It is traditional to gush at engagements. Luxury group LVMH did not hold back as it put a $16.6bn ring on Tiffany on Monday. It declared the US jeweller “stood for love”, as it promised a sparkling premium to its shareholders. Sceptics might mutter that love is blind. But LVMH’s record suggests boss Bernard Arnault will make the union work.
The most compelling aspect of the opportunity for LVMH is its rarity. There are very few tempting acquisition targets in jewellery. The high barriers to entry — resulting from the need for vast amounts of both capital and trust — mean it is not a crowded market. Yet it is one of the fastest growing sectors in luxury. The Tiffany acquisition will put LVMH in pole position in luxury jewellery with an estimated 18 per cent share. That is bad news for its main rival, Cartier-owner Richemont.
LVMH is stumping up handsomely. The deal is based on an enterprise-to-ebitda ratio of 17, more than 50 per cent higher than Tiffany’s 10-year average. And while it is a lot less than the 28 times figure paid for Italian jeweller Bulgari, that 2011 deal was in the aftermath of a recession.
The $135 per share cash offer is about 37 per cent over Tiffany’s undisturbed price. That premium cannot be justified by cost savings. The autonomy of LVMH businesses is preserved under the model developed by Mr Arnault, Europe’s richest man. The scope for pooling functions is limited, though insurance and some other costs will be cut.
Even so, Tiffany should be worth more within LVMH than outside it. The French company’s financial clout will help it boost its marketing and accelerate its retail expansion in Asia. It could also benefit from being free of the pressures of quarterly reporting. Tiffany may have been paring its marketing costs recently, as it struggled to turn the business round.
Investment is needed to revive a tarnished brand, but LVMH should be able to raise Tiffany’s operating margins over time. They are under 17 per cent, although have been as high as 19 per cent in the past. LVMH has form when it comes to improving the profitability of acquisitions. After Bulgari was acquired, its sales doubled while profit rose fivefold. Analysts at RBC think LVMH can expand Tiffany’s operating profit margin to 23 per cent by 2025 and grow its top line at a rate of 7 per cent. That would allow LVMH to deliver a post-tax return on the acquisition price above its cost of capital by 2025.
Marriage, as the saying goes, is an eye-opener. But the risks to LVMH are small. Its balance sheet is healthy — its net debt-to-ebitda ratio will only increase to about 1.5 times. And the company has a stellar record in getting the most from its acquisitions. That is one of the main reasons LVMH’s share price, little changed on Monday, is up 60 per cent this year. Its €205bn market capitalisation exceeds that of four of Europe’s largest banks. There is no reason Mr Arnault should not replicate his past M&A success.