By and  on February 23, 2006

PARIS — Could the high-flying fashion and luxury sector, which has lately sat on the sidelines of the mergers and acquisitions arena, be getting back into the game?

Absolutely, say many analysts and dealmakers, who are predicting an uptick in transactions this year from a broader array of business players, with beauty, jewelry, innerwear and accessories likely to be the most active categories. Today's expected announcement of Change Capital's purchase of Jil Sander could merely be the beginning.

Detractors argue the industry is already quite consolidated, and the climate doesn't favor big purchases — excepting industrial assets. Yet many forecast a new era of smaller and more strategic deals from lots of left field candidates beyond the "big three" luxury players: LVMH Moët Hennessy Louis Vuitton, PPR and Compagnie Financière Richemont. They say a preponderance of cash and rapid growth in luxury goods in the U.S. and emerging markets also set the stage for more transactions.

"I do expect activity to pick up in 2006," said Pierre Mallevays, managing director of Savigny Partners LLP, a corporate finance and M&A firm in London. "People are starting to look around again."

"I believe from both from a supply and demand standpoint, M&A will resume this year in the sector," agreed Antoine Colonna, luxury analyst at Merrill Lynch in Paris. "The main difference with the two previous years from a demand standpoint is balance sheets are strong again and, from a supply standpoint, valuations are closer to peak levels."

Various other factors also suggest an uptick, including a need for groups to establish a balance of power in all product categories — and to find additional growth drivers. There are also succession and management issues, particularly in Italy, and the growing importance of scale in luxury goods, Colonna noted.

Mallevays is dubbing 2006 a year of "smart" investments, in contrast to the feeding frenzy of 1999 to 2001 that led luxury groups to a long period of digestion, and in some cases, indigestion.

"They will buy small to mid-sized companies that are very complementary to existing brands or units," he predicted, citing as recent examples Bulgari's purchase of a watch strap supplier and handbag maker and Steve Madden's acquisition of the handbag and belt designer/manufacturer Daniel M. Friedman & Associates. In the same vein, PPR recently indicated it was eyeing nonapparel catalogues in the U.S. to complement its Redcats mail-order operations.Mallevays also held out the possibility of a "transformational" deal should a major entity like Hermès Inter­national, Chanel, Estée Lauder or Bulgari come on the block.

Karine Ohana, partner in Ohana & Co., a boutique M&A firm in Paris, said she expects a broader range of international players in the next round of deals, including more Asian and American firms.

The recent acquisition of French lingerie firm Prin­cesse Tam Tam by Japan's Fast Retailing Co. is an example of the growing role of Asian firms, as was the 40 percent stake in Paul Smith recently purchased by Itochu, his Japanese licensee. Among notable recent American deals was Warnaco Group's purchase of the international Calvin Klein businesses from Fingen SpA and Liz Claiborne's acquisition of Canada's Westport Contempo Fashions Ltd.

"The emergence of the new players is definitely a driver," Ohana said. "I believe the market is back in the hands of the industrial players who, for the most part, have now recovered from their phase of digestion and are now back on track for new important acquisitions."

What also underlies a renewed interest in buying brands, according to Ohana, is a shift away from mega and "standardized" luxury brands like Gucci, Christian Dior or Prada to "niche brands" that offer innovation and creativity.

Another factor driving M&A activity is the rapid growth of luxury goods in the U.S., a trading-up phenomenon that firms like Coach and The Limited have already seized upon, Ohana noted.

Data from Milan-based consultancy Pambianco show the number of mergers and acquisitions in the fashion and luxury goods industry fell 3 percent to 165 in 2005 from 170 in 2004. A Pambianco spokeswoman said the consultancy expects M&A activity to recover its lost ground in 2006 and grow "slightly."

Since the terrorist attacks in the United States in 2001 shook the global economy, most luxury players have put the focus back on their core business, restructuring and in some cases shedding losing ventures and keeping a tight rein on costs.

Now that good times have roared back, cash is flowing again, and the groups might entertain strategic moves rather than offering share buybacks or special dividends, said Jacques-Franck Dossin, luxury analyst at Goldman Sachs in London."We're getting to the phase where companies seem to be thinking, ‘Maybe I can do other things,'" he explained. "The question is: Who moves first and when? And it is tempting to suspect that a first move by one player could shortly be followed by a similar move by another player."

According to industry observers, the targets that would likely attract the most investor interest include Hermès International, Giorgio Armani, Tiffany, Bulgari, Valentino Group and Burberry. Lancel and Loris Azzaro are among other brands believed to be in play.

"The environment is terrific. There are green lights everywhere," said Antoine Belge, a luxury goods analyst at HSBC in Paris. "The market would respond more favorably to the acquisition of a good brand, even at a higher price. I suspect people overestimate the possibility of a negative reaction."

Belge said he expects any M&A activity to be centered mostly in the watch and jewelry category rather than fashion. On the purchasing end could be LVMH, whose watch and jewelry division, which represents about 4 percent of group sales, has not yet reached critical mass, and Swatch Group, whose jewelry portfolio is underdeveloped versus its competitors. Richemont is billed as more of a reactive player, likely to enter bidding wars to prevent prized brands from landing in the hands of competing groups.

"All groups have been reducing their levels of debt, meaning they can take on board new financing with low interest rates," said Dossin. "If cash flow generation is there, it's tempting to leverage."

The lingerie sector is also ripe for consolidation, according to Ohana, citing a plethora of family-owned firms now feeling the heat from larger competitors.

Italian observers acknowledge that cash-rich groups might be compelled to consider acquisitions, but there are plenty of caveats.

"I sense a lot of fear," said Barbara Giannelli, a brand strategist with Studio Barbara Giannelli. "There isn't the same level of enthusiasm to do deals because people have seen how many [buyers] have gotten burned on acquisitions."

Michele Norsa, chief executive of Valentino Fashion Group, characterized recent headline deals for Jimmy Choo, Joseph and Emanuel Ungaro as rare exceptions in a market climate that isn't favoring acquisition plays, at least in the short term."Everyone wants to focus on optimizing their existing assets," Norsa said. "The focus is on improving [what we already have]. We have brands that are doing well and can do even better. Not all of the acquisitions went as well as expected. We've been lucky."

Giacomo Santucci, a partner specializing in luxury goods and retail at Value Partners, agreed there isn't a lot left to consolidate.

"Armani is not selling at the moment. The right conditions aren't there for Prada and it seems like the company is concentrating on other things at the moment," he said. "As for Bulgari, I'm rather confident that the family doesn't want to sell. I think that medium-sized companies like Missoni will keep their autonomy."

To be sure, most observers agreed private equity funds, which are flush with cash and active in many sectors including retail, would be unlikely to feature prominently in fashion and luxury deals — except where it is the seller.

"We do not expect private equity to be doing a lot in the field because it usually wants a quick return, which is difficult to get with luxury goods," Merrill's Colonna said.

Mallevays agreed private equity players are not likely to be big players. Still, he predicted "smart" private equity would go for mid-size deals and certainly look at distressed companies. While Mallevays was speaking before Change Capital's purchase of Sander, the deal fits into this view.

Mallevays added that he expects most deals to be in accessories and the beauty sector, where a lot of specialty brands are gaining traction.

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