LVMH: Saddling Up for a Bumpy Ride
How LVMH can achieve growth after a failed bid for Hermès
On July 10th, 2012 an all-out war erupted in the world of fashion. Behemoth luxury goods conglomerate LVMH Moet Hennessy Louis Vuitton SA (LVMH) announced their 22% stake in Hermès, an ultra-luxury fashion house, shocking the Hermès family. LVMH had delayed the announcement of their increased stake in Hermès through the use of cash-equity swaps. Alarmed by this aggressive increased stake, Hermès filed a lawsuit against the conglomerate accusing LVMH of insider trading and manipulation of their share price. In response, LVMH countersued for slander, blackmail, and unfair competition. This complex situation raises several questions about the future of Hermès, and LVMH’s motive for such an aggressive acquisition strategy.
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LVMH is the largest player in the luxury goods market. To date, they have acquired over 60 luxury goods companies, ranging from wine & spirits to leather goods and fashion houses. In 2011, LVMH had sales of over €23.5B, largely from the fashion and leather goods segments, and more specifically the Louis Vuitton brand.
The Hermès brand has long been a strong player in the ultra-luxury goods market, offering products priced from €200 to €150,000. With 2011 sales of €2.8B, Hermès maintains its brand exclusivity by restricting distribution and allowing customers to overflow onto waiting lists lasting over one year simply to purchase a renowned ‘Birkin’ bag.
Changing Industry Trends
The luxury goods industry can be divided into three segments: accessible, aspirational and absolute. The most exclusive group is the absolute, which has been the fastest growing segment from 2005- 2010, with a 6% CAGR compared to luxury goods overall at 3% CAGR. This trend is forecasted to continue with the absolute segment growing at an 8-10% CAGR until 2014. The disproportionate growth of absolute brands decreases LVMH’s ability to serve ultra-luxury shoppers due to the diminished perception of their flag- ship Louis Vuitton brand. Unlike Hermès, Louis Vuitton is losing brand value due to overexposure and wide distribution. With the potential commoditization of Louis Vuitton, LVMH may not be positioned to fully capitalize on changing industry trends. Strategies exist for Louis Vuitton to refocus on exclusivity and restrict distribution to shift upmarket, but these will not satisfy LVMH’s immediate desire to service the growing ultra-luxury goods segment.
The Hermès Conundrum
Hermès’ current success in the ultra-luxury segment makes the company a seemingly attractive target to address LVMH’s short-term desire to serve the ultra-luxury consumer. However, there are two primary obstacles preventing a successful adition of Hermès to the LVMH portfolio: Hermès’ share structure and the firm’s misalignment with LVMH’s strengths.
A hostile takeover by LVMH is highly unlikely given that 63% of Hermès shares have been transferred to a private holding company controlled by the Hermès family. The family’s primary concern is that LVMH will capitalize on production synergies that will ultimately diminish the quality of Hermès products. In the past, LVMH has offered all-share deals to target families concerned with forfeited control and ownership. In this case, however, LVMH would need to pay an exorbitant premium to obtain buy-in from the Hermès family. Acquiring Hermès would be unordinary for LVMH, as the conglomerate normally targets underperforming and undervalued firms. Hermès is currently valued at a trailing P/E of 34.7x compared to LVMH’s P/E of 18.5x. At these ratios, this acquisition would be heavily dilutive for LVMH in an all-share deal. Beyond the difficulty of striking a deal and divergent views as to the potential synergies, the primary risk is that acquiring Hermès represents a stark departure from LVMH’s core competencies. Acquiring undervalued and underperforming luxury goods companies containing history and culture has been a signature strategy for LVMH. Hermès’ strong financial performance makes the company unlike LVMH’s previous successful acquisitions. There is little value to be created through brand growth and recognition. Furthermore, it is becoming clear that LVMH will not win the battle for control of Hermès due to the Hermès family’s staunch resistance. LVMH should step away and utilize its resources in a different manner.
Short-Term: Who Instead?
There are several other acquisition targets that better align with LVMH’s traditional strategy. UK jeweler and ultra-luxury brand Asprey is a firm with a strong reputation, named the number two ultra-luxury jeweller globally by the 2012 Luxury Brand Status Index. Asprey has suffered financially, emerging from restructuring in 2006, and have yet to turn a profit. The firm’s focus is on jewellery, though they do have an extensive portfolio of leather goods. Asprey’s reputation for high quality craftsmanship could be paired with LVMH’s expertise to increase the relevance of Asprey’s handbags. From a broader perspective, there are alternatives to Hermès that sync with LVMH’s historical acquisition strategy.
With other brands available to satisfy LVMH’s short-term ambitions of serving ultra-luxury shoppers, abandoning the Hermès acquisition is a viable option. LVMH could sell down their shares in Hermès and use the significant return to acquire another brand to compete with Hermès directly. Furthermore, LVMH would still have remaining funds to develop a long-term solution to moving Louis Vuitton upmarket and back to its position as an ultra-luxury leader.
Long-Term: Entering Asia
The luxury goods industry’s short-term trends justify an acquisition geared toward serving absolute shoppers. However, when the industry is viewed by region, LVMH’s necessary long-term focus becomes clear. The luxury market can be split by geographic regions: Europe, Americas, Japan, Asia, and Rest of World (RoW). Asia has a CAGR over 2011-2014 of approximately 22%, compared to the Americas at 4-6%, and Europe at 2-4%.
Asia’s industry leading growth is driven by favorable demographic trends and strong economic growth in China. The Asian market mirrors the changing industry dynamics, with strong absolute growth from Asian consumers whose preferences are moving towards higher-priced and more exotic products. Currently, Chinese customers account for approximately 20% of global luxury consumption; however, they often make their purchases while travelling abroad, with some estimates that Chinese customers buy half of all luxury goods sold in Paris, London, and Milan. This illustrates an opportunity for a strong brand to repatriate these lost sales. Although this is a high risk strategy, if properly approached and captured, this segment could revolutionize the luxury goods industry worldwide.
An opportunity to expand into the Asian markets has already been explored by Louis Vuitton. In July 2012, Louis Vuitton unveiled a new collection of handbags by Japanese artist Yayoi Kusama. This new line of products spurred sales growth and generated buzz around major fashion capitals of the world. Although this new collection has generated some sales growth by appealing to the Asian market, consumer tastes vary greatly between Japan, which is slowing in growth, and China, which is rapidly expanding. Chinese consumers place high value in “recognizing and patronizing indigenous designers”. Given its history, mainland China is generally less susceptible to Western influence than other Asian regions such as Japan or Hong Kong, where markets are overflowing with Western products.
Consumer sentiment towards Westernization may be less powerful in China, where domestic preferences run deep. Although Chinese consumers will continue to look to the West for fashion trends, their individual preference towards historical Chinese elements being incorporated into fashion will strengthen as well.
Capitalizing on Chinese Growth
LVMH can satisfy this market by taking the quality of Louis Vuitton products and putting a Chinese “twist” on the design. Hiring a Chinese designer to create a completely new line of handbags, based on the fashion designs that were popular during historical Chinese dynasties, will cater specifically to the upscale Chinese consumers. The leather and production will continue to be sourced from Italy in order to maintain the quality of products. The interior fabric with the Louis Vuitton monogram should also be kept as part of the design for this product line to be consistent with the Louis Vuitton brand. The new line should only be available in Chinese flagship Louis Vuitton stores in order to maintain exclusivity. Affluent customers will need to travel to China to purchase a handbag from this new line, creating a comparable experience to the Birkin’s infamous wait-list. Similar to Dior’s successful “Secret Garden” campaign, shot in Versailles to pay tribute to the brand’s French roots, this campaign should link to China’s rich history. Although LVMH has pursued a similar strategy in the past, this brand extension will not come without significant hurdles.
LVMH must be able to secure top Chinese talent in order to establish a genuine cultural connection. Although in the short-term, traditional styles may still dominate the Asian market with Western influenced luxury goods, careful attention to shifting consumer preferences will allow LVMH to win the battle for this high growth region in the long-term. As we have seen with Louis Vuitton and its rapid distribution growth, luxury brands are not invincible. They take years to build, but can quickly be degraded through commoditization or duplication. In the short-term, LVMH must step away from their current pursuit of Hermès and utilize their capital to fund projects that outmaneuver Hermès in the absolute segment. Moreover, in the long-term, LVMH must develop strategies to capture the growing Chinese luxury market who will ultimately decide which players thrive and falter in the future. If the Hermès experience is to teach LVMH anything, it is that it must take immediate action if it wants to solidify its dominant position in the luxury goods market.