Business Breakdowns
· Swetha Ramachandran
[00:00:00] S1: Exactly. And I think here, Meta, this is sort of a symbiosis where both companies do need each other. EssilorLuxottica does need Meta's AI in order to power this interest in smart glasses, where if you consider the relative size of smart glasses to smartwatches, smartwatches are estimated to be worth about a market size of about $34 billion, and smart glasses maybe about $3 billion. So there's a huge gap in terms of potential, although you could argue that the form factor of a watch lends itself to much greater adoption than perhaps a smart glass. But AI is the key unlock here. And so Meta AI powering Ray-Bans is a fundamentally different proposition from the old Ray-Ban Stories 1.0, which had much more limited functionality. We don't have a lot of details in terms of how the economics are shared between the two companies on the sales of the Meta Ray-Ban product. Both companies are quite cagey about it, other than to say that this is a long-term partnership and they want to continue to innovate. I do think that they're building capacity at the moment to sell up to 10 million units of this. They sold 2 million units of the Meta Ray-Ban glasses last year. It's priced surprisingly affordably at just about $300 a pair at retail in the US, and I think the reason for that is their attitude that "if you build it, they will come." And the idea is to increase adoption before competition comes and staves off their growth potential. I don't know that this will necessarily be successful because this is an inherently competitive space. They have a first-mover advantage, but they may not be ultimately the winner in this space depending on the functionality that comes out. Perhaps Apple comes out with its own version of the smart glasses with superior functionality, or any other player. For example, I just read about a voice assistant called Sesame, which makes AI glasses, and they're apparently very highly rated as well. So I think this is going to be quite a competitive space. It's quite different from anything EssilorLuxottica has done before because they don't own this technology; they don't own Meta AI functionality. So that partnership model will be interesting to see how that evolves, and it'll only be as successful as Meta AI itself is successful.
· Zack Fuss
[00:00:00] S0: When you consider the strengths and weaknesses of the business itself and the competition, we've touched on a number of these topics, but if I can just summarize: you have a vertically integrated business with dominant brands; they reinvest heavily into their business. They've been able to stave off competition from upstarts such as Warby Parker. What is, if you put it all together, the special sauce that makes this business tick?
· Swetha Ramachandran
[00:00:00] S1: Their key is their scale, which allows them to continue to invest in R&D and innovation, and at the same time, their vertically integrated structure that also allows them to push that innovation into their own distribution channel. That, and also the unique aspect of EssilorLuxottica relative to other closed network, vertically integrated players—let's say Inditex, for example, which owns the Zara brand: they make the product, they sell it in their own stores. But actually, its own competitors are also its clients and customers because it has an open network framework. They very proudly said, for example, at their capital markets day that Hoya, which is technically one of their competitors, is also one of their big customers. And similarly, Kering Eyewear works closely with EssilorLuxottica as well, given that the DTC, the retail network of EssilorLuxottica, is actually a significant customer of Kering Eyewear—the Gucci sunglass brands, for example, selling them in their stores. That is an interesting feature. You would never find, for example, at a Zara store, something from H&M. That is quite different about this business, that open architecture which helps them scale up, and then that scale is a virtuous cycle that allows them to reinvest behind their stores, but also behind innovation and R&D. Investment in R&D has actually driven significant proprietary IP. They have over 12,000 patents pending or granted across more than 2,000 patent families. They have nearly 21,000 trademarks that are pending or registered. That innovation is going to come to center stage because it's across all of their major areas. It's across vision care, eyewear design, technological innovation. It's across smart eyewear. Sunlenses, they have over 50 sunlens researchers to think about new mold processing and optical technologies, as well as of course, digital transformation. That is that in-store experience with an option to explore the complete collection digitally, the face scanner technologies that help you, the virtual try-on on Ray-Ban.com. I have to say I've personally been quite impressed by this when I was recently in the market for a pair of Meta Ray-Bans. All of these help it distinguish itself from the competition. But the real secret sauce is this vertical integration because that is quite unique about this company.
· Swetha Ramachandran, Zack Fuss
And to cover every step of the value creation process, focusing on manufacturing, service, all while having a very geographically diversified footprint is quite complex and it's not an easy feat to be achieved by many companies. That's why maybe the mid-teens margin is actually fair. Mid- to high-teens. I'm really not sure that that 20% target that they're pushing for may necessarily be achievable given the complexity of operating this business. And of course, we haven't even touched on tariffs yet. That could also be a potential spanner in the works of their margin ambitions. But that secret sauce, at least their scalability and relative competitive advantage, should continue to be enhanced because of their vertical integration. [00:00:00] S0: When you think about vertical integration and a business that's described as dominant, we find that there's increasingly pressure on these types of businesses for the FTC or the DOJ to pursue them on the basis of antitrust. You have to think about how can they narrowly define a market in order to prove that they are instituting harm upon the consumer. But when you consider sleepy categories such as retail, you typically don't see much in the way of antitrust action. My curiosity is, headlines suggest that they face these trials. What is the concern? And how do shareholders weigh what the actions being pursued against EssilorLuxottica may or may not be?
· Swetha Ramachandran
[00:00:00] S1: I don't want to dismiss these claims entirely, but if we just look at the objective facts, they have a 33% share of frames and sunglasses. That doesn't suggest to me that they're so dominant. It's not a category where they're generating substantial gross margins, which suggests that they may be taking advantage of customers. They also, in their own stores, they're selling competitor products. So you're not obliged to buy something that is made by EssilorLuxottica that gives them a higher markup than one of their competitor brands. I mean, sunglasses. Anyone who's ever spent any dead time at an airport trying to find something to do and has stopped by a sunglass store. You only have to see how many options there are for you to know that no company really has dominance or pricing power in this category. Then we can look at the eyewear side of the business. And here you could say that perhaps this is similar to pharma in a sense, where innovation does get rewarded with pricing power. So for example, the Nuance hearing aid technology could retail for about $1,500. But that is OTC; that's private pay. You've got Stellest, which is their offer to actually arrest myopia in young children, which is hugely valuable. So that before the retina changes shape and the lens needs permanent correction, they're able to actually slow down the progression of myopia with Stellest. And you could argue that that innovation should also carry a premium should you want to maybe buy those products. But in their core bread-and-butter business in lenses, it's very, very hard to argue that they actually have meaningful pricing power that is taking advantage of consumers. There's no evidence that I can see of this, given that the market still is fragmented, even if in the lenses side of the business, they're a little bit more dominant than on the sunglasses and frame side of the business. I would find this incredibly hard to believe, given 40% of the market rests in other non-big player companies.
· Zack Fuss
[00:00:00] S0: So it sounds like over the next few years we expect the business to continue to execute on their growth plans, layering in some of these more moonshot strategic actions. You've mentioned the prospects of tariffs, which, to use the T word, I hope are transitory in some effect, but obviously will have competitive impacts on their ability to kind of sell cross-border. But I guess I'm curious, what are the lessons that you take away from studying a business like this that you think A) can be applied to other businesses that you evaluate for investment and B) strategically where you see parallels to investments in your coverage universe?