By
Bloomberg
Published
January 22, 2024
When Bernard Arnault presents LVMH's annual earnings on Thursday, investors and analysts will be hanging on his every word as they try to decipher the direction of high-end demand.
However, LVMH is being penalized by shareholders for its disparate set of businesses. Breaking the giant could generate significant value for investors. Incidentally, it could help resolve the looming succession issue as founder and CEO Arnault moves closer to handing the reins to the next generation.
LVMH suffers from a conglomerate discount, because it not only includes its two biggest brands, Louis Vuitton and Dior, but also watches and jewelry, cosmetics, wines and spirits, duty-free shopping and hospitality. LVMH shares trade at about 16 times this year's estimated earnings before interest and taxes, less than half of Hermes International SCA's 34 times.
Some discount for Hermes is guaranteed. In fact, the Birkin bag maker can control demand for its iconic products. Meanwhile, LVMH's valuation could also reflect concerns that its scale means there is less room to grow and that Dior is slowing down after a remarkable run.
However, the reduction seems harsh. After all, Louis Vuitton is expected to generate 12.3 billion euros ($13.4 billion) in operating profits this year, an impressive 51.8% of sales, according to HSBC Holdings Plc estimates.
Even at the simplest breakup valuation, the justification for a split is compelling. For example, by placing Louis Vuitton and Dior at a multiple closer to that of Hermès than the rest of the fashion and leather goods sector, these brands could be worth as much as the group as a whole, which currently has an enterprise value of a few euros. 360 billion.
Luxury goods groups don't do “buy one, get one free” deals. But that's actually what LVMH investors are getting. The other fashion and leather goods houses within the LVMH group, such as Loewe, Fendi and Celine, are running out of money, as are beauty retailer Sephora, jewelers Tiffany and Bulgari, and wine and spirits. That seems like a good reason to explore a separation.
Questions about LVMH's structure should be motivated primarily by valuation. But dismantling the group could also help avoid potential obstacles to succession. Arnault will turn 75 in March and his five children hold management positions within the company. In the end, he will have to decide whether he chooses one to be CEO or divides the responsibilities between them. Handing the reins to an outsider seems unlikely, although he could name a non-family member as chief executive until one of the next generation is ready to take over, emulating the deal at Prada SpA.
Of course, no way to break up LVMH would be perfect. It could be split into four or five separate businesses, depending on whether Sephora remains within a retail division or this unit is combined into an expanded cosmetics and fragrance company, which includes brands such as Parfums Christian Dior, Guerlain and Fenty Beauty.
There would also be some additional costs if each arm had to support its own central functions and head office. Individual companies may have less influence than the giant when it comes to buying advertising, securing the best store locations, digital marketing, and recruiting top talent. But synergies between luxury brands are relatively few. And an independent fashion and leather goods business would still eclipse its rivals.
The bigger question is whether Arnault Sr. would really take an ax to the empire he's spent 40 years building. In fact, he's been taking steps to keep it together. In 2022, he orchestrated increasing the age limit for his functions by five years, to 80. He has also strengthened family control, restructuring his holding company, Agache SE, into a limited company, with the patriarch as managing partner and the capital social in power. equally among the five children.
But the debate will only intensify if the conglomerate's discount holds (right now, luxury valuations are also depressed by slowing demand after the extraordinary boom of the last three years) and as we get closer to a decision on The succession.
Alternatively, a strategic change could force you to put it on the agenda. A merger with Chanel could require the separation of the expanded fashion and leather goods unit. Meanwhile, Diageo Plc owns 34% of LVMH's wine and spirits division. The acquisition of the rest by the British company has long been considered a possibility.
Whether LVMH is more valuable as a whole or divided into its constituent parts is more of a PowerPoint idea for now. The scale of the company and the family's control make activist intervention unlikely. But for investors, it's a conversation that needs to be had.
