Luxury goods barons are jingling the change in their pockets. Bernard Arnault’s LVMH spent €3.7bn on Italian jeweller Bulgari earlier this month; investors seem to think Tiffany of the US and the UK’s Mulberry and Burberry could soon be snapped up too. The sector is certainly flush – average net debt is 0.2 times earnings before interest, tax, depreciation and amortisation, compared with a 1.1 times historic average – but more M&A would be a daft use of resources.
A better idea might be to throw excess cash in the direction of the world’s hottest regions. It could fund 4,000 new stores in China, for example (UniCredit estimates they cost €1m-€1.5m a pop.) These tend to make money quickly because costs are low – Luxottica says its stores in China need to sell only three pairs of spectacles a day to break even. Gross and operating margins tend to be higher in China than in the west, while top-line growth is roaring as the country urbanises. Assume sales per store of €2m and a 15 per cent operating margin, and the marginal return on investment would be 20-25 per cent.
Compare that with acquiring, say, Burberry, maker of aviator jackets and subject of perennial takeover rumours. Its market value has increased from ￡3bn to ￡5bn during the past 12 months. Even assuming a suitor such as PPR or Richemont could secure the company without offering a premium (Mr Arnault paid 60 per cent extra for Bulgari), and squeeze out ￡50m of synergies, the first-year pre-tax ROI would be only 4.5 per cent.