Monday, February 16, 2009

Ultra Luxury Watches the Next Shoe To Plunge

A little over two years ago, Los Angeles-based private equity group Leonard Green acquired luxury watch distributor Tourneau, best known for its 57th street and Madison flagship New York store, in a $355 million going private transaction, which represented a then 12.5x multiple of its $28 million EBITDA. As part of the transaction, Leonard Green invested over $220 million of equity, and raised $130 million of debt. Looking at recent trends in luxury watch sales, it is safe to assume that if the equity invested in Tourneau is not currently worthless, then it will be very soon. It is also likely that GE Capital and TCW, which provided the debt financing, are also looking at losses on their investment.

Makers of luxury watches are staring at at an abyss, as marginal demand from U.S. bankers and Hong Kong tycoons has disappeared. The luxury watch industry business model has historically been one of roll ups, not so much organic growth, as until the hyperbolic wealth creation over the past decade (and current destruction), there was limited demand for $5,000 timepieces. Swiss export watch sales have more than doubled from CHF 700 million in 1998 to over CHF 1.4 billion in 2008. Assuming a full deleveraging cycle eliminates the excesses of the past decade, it is easy to see sales plummet rapidly by as much as 50% over the next several years

The conglomerate nature of the business is obvious when one considers that only 5 major companies own the majority of luxury Swiss watch brands in the world (excluding Rolex which is a one trick pony):

Now, as the marginal purchasers disappear, Swiss watch makers are left scratching their heads how to maintain the top line growth and prevent the bottom line collapse. One good indication of the sad state of the market is listening to what these companies themselves have to say:

"October was very difficult. November is very difficult, in line with October, no worse no better. We anticipate a bad Christmas. 2009 will be very difficult." (Bulgari CEO Francesco Trapani )
"I am not expecting an overall increase in the watch market next year. But I am not expecting a sharp drop either. I think it should be just sluggish. Stable to slightly negative. Asia used to be stronger, it is still pretty steady, but growth rates have come down from last year, but it is still growing pretty well." (LVMH CEO Jean-Christophe Babin)
“Since October, the real economy has begun to experience dramatic repercussions from the financial crisis. Demand for luxury goods...has fallen dramatically and Richemont is currently facing the toughest market conditions since its formation
20 years ago. Given the current economic climate and the uncertainties facing us, we see no cause for optimism. We must assume that there will be no significant recovery in the foreseeable future.”
(Richemont Q309 trading statement, 19 Jan.09)

"Last year was an absolute record. We expect a decline this year and in 2010. As watch export data shows, we all suffered a decline in sales in the last two months." (Rolex CEO Bruno Meier)

"In addition to an unfavourable base effect, this decline clearly illustrates the curb on growth suffered by the industry as a result of the world economic climate. The annualised variation slowed to 8.7%, falling below the 10% mark for the first time in more than three years. At a monthly level the industry had not experienced a decline since March 2005." (Federation of the Swiss Watch Industry, November 08 commentary)

What do the statistics say: the drop is already being felt. While 2008 overall was a strong year, with Swiss watch exports growing 6.7% relative to 2007, mostly due to H1 strength, December demonstrated a substantial drop in export sales, down 7.6% from a year prior. Furthermore, the bulk of watch sales has been concentrated in the gold and platinum category, and the highest priced segment of the market (watches over CHF3,500) has yet to demonstrate a drop. This ultra-luxury segment has averaged 25% growth since 2006, compared to 1% for the CHF250-500 category and flat for the CHF500-3,000 segments.

Curiously, Swiss watchmakers are hoping the decoupling theory plays out as the U.S. accounts for only 19% of watch sales, while Asia is an impressive 46%. If recent Chinese import data is any indication, the bottom will fall out of the watch market with a vengeance.

While December 2008 finally demonstrated a drop in export sales in the US, Hong Kong, China, Singapore and Spain, the rest of the market, especially Japan, France, Italy and Germany, has yet to exhibit the drop that will inevitably occur.

The next chart indicates that the tide is only now just turning in the luxury watch sector, which, as a true lagging indicator, will present significant pain to public luxury watch makers such as Richemont, LVMH and Bulgari.

Of course, it is premature to declare luxury watches a dead concept. There will always be people willing to shelve out a lot of cash for that one unique collector's piece (regardless of what maintenance costs may end up being over the long run). And to see the fanatical dedication of an entire community of watch lovers, one should just observe the lengthy forums at Regardless, for conglomerates which have already rolled up the market, with few profitable private brands left outstanding, growth through acquisitions will be complicated, while relying on organic growth at this point will be foolish. Thus, as investors we would be very cautious about bullish positions in such stocks as LVMH, Bulgari and Richemont (Zero Hedge has no positions in these securities).

The one industry which will undoubtedly suffer are undiversified distribution outlets, of which Tourneau is a prime example. As consumers trade down, very few if any will be willing to give the middlemen a 20% markup simply for holding inventory and providing brand legitimacy, as more and more vetted direct vendor operations arise.

In retrospect it is amusing to see just what the P&L assumptions embedded in the Tourneau acquisition were. Not surprisingly, sales were supposed to rise arithmetically in perpetuity as the company generated more and more free cash flow. Instead, it is likely that working capital at the company has ballooned, as Tourneau has been unable to unload inventory, having to fund the deficit with increasing amounts of debt, which has likely eradicated any invested equity value.

As the credit cycle turns, more and more tangential offshoots of the uncontrollable spending spree will be impacted. What is true for luxury watches, will easily apply to such market top-tick gimmicks as ultra premium Vodka, gold plated iPhones, $300 bottle service at trendy night clubs, and many more artifacts of a conspicuous consumption economy that is now unwinding with a bang.
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Anonymous said...

Although I'm in agreement with your analysis, no discussion on this segment of the market is complete unless Patek Philippe is included. Many collectors are still paying record prices for "no excuse" examples from this manufacturer. They are family owned, and many collectors elevate their status to a form of art. Time will tell if this continues in this environment.

Anonymous said...

Excellent run-down of an industry plagued by not only a counterfeit black market but also a booming gray market as well. Pretty hard to Tourneau to hit it out of the park. In any market.

Anonymous said...

I will stop buying expensive bottles of Vodka at Pure when you pry the credit card from my cold, lifeless corpse. :)

Anonymous said...

Kudos to the IBanker who got $355m with those historical numbers - hook, line and s(t)inker...

cool_stuff_or_not said...
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cool_stuff_or_not said...

Very good post, it's probably 1980 for the swiss makers again, and again they only have themselves to blame for the current problems ...

I also wonder why Rolex is kind of missing from the article - as an industrial machine-made builder of rather inexpensive watches of which the marketing certainly accounts for more than 50-80% of the actual selling price it will have an even bigger problem given that they sell to the worst-affected segment = the middle-class, than for instance Lange which is directed to the very rich ...

Unknown said...

rolex is privately held and does not disclose sales figures, not even production numbers.

ChristyACB said...

Excellent rundown! Thanks for the giggle at the whole gold plated Iphone stupidity.

Anonymous said...

I think your analysis is mediocre as best. While I agree that the Tourneau transaction was clearly a flop, Your analysis of the industry is severely lacking. The concept that the industry will contract to 5 conglomerates (excluding Rolex) is far fetched and demonstrates your lack of knowledge about brands, and brand their equity. The market is weak in the US and some of Europe, but South East Asia and parts of Europe are still holding strong. Worldwide the high end market for high end pieces(above $10,000 USD) is growing/ holding strong.

Sure, the industry is slightly contracting, but so say it is "next to plunge" is laughable. Obviously the double digit annual grown seen over the past 5 or so years will not sustain in this economic situation. Compare the contraction of this industry to others and I think you may be surprised that it has shown less of a contraction. No bail outs pending for the watch industry.

For anyone who is interested in non-biased data, I would encourage them to visit the industry source at

Your blog isn't worth the time it took to read, and your other posts are worse than this one..."Things you own end up owning you"...You certainly hold no bias.

Go ahead and delete this post as I am sure you will. Hopefully your ego remembers it, and you think twice before making such bold predictions in the future.

Tyler Durden said...

i appreciate the anger although i am very confused by what your point is. are you i) concerned about the watch industry, ii) disagree that watch sales will drop, or iii) displeased with the thematic content of other watch unrelated posts on this blog?

Anonymous said...
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