Could luxury’s go-go acquisition binge really be over?

As Holding di Partecipazioni Industrali is said to be near to selling Valentino to textile and apparel group Marzotto, the question is being asked whether this could be among the last major acquisitions in the luxury sector for awhile. Some analysts are predicting a dry spell of at least 12 to 24 months — excepting, of course, those companies that are desperate, cash-strapped or mature and have no choice but to go for a fire sale.

HdP’s long-planned sale of Valentino would complete its departure from the fashion sector and would come shortly after LVMH Moet Hennessy Louis Vuitton dumped its ill-fated plan to build Phillips into a major auction house to rival Christie’s and Sotheby’s. As reported, LVMH on Tuesday sold a controlling stake in Phillips, de Pury & Luxembourg to its president Simon de Pury and Daniella Luxembourg.

According to sources here, HdP could announce the sale of Valentino to Marzotto as soon as this week. Negotiations are said to be in the final stages with the price for the transaction being, once again, the stumbling block. In 1998, HdP dished out a hefty $300 million, three times the direct sales of the company and a figure that seems more exorbitant today than it did back then, when bidding wars for big brands lost touch with reality.

“I think that the two parties have to settle on the price, but clearly HdP won’t get back the money it spent,” said a source close to Valentino. “I don’t think that Valentino and [his business partner Giancarlo] Giammetti are that interested in Marzotto buying their company, but the truth of the matter is that they have no say in this transaction.”

Marzotto owns a majority stake in Hugo Boss and produces licensed collections for Gianfranco Ferre and Missoni, and has been concentrating on promoting its own lines, Marlboro Classics, Lebole and Borgofiori. Last year, the company tapped designer Alberto Biani to help define Borgofiori and expand the line abroad.

A source close to Marzotto also confirmed that the deal is in the home stretch. “Valentino can become a good asset for Marzotto, but it’s all according to how [Marzotto] will interpret the brand, because one’s a fashion company and the other is a company whose core business is textiles. It’s two different mentalities, different wavelengths. It’s a gamble.”

According to the source, Marzotto’s most profitable divisions are Hugo Boss and Marlboro Classics, a line of leisurewear, but both divisions are run by independent management, which raises the questions as to whether or not Marzotto’s old-school managers, pinstripes, ties et al, are suited to renovate the design house and exploit the brand’s potential in a trendy, modern way.

Both Gucci and Bulgari’s Opera fund looked at Valentino before deciding to back away over HdP’s asking price. In the end, the three keenest bidders weren’t any of the big luxury groups, but were a textile manufacturing company, Marzotto, and the cash-rich Lawrence Stroll and Silas Chou of Asprey and Tommy Hilfiger fame and the French group Frey.

The lack of one of the five major luxury players could indicate that the deal-a-day climate for mergers and acquisitions has given way to a new sobriety. Under pressure from investors to stem eroding profits, luxury players are digesting what’s on their plate, cutting costs at every turn and even shedding troublesome or non-core assets. LVMH, Prada, Gucci and Compagnie Financiere Richemont SA have all issued a string of profits warnings as the global economy continues to struggle. Meanwhile, there are increasing fears over the Japanese economy, where more than 1 million heads of households are now unemployed.

The soft economy has changed the song of luxury goods from “buy at any price” to “profits first.”

“A lot of people are still recovering from the excesses of a few years ago,” said Andrew Gowan, luxury analyst at Lehman Bros. in London. “We’re not generally fans of acquisitions in the industry. I think you really want to be in the business of collecting stars, which LVMH is beginning to realize. You might be better off being a smaller company with a few star brands than a sprawling empire.”

In a recent research report on LVMH, Lehman Bros. urged LVMH to dispose entirely of its selective retail division, which chairman Bernard Arnault has described as “non-core.” Earlier this year, LVMH sold its Solstice retail eyewear chain to a privately held group called Solstice Marketing Corp. Safilo, the giant eyewear company, is the primary investor in that group, according to Ed Jankowski, chief operating officer of Solstice Marketing Corp. It also is said to be looking to sell its Sephora beauty chain, as reported in WWD in December, and its duty-free chain DFS. And it’s digesting Donna Karan, a long process after the American designer company reported huge losses after LVMH completed its due diligence.

“The net result of the disposal would be a group more focused on ‘core’ luxury goods, deriving almost half of its revenues and more than 60 percent of operating profits from the fashion and leather business,” the report said. “In the process, the group would also lessen its dependence on traveling Japanese by more than one-half+and thus, logically, also the stock’s unusually high correlation with the yen.”

Doriana Russo, the director of luxury goods research at Schroder Salomon Smith Barney in London, agreed “there will be pressure on management to get rid of assets that aren’t performing.” Indeed, LVMH’s sale of Phillips “signaled” what could be a new trend: getting rid of what’s not a good fit for its portfolio, Russo said.

Analysts cited Hackett, Sulka, Lancel and even Chloe as properties luxury group Compagnie Financiere Richemont might consider parting with, for example. “There are no specific operating synergies with these brands and, frankly, it doesn’t make any sense for them to be there,” Russo noted.

Analysts said they do not expect Gucci Group, which counts Yves Saint Laurent, Bottega Veneta, Boucheron and Balenciaga among its stable, to get rid of any of its properties, but said the debt-ridden Prada Group could flip recent acquisitions such as Jil Sander, Helmut Lang or Church’s, reiterating widespread market speculation. As reported, Prada sold its 25.5 percent stake in Fendi to LVMH last November for about $260 million.

Even six months ago, industry executives, analysts and consultants were predicting no end to mergers and acquisitions, arguing bargains would abound, distressed companies would call for help and conglomerates with cash would continue to shop. Gucci Group, for example, has a cash pile of about $1.8 billion from its strategic alliance with retail giant Pinault-Printemps-Redoute, but it hasn’t made a major acquisition in some time, as it focuses on turning around Yves Saint Laurent Rive Gauche and building such nascent brands as Stella McCartney and Alexander McQueen.

Last fall there still seemed plenty of candidates destined to become part of one of the mega-groups. Among the properties then considered ripe for the plucking included the fashion houses Calvin Klein (or at least some of its licenses), Dolce & Gabbana, Missoni, Valentino and Versace; the leather goods firms Goyard, Longchamp and Furla; and the jewelry concerns Chopard, Dihn Van, Poiray, Harry Winston, Pomellato and Graff.

But as the reverberations and stubbornness of the poor economic climate have become clearer, transactions haven’t materialized. Industry observers now wonder whether they ever will.

Analysts said price remains a key issue.

“The priority now is to grow through the company’s own lines,” said one European analyst, who requested anonymity. “There is a series of fashion companies on the block, but there are not enough buyers out there. Most of the possible mergers and acquisitions deals have been done and many companies that have grown through acquisitions are heavily indebted today.”

Willing sellers have the expectation of the high multiples that were possible from 1998 to early 2000, during the height of the acquisitions frenzy. A new zenith was reached with the joint acquisition of Fendi by LVMH and Prada, who paid an unprecedented 33 times the bottom line in an industry where 25 is considered a very high multiple. Meanwhile, buyers have the expectation of bargain prices, given that valuations for luxury concerns have fallen at least 20 percent in the past six months.

“If you’ve got a well-run business, you wouldn’t sell it now,” Gowan said, citing Chanel and Ferragamo as examples. “In theory, it’s a cheap time for valuations, but it’s a theoretical cheap. You don’t have sellers, most importantly, and buyers are distracted.”

Russo agreed: “Sellers have a certain benchmark in their mind and buyers are not willing to pay those ridiculous prices because they know how difficult it is to get synergies out of those transactions.” She said the fact that Calvin Klein and Valentino have not yet sold suggest big discrepancies on price. As reported, Klein already has turned down a $900 million offer for his company prior to Warnaco filing for Chapter 11. And even those who once considered selling to a larger group now recognize they might have made a mistake. “I am happier than a year ago,” Giorgio Armani said earlier this week. I decided to turn down very flattering offers for my company and now I am happy I did it — also considering what has happened in the meantime to other groups.”

What’s more, a lot of firms that may be on the block need restructuring, which has proved to be a difficult and costly enterprise. Russo said the question is no longer “How much can we develop the brand?” but “How much will we have to spend to restructure it?” That was the problem of the former Pegasus Group, which attempted to become an American LVMH by snapping up such brands as Miguel Adrover and Judith Leiber. It quickly unraveled because of the huge investment needed to build these into major brands.

“The economic side of the transaction becomes more important than the strategic side,” she said. “They need not only to be able to manage growth, but to be able to manage costs. This is the major challenge for the luxury goods companies at the moment.”

Gucci Group chief executive Domenico De Sole was traveling in Asia Wednesday and could not be reached for comment. However, he reiterated as recently as Monday in a press conference in Seoul that he is receptive to good acquisition opportunities.

“We have a lot of work to do with the brands we have acquired,” a Gucci spokesman said, paraphrasing De Sole’s remarks. “But still, we do have cash available for acquisitions if we find the right thing to buy. We don’t just collect brands.”

Analysts at Bear Stearns, in a January research note, wrote that while sales of luxury goods have recovered from the dramatic drop-off in the second half of September, the sector remains “extremely volatile, making it particularly difficult to make sense of the broader marketplace for luxury goods.”

One major factor impacting luxury goods sales has been the consumer pull-back on traveling and tourism. “Given the precarious state of the global economy, which includes rising unemployment rates, sinking consumer confidence and a corporate emphasis on cost-cutting initiatives, we expect that both business and leisure travel will remain depressed for at least a year,” the analysts wrote. They concluded, “For all of the same reasons, we expect sales of luxury goods to remain weak for at least the next six months.”

Dana Telsey, the lead retail analyst at Bear Stearns, said Wednesday that her firm is very bullish on the luxury sector. She noted that there are 7.2 million individuals worldwide with liquid net worth over $1 million, and that the high net worth individual category is growing over time. In addition, the luxury goods industry is an $80 billion industry growing in average of 6 percent over the past ten years. In the last few years, the growth rate has been closer to 8 percent.

Telsey isn’t comfortable giving out growth projections for 2002 yet, noting the paucity of available information from holiday sales since many luxury firms won’t be reporting that until next month.

“Certainly luxury didn’t grow as fast in 2001 as in past years. We’ve seen some moderation from the lack of tourism and the Japanese not traveling. The luxury sector should improve, however, as the economy improves.”

Telsey believes that the growth initiatives many luxury goods companies have undertaken in the last few years — broadening product assortments, extending price points and expanding geographic presence — will position most companies for long-term earnings growth.

“A lot of these luxury companies still have room to expand their store base, whether in certain parts of Asia or in North America. While we see a slowdown of the pace of acquisitions, the focus will still be on good core luxury brands. LVMH was the most acquisitive, so it had the greater potential to make some divestures. I don’t think this is a hint of any new trend [toward contraction.] There are still many brands to be acquired. In Italy alone you have in excess of 50 smaller, good luxury brands that could be acquired,” Telsey said.

Carlo Pambianco, owner of a Milan-based luxury goods consulting firm, said he did not register a drop in merger and acquisition activity last year, counting 155 transactions compared to 158 the previous year. In the first 50 days of the year, Pambianco counted 21 transactions. “If this pace continues, we will have around 153 deals by the end of the year, so there wouldn’t really be a big difference in number,” he said. “The difference is in the size of the companies. Major labels are not infinite and they are out of the market. These deals may not be cover-story material, but they exist, and there are so many sectors that are changing, from textile to sportswear.

“In the first two months of 2002, I’ve noticed a psychological block, but I forecast an acceleration of mergers and acquisitions for the smaller fashion houses in the next two to three years,” he continued. “Smaller and medium fashion houses have to sell. Even if business is slower, the market today rewards bigger groups. Those companies in the medium range are the ones that are suffering the most now, and they have to find a solution, either with a relaunch or a sale.”

Others aren’t so sure the feeding frenzy will ever return. Christine Kilton-Augustine, retail and apparel analyst at ABN-AMRO, observed, “I wonder if maybe these big conglomerates will start to unwind and whether there’s really a case to be made for synergies at the back of the house for the luxury goods end of the business. You have to wonder how big can any one business get. While you can cobble businesses together and get synergies in advertising leveraging, becoming part of LVMH is not the right answer for everybody. To do it successfully, you still have to have the right brands and there are many good, high-end brands out there that are still independent.”

Frank Badillo, economist at market research and consulting firm Retail Forward, said, “The luxury sector will remain weak for at least the first half of the year, with some hope of a second-half comeback. There are still some question marks out there and the hoped-for rebound in the economy isn’t assured yet. One factor will be whether the job market is on the mend yet. I don’t think so. There may be some new job cutting that will keep the consumer cautious and keep luxury goods under wraps.”

– Alessandra Ilari, Luisa Zargani, Milan; Vicki M. Young, Melanie Kletter, New York and Miles Socha, Paris

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