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Have Tiffany and the diamond market parted their ways?

09 december 2019

LVMH, the global luxury giant with a French residence permit, acquires US-based Tiffany clinching the industry’s largest deal worth $ 16.2 billion. The purchase will not only strengthen the position of LVMH in the jewelry business and provide access to a wider consumer network in the United States and Asia, but may affect the perception and value of diamonds, which are the main jewelry component in terms of cost. At first glance, the purchase of Tiffany may be explained by the fact that the major owner of LVMH, Bernard Arnault, who is second only to Jeff Bezos and Bill Gates on the list of the world’s richest people, sees great prospects for diamond jewelry demand. But we may equally assume that Tiffany, accepting the offer of absorption with a premium of no more than 10% of its current quotes and abandoning independence, either does not see such prospects or regards them as very moderate.

Indeed, Tiffany - a brand that is synonymous with exquisite and expensive diamond jewelry - is currently experiencing hard times. Consumers are not craving for jewelry as was the case at the time of Breakfast at Tiffany's, the legendary movie starring Audrey Hepburn, who dreamed about shopping in the boutique of the same name. The change in consumer preferences, which is not in favor of jewelry, is affecting the market and this prompted Tiffany to change its traditional marketing policy last year, targeting a younger audience with “fashion icon of the decade” Kendall Jenner and actress El Fanning. The idea of ​​responsible consumption will re-direct many buyers to cheaper synthetic stones making them abandon the traditional accessories that for decades have generated profits for all stakeholders in the “diamond pipeline,” being especially benevolent to large jewelry retailers. Giants are losing ground to smaller local players - according to a Morgan Stanley survey, brands now account for only 23% of global jewelry sales. The stronger U.S. dollar is also bearing heavily on Tiffany’s performance reducing the buying spree fed by tourists, which is vital for the company.

Tiffany’s comparable sales in the first half of the year decreased by 4% (in America by 5%), while the company’s sales of wedding jewelry fell by 4%. Revenues went down by 3% to $ 2.1 billion. The continuing unrest in Hong Kong and the trade war between the United States and China did not contribute to any obvious improvement of the jeweler’s results in Q3 2019.

By October 28, 2019, when the media first announced the upcoming deal, Tiffany shares fell 35% from their highs in mid-2018, which was a good year for the company. The expectation of their further decline after the publication of Tiffany’s third-quarter results only spurred LVMH to make a bargain without waiting for industry rivals to take advantage of the jeweler’s weakness, according to Reuters. The parties discussed the deal in mid-October, during the opening of the LVMH factory in Texas, the first in the United States, which was attended by President Donald Trump. It turned out that Trump is well acquainted with the products of the French concern, having spent a lot of money on Louis Vuitton bags.

The Italian trio – LVMH managing director Antonio Belloni (65 years old), Tiffany board member Francesco Trapani (62 years old) and Tiffany CEO Alessandro Bogliolo (54 years old) - played a key role in the deal, said Reuters. Trapani and Bogliolo worked together at Bulgari absorbed by LVMH in 2011, after which Trapani oversaw the integration of Bulgari into LVMH for several years and later launched a foundation, which consolidated a large stake in Tiffany and was instrumental to replacing the company’s former head Bogliolo in the course of an activist campaign. Bogliolo's efforts to increase Tiffany's attractiveness amid a global slowdown in jewelry demand have been closely monitored by Belloni, who attracted yet another participant of the Bulgari takeover, Italian banker Luigi De Vecchi from Citibank, to close the deal before Thanksgiving on November 28, 2019.

At first, LVMH offered Tiffany $ 14.5 billion ($ 120 per share), but the offer was rejected. As a result, the bidding went up to reach $ 135 per share, and the deal was closed at $ 16.2 billion. This will eclipse the acquisition of Bulgari, which cost $ 5.2 billion in 2011, and the purchase of a stake in Cristian Dior two years ago for $ 7 billion. The price of this transaction, which claims to be the largest for EU companies in 2019, turned out to be 37% higher than Tiffany quotes at the time before the first information about the intentions of LVMH appeared. However, taking into account the growth that followed, the premium by the date of final approval was about 10% (although Tiffany quotes would most likely have returned to their original level, should the transaction be rejected). At the same time, many analysts rated Tiffany shares higher - for example, the price target from Cowen was $ 160 and from Credit Suisse - $ 140. The transaction will be fully paid in cash and closed in mid-2020. The buyer is a Delaware-based subsidiary of LVMH bearing a "talking" name of Breakfast Acquisition Corp.

The purchase will provide LVMH with access to the Tiffany network of 300 stores considered one of the most successful in the world, which will help LVMH expand its presence in North America and Asia. LVMH will strengthen its position in competition with its main rival in the sale of luxury goods, the Richemont Group, which owns Cartier, Van Cleef & Arpels, Montblanc and Vacheron Constantin. Having a capitalization of about $ 220 billion, LVMH is aggressively expanding in the luxury market and spent more than $ 12 billion since the beginning of 2016, while in the jewelry sector LVMH is still inferior to Richemont. Kering and Hermès are among other major market participants and competitors of LVMH.

Currently, LVMH is the world's largest manufacturer of luxury goods (75 brands), including accessories (Louis Vuitton and Fendi), cognac, champagne (Moet & Chandon, Dom Perignon, Veuve Cliquot and Krug), watches (TAG Heuer, Hublot, Zenith), jewelry (Bulgari, Chaumet, Fred, as well as a joint venture with De Beers), clothes ( Givenchy, Loewe, Marc Jacobs, etc.), perfumes and cosmetics (Christian Dior, Guerlain, Givenchy, Kenzo and Sephora, a chain of personal care and beauty stores). LVMH has 4,600 stores in 70 countries, which employ about 156,000 people. Despite a weakening appetite for luxury amid a trade war between the US and China, LVMH sales are growing and exceeded analysts' expectations in the third quarter going up by 11% to 13.3 billion euros.

For LVMH, the purchase of Tiffany means stronger positions in the jewelry and watch segment, where the French giant is not as smart as in fashion accessories and cosmetics. Now this sector accounts for only 9% of total LVMH sales, and it was this sector - mainly represented by Bulgari - which was one of the drivers of the consortium's sales growth in 2018 (by 12%). According to estimates by Deborah Aitken of Bloomberg Intelligence, growth in branded jewelry is about 6% per year, which is 200 basis points faster than high-end watches. The purchase of Tiffany will more than double the LVMH jewelry segment and increase its market share to 18%, Aitken expects.

"Tiffany makes sense for LVMH because of the scarcity of acquisition targets with global scale and brand appeal in jewellery, the least-crowded category in the luxury sector," says Mr Rogerio Fujimori, an analyst at RBC Europe. He believes that under the leadership of LVMH Tiffany will strengthen its position as one of the leading players in the jewelry sector, which is one of the most attractive in the luxury market.

“Tiffany is a rare asset in the world of luxury. It's really a singular asset in the world of luxury jewelry," says the former head of LVMH North America Pauline Brown. She also does not preclude the possibility that there will be other bidders coming forward in the next few months, until the deal is closed. The major one, of course, is Richemont. According to Brown, the deal was done at a very healthy price, but it should be kept in mind that one year ago Tiffany was actually trading at a higher price compared with what was now offered by Bernard Arnault's company.

LVMH will equate Tiffany with its Bulgari brand, making Tiffany even more exclusive through higher prices, believes Aaron Kirchfeld, Bloomberg’s observer. "I think they want to go to the customer who is going to buy a nice Louis Vuitton purse and as they are walking out they see a sparkling diamond on the right and they say 'hey, why don't I add that," Kirchfeld said.

As part of the LVMH family of brands, the company will focus on making and selling items that are "as expensive as possible," agrees Arash Massoudi, corporate finance and deals editor at the Financial Times. At the same time, the lower-priced items will continue selling, but the high end will be the main focus. LVMH is "really good" at elevating brands it acquires, and its track record could be used to boost Tiffany, which lost some of its shine lately, he said. LVMH Chairman and CEO Bernard Arnault has been pro-actively searching for new acquisition targets over the past two or three years to bolster the business and its acquisition of Tiffany addresses a "weak spot."

"Following a strategic review that included a thoughtful internal process and expert external advice" this transaction will deliver "a compelling price with value certainty to our shareholders," said Roger N. Farah, Chairman of the Board of Directors of Tiffany. The transaction meets the best interests of shareholders and represents the best development option for Tiffany, he assured the company's employees in a special statement.

Alessandro Bogliolo, Chief Executive Officer of Tiffany, said, “This transaction, which occurs at a time of internal transformation for our legendary brand, will provide further support, resources and momentum for those priorities as we evolve towards becoming The Next Generation Luxury Jeweler. As part of the LVMH group, Tiffany will reach new heights, capitalizing on its remarkable internal expertise, unparalleled craftsmanship and strong cultural values.”

Despite the assurances from top management, some might have been surprised at the ease with which Tiffany agreed to the takeover offer. Tiffany’s business doesn’t look so bad as to unexpectedly abandon its own path in business, even despite the fact that its attempts to create a diversified holding similar to that of LVMH by way of developing expertise in perfumes, watches and accessories, were unsuccessful. At the moment, it is already known about three pro-active investigations launched by Monteverde & Associates, Rigrodsky & Long and Halper Sadeh. Their goal is to find out if the board of directors and top management of Tiffany violated the law and its fiduciary obligations to the company, including among other things possible undervaluation of Tiffany for the transaction with LVMH. Starting with ordinary corporate blackmail, such a process may require additional argumentation from the participants and at least delay the completion of the transaction.

The comments of LVMH mainly boil down to stating the importance of the transaction for the concern and the reluctance to change anything in such a specific market. “Our first and only priority is to implement the strategy that has been described by the management team,” said LVMH chief financial officer Jean-Jacques Guiony.

However, one change is already knocking on the door of this transaction: Tiffany’s rejection of publicity. “When you have to do quarterly reporting, it doesn’t help [you take] a long-term view. ... We expect to bring Tiffany time and capital, which are things that are not that easy to get when you are reporting to the stock market,” he said.

“We think the jewelry segment is extremely interesting. It has recorded significant growth over the last year. Due to the capital investment nature of this business and due to the fact that, more than other segments in luxury, there is an element of trust. The barriers to entry to this segment tend to be quite high,” Guiony stressed.

Earlier this year, Tiffany launched a diamond tracing platform for diamonds weighing 0.18 carats and more as part of the Diamond Source Initiative. Each stone is given an individual number, according to which a buyer can obtain data on the geographical origin of any diamond. The bulk of rough diamonds is supplied to Tiffany’s factories under direct contracts from Botswana, Canada, Namibia, Russia and South Africa, and the company requires guarantees of conflict-free origin from its suppliers.

The new owner highly appreciates the sustainability of the rough supply chain and Tiffany's responsibility in selecting sources, emphasized the LVMH chief financial officer. He noted that Tiffany, being a vertically integrated producer, belongs to a small number of retailers who can confirm the origin of their diamonds. “Sourcing and sustainability are quite important, and that is something we could learn from them,” said Guiony.

The deal and the deference that LVMH demonstrates to the industry seems to many experts a good help for the diamond market.

«This is very good news for the entire luxury market. Arno and LVMH may become a new conductor of interest leading to the jewelry market in general and to diamonds in particular. The place of the main advertising provider has been empty here after De Beers left pro-active positions. All the attempts to reproduce something similar have yielded nothing. Now LVMH can revive the market,” said Igor Kulichik, Deputy Chairman of the Board of Directors at AGD Diamonds and former CFO at ALROSA.

“The fact that large luxury players pay attention to the jewelry industry and try to strengthen their positions is a positive thing. Large players such as LVMH clearly do not expect a short-term effect, they see a long-term upside behind all the fluctuations and destocking cases in the diamond market. People in this business hold all trends at their fingertips, they follow these trends and understand where there are prospects and what is not at all fashionable,” said Nikolai Sosnovsky of Prosperity Capital.

An analyst from a foreign bank in charge of metals and mining, who asked for anonymity, was not inclined to extrapolate the positive aspects to the entire jewelry market. "It's like projecting the activities of Lamborgini on the overall situation in the automotive industry,” he said. “The segment of Lamborgini has little overlap with Folkswagen and AvtoVAZ. Tentatively speaking, the customer base of Luk Fook and Smolensk’s Kristall is not particularly thriving, while Tiffany consumers have been doing all right until now and will keep it that way going forward. I would not spread the positive aspects to the entire jewelry market, which has different segments. This may not indicate that LVMH has a general positive outlook regarding the situation in the industry.”

Sergey Goryainov of Rough&Polished also does not believe that the motive for buying Tiffany is the expectation of a growing diamond jewelry market. “There is no reason to say that LVMH feels some prospects in this market. Then we can conclude that Tiffany does not see them, since they are selling their business.” According to Goryainov, the main goal of the French luxury giant is to diversify the holding and reduce risks in all segments. The deal is logical, because a single brand is less stable – just one mistake in a marketing campaign, especially in the current environment of the diamond market, can turn into a long-term failure. Similar logic caused the sale of another legendary jeweler, Harry Winston, which joined the large conglomerate of Swatch Group.

Goryainov believes it would be wrong to expect generic marketing of diamonds from Bernard Arnault, something now considered by diamond miners as one of the main tools to achieve more stable demand.

In addition to diamond jewelry, Tiffany is producing many other goods in different price ranges, recalls Goryainov. Tiffany’s jewelry line, besides diamond necklaces worth $ 165,000, includes silver pieces sold at $ 200 in the mass market. Last year, diamond jewelry accounted for a quarter of Tiffany's annual sales (worth about $ 1.2 billion).

“Arno will promote the Tiffany brand. And it is not necessary to sell diamonds under this brand, you can sell elegant jewelry made even out of rubber,” says Goryainov. He believes that something similar to the transformation that happened with the Faberge brand may happen to Tiffany. Initially, the goods produced by the famous house of Russian jewelers were very diverse and they used any materials to make them, starting from malachite and rock crystal to jade and diamonds. In the 21st century, Faberge came under the control of South Africa’s Gemsfield, the largest producer of colored precious stones, and this jewelry house settled in a narrower niche, drawing consumers' attention to the fact that “the use of colour is and has always been a Fabergé signature.” The updated Faberge product line is dominated by a wide range of bracelets, pendants and rings with rubies, sapphires, emeralds, alexandrites and other colored stones.

Meanwhile, the markets trading in rough and polished diamonds remain weak, despite the above mentioned high-profile deal, Goryainov believes: the hopes nurtured for consumption growth in China have not been fully realized, and diamond miners’ sales are threatened by both synthetics and the input of recycled diamonds into turnover.

Igor Leikin for Rouh&Polished