Third Point holds a ~$700 million stake in EssilorLuxottica (XPAR:EL, Financial) (the “Company” or “EL”), which we purchased in early 2019. EssilorLuxottica is the world’s largest eyecare company, generating over €17 billion in revenue and nearly €4 billion in EBITDA annually. Formed in late 2018 through the merger of Essilor,the world leader in ophthalmic lenses, and Luxottica, the world leader in eyeglass frames and sunglasses, the pro forma Company has the industry’s only vertically integrated business model from design to manufacturing to retail sales. The logic behind the merger was elegant: combining frames and lenses allows the Company to control the entire eyewear value chain and transform an antiquated industry structure. Both consumers and shareholders should reap the benefits.
Eyecare is an attractive industry, with over €100 billion in revenue and several structural growth drivers. Over the next 30 years, secular trends including an aging population, consumer lifestyle changes such as staring at screens and less time outdoors, and emerging markets penetration will lead to ~2 billion more consumers with vision correction needs.3
EssilorLuxottica has many of the key characteristics we look for in an investment: compelling end”market growth in a defensive category, strong market share, high returns on invested capital, potential for incremental capital deployment, and competitive moats created by brands and technology.
The combined EssilorLuxottica has the potential to grow well ahead of the industry. Eyecare is an underdeveloped consumer category – online and omni”channel selling is in its infancy, the retail channel is highly fragmented, and many consumers, particularly in emerging markets, do not have access to vision care. EL plans to use its scale, global footprint, and product innovation to optimize the market. For example, the Company is improving access to vision diagnostics equipment and leveraging its consumer touchpoints to increase awareness around vision correction. By driving conversion rates of high”value lens coatings and premium eyewear brands, EL will accelerate growth across the eyecare industry.
Despite EL’s scale and strong brands, the Company sells less than 10% of glasses purchased worldwide each year and independent optical stores account for over half of the global market and upwards of 80”90% in emerging markets like India and Latin America. This fragmented industry structure, combined with EssilorLuxottica’s clean balance sheet, presents a significant opportunity for consolidation, particularly in retail distribution. These types of acquisitions have proven highly accretive for EL due to its ability to in”source procurement and distribute well”known brands through a new retail network. The proposed acquisition of GrandVision is the latest example of this successful strategy.
Synergy Opportunity
The merger provides a runway to create additional value over the next several years. Our analysis of potential merger synergies points to over €1 billion in additional profit through efficiencies and revenue growth, almost double the Company’s current targets. In the near” term, this will be driven by cross”selling to wholesale customers, in”sourcing lens procurement, and supply chain efficiencies. The longer”term opportunity to disrupt the industry value chain is even more appealing: combining lens and frame to shrink raw material need and waste, reducing shipping costs by merging prescription labs with global distribution hubs, and providing a true omni”channel sales offering. These initiatives will transform the way glasses are sold, significantly improving the customer experience.
The combination of two powerful franchises in the eyecare space, meaningful top and bottom”line synergies, and ongoing capital deployment, present a compelling long”term opportunity to increase earnings. We expect EssilorLuxottica to grow earnings and free cash flow at a mid”teens CAGR for the next several years. Combined with the GrandVision acquisition, we expect EL to earn over €8 of EPS in 2023, nearly doubling the figure from 2019.
Governance
While both Essilor and Luxottica had impressive track records of value creation as independent entities, the combined Company is challenged by a poor corporate governance framework. The 2017 Combination Agreement currently in place effectively permits Essilor and Luxottica to continue to run as independent companies. A deadlocked board and management team has slowed integration and strategic decision making.
Despite its many advantages, EssilorLuxottica is losing favor among shareholders who are frustrated by the lack of synergy realization. With an array of potential threats – upstartbrands, insourcing by major fashion houses, and disruptive technologies – the board and the Company should accelerate leadership transitions and delineate a timely merger strategy.
We have met with many of EL’s executives and shared with their board our views formed through many years of experience in partnering with companies to upgrade governance and drive strategy. We are confident that actions to improve governance can unlock a compelling multi”year value creation opportunity that will benefit all stakeholders – shareholders, employees, and the billions of consumers who will gain access to life changing vision care.
From Daniel Loeb (Trades, Portfolio)'s Third Point third-quarter 2019 letter.
