Business Breakdowns
· Swetha Ramachandran
[00:00:00] S1: Yeah. I would have thought after having done the EssilorLuxottica merger, they would have wanted to maybe sit still for a bit. But very promptly thereafter, they also acquired GrandVision, which was primarily a European distributor of lenses, to fill out that white space that they had in European distribution. But maybe coming back to the EssilorLuxottica merger itself, this is quite a fascinating tale in terms of the corporate governance issues that ensued. It was imagined as a merger of equals. Today Delfin, which is the Del Vecchio family holding, owns just over 32% of the group in terms of economic interest. But when the deal was actually first struck in 2018, it was envisioned by Luxottica's chairman, as well as Essilor's chairman at the time, that the two companies would have a power-sharing arrangement equally for three years, with Del Vecchio actually agreeing to limit the exercise of his larger voting rights, and that they would wait for three years before they then jointly appointed a group CEO. And actually in practice, I mean this is an Italian company marrying a French company. Very different cultural profiles, governance, and managerial cultures as well. There were all of these things perhaps that, in the excitement of getting the deal done, had been swept under the carpet but that actually very much came to the fore over the subsequent few years. There was a very long and publicly drawn-out battle in terms of corporate governance over 2018–2021 and these splits. It was quite damaging, I would say, for morale, definitely the share price, market and investor perception in the credibility of this combined management team, or even really the benefits of this merger, because of the frequency with which these governance disputes were reported in the press. Mr. Del Vecchio believed that Mr. Sagnières, who was his French equivalent, was trying to grab power. Mr. Sagnières fought back and said that Mr. Del Vecchio was trying to execute a nil-premium merger. There was arbitration involved, and ultimately the company thankfully had to — perhaps not to the benefit of the press, but at least to the benefit of other stakeholders in the business — reach a settlement agreement to overcome these governance issues. This happened in 2019. And so now we have a co-CEO structure. Well, actually, there's a Luxottica CEO, Mr.
· Swetha Ramachandran
Milleri, who is the official CEO, and then there is the Essilor Deputy CEO, Paul du Saillant, who is also in place today. So that has thankfully removed a lot of the distraction from the corporate governance struggles, the impact that that had on the share price for quite some time. And now we're in a different phase. But even very promptly after, even while all of this was going on, they decided to acquire in July 2019 a company called GrandVision, which is a global leader in optical retailing. At that time, EssilorLuxottica's own market cap was about 50 billion euros. And this deal was valued at just over 7 billion euros, at very similar PE, so it was a hugely dilutive deal. But it was a very long, drawn-out acquisition process because the European Commission actually required a lot of concessions and remedies in order for the deal to be approved. And 350 retail stores across Belgium, Italy, and the Netherlands had to be sold. But what the deal did do was to again enhance the company's vertical integration, which is what they had always touted as something that distinguished them from the competition. And this made even more sense actually in the wake of the Essilor acquisition, because what Essilor never had on its own was direct-to-consumer distribution. They had always relied on third-party wholesalers. So coming together with Luxottica, as well as with the added benefit of GrandVision, this really became a full-service manufacturing-to-customer experience proposition under the aegis of one company.
· Zack Fuss
[00:00:00] S0: So now that you have this large, combined, vertically integrated business, zoom out and let's talk about the industry itself. Cyclical versus secular? I understand that 60% or 70% of adults will need corrective vision at some point in their life, so clearly there's sustained demand for their products. How do you think about the way the industry ebbs and flows itself?
· Swetha Ramachandran
[00:00:00] S1: Yeah, it's interesting, because of the two sides of the business. One is not as cyclical in the sense that prescription lenses, they're really a necessity for over 4 billion people worldwide. It's not quite a discretionary product in some cases. For example, we're fortunate enough where eye exams are covered by insurance or employer benefits, which again stabilizes demand. The key feature really is under-penetration in emerging markets, especially in Asia, which drives these long-term structural growth trends in corrective eyewear. It's estimated that uncorrected vision impairment today might cost the global economy north of 300 billion dollars in lost productivity. So there's a huge economic cost to not correcting vision issues. Then of course, you have the other side of the business, which is the frames and sunglasses business. Here, it's much more about brand and quite a bit of fashion as well. And here, we obviously know that luxury spending—spending on discretionary items—does drop during recessions, and so that tends to be more sensitive. So we did see this during the global financial crisis, for example, where the standalone Essilor business at that time continued to grow. People, of course, still need prescription lenses whatever the economy, but the sunglasses business did experience some very moderate, though mid-single-digit, decline, which is somewhat better than what we saw elsewhere in the luxury industry. There may have been an element, perhaps, of this being an affordable luxury, similar to what Estée Lauder coined as the 'lipstick effect', where no matter how bad times are, women will still indulge in a lipstick. But perhaps there's an element of that with sunglasses as well. But there's no doubting that this end of the business is more cyclical. But if we look at the growth drivers for the eye care industry overall, it's clear that an aging population, growing population, and penetration in emerging markets because of rising incomes—all of those are durable and sustainable trends for the long term. Vision impairment is still, today, one of the world's most untreated and undiagnosed disabilities. Basically, 90% undiagnosed in developing economies are at the bottom of the income pyramid, which is really quite astounding, even today. The fact that innovation in eyewear is redefining the entire TAM.
· Swetha Ramachandran
And that, to me, is hugely interesting because, of course, we have the huge hype cycle around smart glasses, which, to no small extent, I think has impacted EssilorLuxottica's valuation in recent months. Could they go mainstream in the same way that smartwatches have? Could that unlock a huge new market? And in this, the Ray-Ban Meta, which launched in October 2023, has really been the only connected glass option to reach mass-market adoption. They just said that they have sold 2 million units of this product. And so, I think that could be really interesting if they manage to make that go mainstream in the same way that perhaps the Apple Watch has. The other innovation could be hearing aids, where they've now announced an expansion into hearing solutions, which is basically a disruptive proprietary technology by the Israeli startup Nuance, which is really at the intersection of sight and sound. So, you've got quality hearing solutions but in the form factor of glasses, and that minimizes the stigma. It also addresses mild-to-moderate hearing loss, which is quite common among the growing aging populations in the Western world. And that, again, is a product that's about to be launched—or is in the process of being launched at the moment—over the counter in the US and at audiologists in Europe. That could be, I think, quite interesting to see how they're able to grow their market beyond their core eyewear market.
· Zack Fuss
[00:00:00] S0: Laying out the strategic motivations of the business, the merger, and understanding the nuances of their go-to-market strategy. Today, I think it'd be helpful if we walk through the P&L of the business from the top line. A business that'll do 25 to 30 billion euros, growing high-single digits, and then down through gross profit margin to operating margins, and all the money that's being spent in between those two. And then, again, you spoke briefly on some of their capital allocation policies. You look at a business here that seemingly you would expect to be somewhat capital-light, but they do reinvest meaningfully below the OCF line. And just curious how you think about the financial profile of the business.