Business Breakdowns
· 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?
· Swetha Ramachandran
[00:00:00] S1: A lot of European businesses get a bad rap for having this heavy family control or shareholding type structure. But that has also allowed these businesses on many occasions to take very long-term investment decisions that might not otherwise have been possible. And I think that's where a visionary like Del Vecchio, in the vein of perhaps someone like Bernard Arnault, are able to have this long-term investment horizon, but perhaps also discipline when assessing prospective returns, future returns from a current investment. And here if you look at what they did, for example with Ray-Ban, this was a brand that had been all but left for dead at Bausch & Lomb. They transformed a struggling brand into a 3 billion plus annual revenue powerhouse. I mean it did take them 15 years, so it wasn't overnight, but they did have the wherewithal to do this. Which is interesting considering the history of the brand from being launched for the US Air Force during World War II to then its eventual Hollywood associations and becoming an icon. But we now perhaps forget that that process actually took many decades. And then of course they continued to build their dominance in terms of acquiring Oakley to build dominance in sports eyewear. They actually bid out several other bidders for this brand. And again, GrandVision, which perhaps no one thought that they had the appetite to do considering they were going through their own complicated merger, that actually expanded their retail dominance further, ensuring direct consumer access to their products worldwide. So I think that appetite for deal making, but also with a sensible rationale, and here we have evidence that they have walked away. They've said no when deals don't make sense. For example, in 2009, this is Luxottica, they were considering acquiring the financially troubled Safilo Group, which is an Italian eyewear manufacturer. And actually, they decided against it because it didn't make financial sense. So I think that disciplined approach while seizing the day, but also knowing when to say no is an important lesson for investors as well as operators. And then I think also perseverance and risk-taking in new businesses. The first iteration of smart glasses, I mean let's look all the way back to Google Glasses. Let's face it, it wasn't a fantastic offer for consumers.
· Swetha Ramachandran
We then had Ray-Ban Stories, the first version, which didn't really take off. But I think now Meta Ray-Ban has really struck a chord. It's somewhat right time, right place because of AI and the integration which has made it that much more interesting. So the question of continuing to tweak that proposition until the consumer readiness is there is something that has come to this company quite naturally and as part of its evolution. It's not a "well, we tried this, it didn't work, let's move on." But also I think the ultimate lesson is that if you see these otherwise lowish margin businesses, vertical integration is the key to unlocking value, and it doesn't work all the time. We saw this end quite badly post-pandemic for, say, brands like Nike and Adidas, which tried to go completely DTC and forgo wholesale. There, the consumer wants choice; they want to be in a multi-brand environment. But the beauty of EssilorLuxottica is that with its 150 brands and plus its retail channel where it can offer other brands, it is able to do that. And so I think that has also been a major driver of margins which are now at 16% versus just above half of this about seven or eight years ago. I think the other lesson of course is don't air your dirty laundry in public. Because that corporate governance boardroom battle that we saw between 2018 and 2021 was quite distracting to the core investment thesis and I presume for management internally as well.