Business Breakdowns
· Swetha Ramachandran
[00:00:00] S1: 75% of their business today is actually from vision care. It's from corrective lenses. That is really where the bulk of the market sits. And sunglasses and frames are a much smaller 25% business overall. And the lenses business is actually much more profitable because it operates in a more concentrated market. So if we just look at the prescription lenses market, EssilorLuxottica has over 50%, almost a 55% share of this market. It tends to be much more concentrated. The other players are really Hoya and Carl Zeiss. It's almost an oligopoly. When you look at the other side of the business, which is frames and sun, that is a much more fragmented business because it's much more brand-led. And here you've got EssilorLuxottica with just over a third of the market, which is decent. It is a much smaller market. So, for example, if we look at prescription lenses, that would be basically the bulk of their sales derived from that. Frames and sunglasses are a much smaller market overall. So 75% revenue from lenses and 25% from frames and sunglasses. And here, the fragmentation is such that you don't really have a meaningful number two. Kering, which has brought back some of its brands in-house, has set up Kering Eyewear, which has roughly a 10% share of the market. Safilo, which EssilorLuxottica actually tried to buy but walked away from. I should say Luxottica, because this was pre-merger, they tried to buy it but walked away from it. That has about a 7% share of the market. But there's really not a dominant player other than EssilorLuxottica. And even here, where I would say this really differs from prescription lenses is that the other end of the market, which is a real fragmented tail, constitutes only 3% of the market for prescription lenses. But actually it makes up about 40% of the market for frames and sun.
· Zack Fuss
[00:00:00] S0: And so I think one of the popular criticisms of a business like this is that they produce a piece of plastic frames for $10, and it ends up as a $200-plus at retail product to the consumer. And I know that the truth is not exactly aligned with this infinite markup, given the gross margin profile of the business, I believe it's closer to 60%. How do the unit economics of what they sell work? What part of the business is more commoditized versus differentiated? Prescription versus luxury? How do you think about the different components and strategies?
· Swetha Ramachandran
[00:00:00] S1: So I guess when we think about pricing power, what I really like to look at is gross margins. Stable, as well as high, gross margins tend to indicate that a company has sustainably durable gross margins over time. And here it doesn't strike me that eyewear is a segment that is particularly strong in pricing power. So why do I say that? On the one hand, gross margins are higher than, let's say, the sporting goods footwear category. If you look at Nike and Adidas, which are incredibly strong brands but still have gross margins only in the 50s percentage-wise, that gives you an indication that it's not just about strong brands. There's also a lot going on in terms of scale and distribution that drives gross margins as well. On the other hand, EssilorLuxottica's gross margins, at about 63-64%, they've remained very consistent over the last five years since the merger. Management itself is not guiding to a material uplift in gross margin because they expect that these benefits from price mix will be offset by some growth at some of their insurance businesses, etc., where there's not as high pricing power. So, I would say this business's pricing power is nowhere near as high as in luxury brands, where it can exceed 80% in some cases, but it's also not as low as footwear. That suggests to me that pricing power is moderate, but that you should expect some price elasticity given the market fragmentation and greater substitutability. It's not the case that you are basically being gouged, if you will, because you have to buy a pair of Ray-Bans. There are perfectly respectable and serviceable substitutes out there in the market because of how fragmented it is, because of how relatively low the barriers to entry are. Although, of course, EssilorLuxottica would say that scale gives them an enormous benefit in terms of procuring efficiencies.
· Zack Fuss
[00:00:00] S0: Speaking to that scale: obviously a high-profile merger completed in 2018. It feels like yesterday, but we're coming up on almost seven years. Take us through the trials and tribulations of combining the business and some of the complementary M&A they've done since.
· 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.