Shopping for High-End Brands Is Harder Than It Looks—Even if You’re a Luxury Giant

Investors hope the pandemic will prompt some owners of independent luxury brands to sell up. But persuading founding families to give up control has been tricky.

By guest author Carol Ryan from Wall Street Journal

All captions courtesy by the Wall Street Journal

To get his hands on Bulgari, luxury-goods titan Bernard Arnault courted the family behind the jeweler for 12 years before they accepted a check for USD 5 billion. The pandemic may soften up some owners of high-end brands, but it will still be hard to cut deals.

A pre-existing gap between the performance of many big and small designer brands has widened since the pandemic began. A major market share grab is under way and “some of the small guys are getting killed,” says Jefferies luxury analyst Flavio Cereda. One Chinese mall operator told Mr. Cereda that the top 10 brands have gone from contributing 45% of total luxury sales before the pandemic to 70 % today, as more minor players are squeezed.

The trend was clear in the first three months of the year, when shoemaker Tod’s sales dropped 16% and those of British trench coat designer Burberry fell 5 % against the same period of pre-pandemic 2019. Industry giants Hermès and LVMH Moët Hennessy Louis Vuitton, LVMUY which Mr. Arnault founded, showed sales growth of 33 % and 8 % respectively on the same basis.

The crisis has forced some founders to rethink their succession plans. For the first time, Italian designer Giorgio Armani said in a recent interview with Vogue that it is less important for his namesake label to be fully independent. Tod’s founder Diego Della Valle also hinted publicly that he would be open to a sale. Investors are betting that a tougher outlook for stand-alone brands will send these and other names into the arms of big luxury houses like Gucci’s owner Kering. Tod’s share price has doubled this year, largely because of deal speculation.

Still, takeovers face hurdles. An obvious one is valuation, as even troubled publicly traded brands appear pricey. The overall luxury sector is trading at 31.9 times projected earnings, compared with a 15-year average of 18.4 times, HSBC calculates. The last time the industry’s stocks were as expensive was during the dot-com bubble.

The wealthy founding families of both public and privately owned designer labels are hardly ever desperate to sell, as even a weak luxury brand generates plenty of cash. They are also choosy about who they will pair up with, restricting potential buyers. Mr. Della Valle specified that he will only sell Tod’s to LVMH, which recently tripled its stake in the shoemaker to 10 %. Mr. Armani said he would only deal with another Italian group. His comment was interpreted as a nod to the Agnelli family’s investment vehicle Exor, which has been buying stakes in luxury companies.

Brands are already finding alternatives to outright sales. On Monday, luxury shoemaker Salvatore Ferragamo poached Burberry Chief Executive Marco Gobbetti in a sign that the founding Ferragamo family wants to turn the struggling label around by itself. The company’s shares are down about 7% so far this week as the prospect of a takeover dims. In March, shoe brand Christian Louboutin sold 24 % of its business to Exor, having turned down multiple approaches from the big French houses, according to M&A bankers.

If they can talk owners around, potential buyers are at least in good shape to do deals. Global luxury sales are expected to match or outstrip 2019 levels this year, consultancy Bain estimates. The rapid recovery is happening around two years earlier than previously expected and means cash is again piling up on the balance sheets of major brands.

If Europe’s four biggest public luxury companies, LVMH, Kering, Hermès and Richmemont, took on debt worth three times their projected earnings before interest, taxes, depreciation and amortization, they would theoretically have a combined firepower for deals of EUR 85 billion, equivalent to about USD 100 billion, by the end of this year, based on Bernstein estimates.

Buying independent brands can benefit both sides. Big luxury houses have deep pockets to invest in e-commerce and marketing, as well as the best boutique locations, in a way that smaller owners can’t. Bulgari’s sales have doubled and its operating margins tripled under a decade of LVMH ownership, for example.

Kering is perhaps most in need of a shopping spree to reduce its reliance on Gucci, which generates 83% of its total operating income. The company may also want to bulk up to compete with LVMH. Its larger rival has added roughly EUR 130 billion to its market capitalisation since the start of last year—greater than the entire value of Kering.

With the most attractive brands like Chanel and Patek Philippe in private hands, the ability to convince family owners will be especially important if major tie-ups are to happen. Here, LVMH has a bit of an edge. It has made six multibillion euro deals over the past decade, including private targets Bulgari and Loro Piana as well as listed U.S. jeweler Tiffany. Kering hasn’t done a single deal worth more than a billion euros over the same period, although it has done a good job of turning around its existing labels.

Even though small brands face a shakier future in the aftermath of the pandemic, buyers will still have to offer big checks and charm to secure a sale.