brought down its cash reserves. As of June 2016, it had cash and cash equivalents of €754 million and unutilized short-term credit lines of €703 million. In the past 5 years, its average interest expenses have only been 1.6% of revenues. Luxottica’s net debt should always be below 3.5 times of its EBITDA as per the financial covenants in its debt agreements and Luxottica has ensured to comply with this condition. Moreover, since Dec. 2014, its net debt to EBITDA ratio has been maintained between 0.5 and 1. S&P has assigned a stable credit rating for Luxottica. Therefore, its financial position is robust and it can continue with mergers and acquisitions.

Furthermore, if Fielmann resorts to licensing and expansion, it could be in the race to lead the market as mentioned in Televisory’s earlier blog. The table and the below graphs show the operational profile of Luxottica and Fielmann. It can be easily deciphered that all these expansion activities have steered Luxottica towards a strong operations base in terms of manufacturing, employees and stores. It is worth mentioning that the total sales outlets (POS) of Luxottica are more than 10 times of Fielmann, while its revenues are only 6 times higher. This is the primary reason for its revenue/POS and EBITDA/POS to be less than that of Fielmann’s. However, its revenue/employee and production/manufacturing facility are much higher and Fielmann requires to make judicious capital investments to compete with Luxottica.

     

       

The bigger question that remains is whether Luxottica can continue with its acquisition spree? Few believe that Luxottica has transformed the eyewear market into a kind of monopoly. The anti-trust regulators in Europe and the USA have directed their concerns over its acquisitions in the past, but none of its acquisitions got rejected by the regulatory bodies. Moreover, it cannot be ignored that one of Luxottica’s biggest M&A, the transaction of Oakley, received early termination under the Antitrust Improvements Act. In addition, there is no denying that it does have the financial capacity to continue with its business model. Luxottica is, therefore, expected to seize every opportunity to expand through acquisitions.