Take two leading companies in the eyewear industry, combine them, and what do you get? In this case, say hello to EssilorLuxottica.

In this episode of Industry Focus: Consumer Goods, Vincent Shen and Asit Sharma dig into the details behind this mega-deal. They explain how the R&D-focused Essilor (ESLOY -2.02%) beautifully complements the fashion-focused Luxottica (LUXTY) as they seek to combine a lens specialist with some of the most popular frames in the world. The cast also considers some of the other major risks and considerations for investors in either company.

A full transcript follows the video.

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This podcast was recorded on Jan. 24, 2017. 

Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen, and it's Tuesday, January 24th. Today, we'll be talking about a recently announced $50 billion deal that will create a truly dominant entity in the eyewear industry. If we still have a little bit of time afterwards, we'll preview some upcoming earnings in the consumer and retail sector. Joining me via Skype to cover these topics is none other than senior Fool.com contributor Asit Sharma. How's it going, bud?

Asit Sharma: It's going well, Vince, how are you doing?

Shen: I'm doing very well. I'm very excited about our topics for today. This is really a crazy deal. I'm also excited to have you on, I think this is our first show together for 2017, right?

Sharma: It is. I'd like to follow up really quickly with something we talked about at our year-end lookback. We were talking about New Year's resolutions. Listeners, I have a new motto for this year. You may know this, it's attributed to Horace: "Never a day without a line." So, for you writers out there, if you want to write, write every day. If you have a hobby, a foreign language, whatever it is, your investments you want to improve, make sure you get at least one touch every day. We'll make it together.

Shen: Alright. Thanks a lot, Asit, for sharing that. Is that part of your resolutions for 2017? I'm not sure if you made any.

Sharma: That's the only one I have that's still standing. How about you, real quick?

Shen: For me? We had an episode about this. Sarah, who's on the editorial team with me for technology and consumer goods, we covered our goals and aspirations for 2017. For me, it's a little bit of decluttering and organizing my life, in not just my living space, but hopefully moving on from that point to more financial stuff, things with family, taking a step-by-step approach with it. But overall, I would say the theme, one word, decluttering.

Sharma: Awesome.

Shen: So, the big topic for today is the recent deal announced between Luxottica and Essilor. This $50 billion deal is with two companies that, in my opinion, very much lead their respective spaces within the world of eyewear. Asit, please bear with me, I'm going to try and set the stage here for these two companies, who they are, and then I'll let you dive into some specifics behind the deal. But for listeners who might not be as familiar with these names -- we don't cover them that often on the show, and they're based in Europe -- so our listeners can get a good idea of the scale of their operations, which I think is very important, and how they will come together.

The first, Essilor, their history. An investor overview describes a company based in France, has a nearly 170 year history as Essel, one of the two companies that merged to form the current company, was originally founded in 1849. It has about 60,000 employees in over 60 countries. Products are distributed to over 100 countries; 32 production plants, 490 prescription labs, 16 distribution centers. I think all and all, what you need to know is that they make over 500 million lenses annually. Their products get distributed through eyecare professionals, online channels. It is a leader in its space, has 40% market share for prescription lenses, 15% market share for both sunglasses and reading glasses, and that does not even include some of the optical equipment and instruments they also produce. For those of you listening who do have prescription lenses, you might recognize some of the names in their portfolio, which includes Transitions, Varilux. The company trades on the Euronext Exchange with about a $25 billion market cap and $7.7 billion in revenue for the trailing 12 months. 

Luxottica, which is the other company that is in this transaction, this is one that, I've spoken to a lot of people about this company, mostly as consumers, they don't know it, but when I mention some of their in-house brands and the many others they license with, people know exactly what I'm talking about. Luxottica is based in Italy, founded in 1961 by Leonardo Del Vecchio, who is now the second richest man in Italy. He's a majority shareholder in the company with an approximately 62% ownership stake through his family holding company called Delfin. Luxottica has 79,000 employees. Their manufacturing operations are based in Italy, China, U.S., Brazil, and India. Their home country of Italy makes up just over 40% of that output. Eighteen distribution centers give the company a network that covers more than 150 countries. They also have, besides producing these glasses, a retail network of 7,400 stores of chains that many of you will recognize, including LensCrafters, Pearle Vision, Sunglass Hut. They're also behind EyeMed, which is a major U.S. vision benefits provider. Their brand portfolio includes Ray-Ban, Oakley, Oliver Peoples, and then they license major brands like a Burberry, Chanel, DKNY, Ralph Lauren. So, Luxottica is the largest eyewear company in the world. It's market cap is about $26 billion, with $9.9 billion of revenue for the trailing 12 months. Once they come together, they will still very much be the largest eyewear company in the world. 

But, these two companies are going to come together, I think their new headquarters is going to be based in Paris. What else do you think our listeners need to know about the deal?

Sharma: The first thing our listeners need to know about this deal is, is it a complementary deal? Or are these companies just overlapping each other? Many times, when two giants merge, Wall Street loves it initially, there's a pop in both stocks. And that certainly was the case here. I think Essilor popped about 13% the day this deal was announced, which was last Monday, and Luxottica shares popped about 8%. That's the initial excitement that manifests itself when two really big companies announce that they're going to merge operations. But longer-term, this can work to the disadvantage of both companies. If you merge up and start to dominate an industry so much, the statistics which pertain to growth, you inform those statistics. Growing faster than the industry becomes difficult when you are the industry. 

What's different about this deal is that these are two very complementary products. Essilor as a lensmaker sees itself very much as a health vision company. Oddly enough, Luxottica, although we know them for brands like Oakley and Ray-Ban, they also see themselves as a health vision company. When you think about sunglasses, they provide protection against UV light, and also a new phenomenon that's blue light, the light from all our devices, especially at light, which tends to deteriorate our eyesight and overall health quality. So, these companies see themselves as merging up as a giant health vision company. And I think that's important because they will be able to, together, co-market products. They also have some synergies in their supply chains. So, that's the first thing you want to answer when you look at a merger like this -- is this just pooling a lot of assets together that won't grow faster than the industry in the long-run? Or does this have the potential for gains down the road? This deal certainly does.

Shen: I think what you described in terms of what might be considered the mission statement for these two companies, health vision companies, is really important. Long-term, I think the combined entity, which is going to be named EssilorLuxottica, it's a very strong position to benefit from some global tailwinds around healthcare for your vision, which includes, there's an aging population, there's growing needs for eyewear and health of your vision in emerging markets. And, I think both companies have been touting this number, basically an estimate that 2.5 billion people worldwide still grapple with vision problems of some kind, and their products, be it the lenses or the sunglasses or whatever it is, can come together and help address this issue, certainly a huge market.

Overall, for this combined entity, it will generate half of its revenue in the U.S., with Europe accounting for about one quarter and Africa, Asia, and the Middle East making up the remainder. Definitely a lot of opportunities, I think, for the company, not only in its more entrenched markets like the U.S. but in emerging markets as well.

Sharma: That's true. And what's really interesting in terms of how that market looks on paper, Luxottica has great brand presence in the U.S. and Europe as a maker of frames. So, if you take the demographics you were talking about, Vince, as people age in developed countries, they also have that disposable income to buy high-end frames, vanity frames, really. Essilor is very well-placed in emerging markets where there's a growing need for people to have corrected lenses and corrected vision. In places like the Middle East and Africa and Asia, that's really a limitless market for this combined company, which is something that I'm very excited about when you look at them together.

Some of the other things about this deal that are attractive from a financial standpoint are just the synergies involved. Since they don't have a lot of overlap, the companies can really dig into each others' strengths. I think they're shooting for a combined €400 to €600 million of cost savings annually. That translates to about $430 to $640 million per year on an annual run rate of about $16 billion. It's quite a savings just in the near-term. Another thing from a financial standpoint, which I really love, is that the combined EBITDA of this company -- that is earnings before interest, taxes, depreciation and amortization -- is going to be about $3.7 billion on that run rate that I was just speaking on. You may wonder, is this EBITDA supported by a lot of debt?

Oftentimes, the reason big companies merge is they're very leveraged on their balance sheet, and when you combine, you have the ability to refinance. But neither one of these companies is that leveraged. In fact, their combined pro forma balance sheet is going to show a net debt to EBITDA ratio of under one time. What that means is, if you take the relationship between debt on the books and earnings in one year, they're about equal. And that's a great position to be in. So, another reason to really be interested in this combined company.

I do have one complaint, though. I don't like this name. EssilorLuxottica. You know? That is really hard to pronounce. But, I'll return to that. Let's talk about some risks we might see in the deal. Do you want me to jump in with once, Vince, or do you want to grab the first risk that you see?

Shen: Before I get to the risks, which we can have as some of our takeaways for this topic, I think it's important to note that for the deal itself, with the combined entity, you've mentioned some of the numbers behind it. 140,000 employees, annual revenue of over $16 billion, EBITDA of nearly $4 billion. The name, which you are not quite happy with, I think makes sense in this case, since a lot of people were considering this a merger of equals. And even the management structure reflects that. Del Vecchio will serve as executive chairman and CEO of the company, while Essilor CEO Hubert Sagnières will hold the title of executive vice-chairman and deputy CEO of the new entity. And they're supposed to have equal powers. How that will work in terms of this co-CEO, co-leader structure, we'll see. I think some people have some concerns about that. But the board itself will have 16 members -- that will also see an equal split of nominations from the two companies. And this is an all-share deal. Luxottica shareholders will exchange their holdings for Essilor shares based on a ratio of 0.461 Essilor shares per one Luxottica share. Of course, Del Vecchio, his majority stake in Luxottica, which is about 62%, will need to go first, followed by the remaining outstanding shares at the same exchange ratio. Once the deal closes, Del Vecchio will own between 31% to 38% of the new entity. The deal is expected to close by the end of the year, of course. 

This will segue nicely into our risk factors. Being a cross-border deal between Italy and France, and also such a large deal, despite the fact that you could say that one focuses on frames and one focuses on lenses, two very distinct parts of the supply chain in that industry, there could still be significant scrutiny just with the size and the fact that they have, in recent years, been encroaching a little bit into each other's expertise area. In terms of other risks, or other things that give you pause about the deal, what do you have on your mind, Asit?

Sharma: I think, for me, that split of this down-the-middle merger of equals structure, that bothers me a little bit. And I want to point out one more thing, given the excellent rundown of the deal specifics. Del Vecchio's voting interests are going to be limited to 31%. He can buy up to 38% of the shares, but they're taking a lot of care to make sure that both parties come to the table and are dead equal. This board arrangement, eight board members for each company, is one example. The name, I'll return to that, EssilorLuxottica, because neither side really wants to give up their traditional name. Both are very long-lived companies. These types of deals go great when the money is plenty and revenues are increasing. As we've seen in the U.S., when things start to go downhill, Chipotle was a much-discussed example from last year, as was Whole Foods, these types of equal arrangements. In these cases, we're talking about dual CEO structures. But in terms of board structures, as well, the same pertains. When things start to go south, revenues decrease, or profits decline, then two sides which are split down the middle have a hard time getting to the difficult decisions. So, that always bothers me a little bit.

The other risk which isn't as evident but leaps out to me is that, culturally, these are slightly different companies. Essilor is more of a scientific-leaning company in that it does high-end ophthalmic lenses. Luxottica, which I think you pointed out, Vince, is sort of moving into that territory itself. But Luxottica is more of a brand company, more of a vanity company. Although, yes, its eyeglasses are vision-centric, health-centric, they really have made their margin on upscale brands, especially in the U.S. and Europe, so they're slightly different cultures here. I do like the way that the press releases have gone. They seem both to be rallying around this point of vision healthcare companies. But still, there's just a little bit of cultural difference, again, with the traditional Franco-Italian history between those two countries, which is sometimes very friendly and has sometimes been antagonistic, may also come into play here. But we see that a lot in the E.U.

Shen: Yeah. And on that note, I think it should be noted that at Luxottica, with Del Vecchio currently heading up the management team there, this is actually after stepping back into a more executive role in 2014, as chairman, he was looking for a CEO. He has gone through three in the past two years or so, and there was definitely a lot of investor concern about what the succession plan is going to look like. Del Vecchio had stated that he does not want anybody from his family to take over this leadership position at the company. So figuring out that succession plan, what happens with his holdings and his heirs, was definitely a point of concern with investors for Del Vecchio himself. This deal with Essilor seemed like a very clean, tidy way of having that come together, especially with the dual-CEO structure. Just an interesting point there. Also, the fact that, this is not the first time these companies had consider doing such a deal. They were in negotiations back in 2013. I think that fell through due to some governance issues and concerns that they're now able to tie up with the board structure and the leadership structure that we described. Overall, I think this is definitely an example, as you mentioned, Asit, of a deal where it's really easy to imagine the benefits of the two companies coming together, bring together those frames and lenses under one roof. Overall, I think both stocks recently have actually seen some downward pressure, definitely saw a bump, as you described, after the announcement of the deal. But, together, and with both of their very well-known and revered operations within the industry, bringing those together will be very interesting to watch going forward. Any other takeaways from you before we move on?

Sharma: Yeah, one brief last point on Del Vecchio. He's now 81 years old and really comes out of this tradition of publicly traded companies in Europe that have a strong family presence and very strong-willed. So this dual-CEO structure is probably a good thing, and Luxottica shareholders can breathe a little sigh of relief. Vince, if he calls you up asking you to run the combined company, turn it down, man. You'll be back at the Motley Fool in like two months, not because you're not capable, but he's been going through CEOs at quite a clip. (laughs) Stay with us. 

Shen: So, again, the deal is expected to close by the end of this year. I should note that with this part of the discussion around management, Del Vecchio is expected to hold his position with the new entity for about three years, and then he will step down, unless shareholders vote to keep him. But that point, he will be a ripe old 84. So, it'll be interesting to see how the integration works out, and what opportunities this massive company will pursue once the deal closes. 

But as we run into the last few minutes of the show here, I want to cover at least one bit of an earnings preview coming this week. It's for a company that we're all familiar with, Starbucks (SBUX -1.14%). They're releasing their fiscal 2017 first quarter results after the close on Thursday. Asit, what will you be watching and looking for in the report?

Sharma: Vince, I spend a lot of my working hours during the year looking at Starbucks and its component parts. I know you do as well. And many of our listeners spend a lot of time trying to analyze this company as well, because they're invested. So rather than look at any one piece, what I'm really interested in for this earnings report are two numbers -- 5% and10%. 5%, I'd like to see the U.S. comparable sales run again above 5%, which has been a benchmark for Starbucks for many quarters, and they stumbled on that last year. Out of the last three quarters, I think they only hit that benchmark one time. So I'd love to see that number come back above 5%.

The other number that I'm looking at is 10% overall revenue growth. Taken together, these two numbers are part of Starbucks' structural framework of their business model. So, if we have one without the other, it's a signal that perhaps the company is slimming down a bit. This is going to be the first quarter of their fiscal 2017 year, and it includes the very busy holiday season, which is traditionally a strong quarter for Starbucks. So, I want to see these two numbers pop above their benchmarks and from there, work backwards to the component parts. How about you?

Shen: Yeah, I think those two numbers that you mentioned are really key. Keep in mind that the company has very ambitious plans over the next five years, including an expansion of 12,000 locations, so the company would have a total network approaching 40,000 stores. Part of their goals also in financials is to deliver 10% annual sales growth -- so, one of those two numbers that you had mentioned -- and then, annual EPS growth of 15% to 20%. But I think something else in terms of recent news for this company that a lot of people have been watching is the fact that Howard Schultz will be stepping away from the CEO position this spring. How did you feel when you heard that news? Any concerns there? Or do you think this is a well-oiled machine situation? The CEO Kevin Johnson stepping in, he's already managing the day to day operations as it is. What do you think?

Sharma: I hate to use a tired metaphor, and some metaphors, we just have to pull them out and beat them back to death, but I think it's a glass half full, half empty situation. Howard Schultz has built a machine, in terms of what this company can produce in its earnings per share every quarter. It's a very structuralized company. He's implemented many technological changes, and he's hired great people in the management team. But what we lose with Howard Schultz moving more toward a brand-type of position with Starbucks and out of the CEO chair is that strong sense of vision, the idea to take big bets and go on knowledge, instinct, data, and jump into a market or technology.

We saw with Steve Jobs that Apple hasn't been the same company since he's left, although on an execution basis they're still very strong. The glass being half full here for me is to see if Kevin Johnson, who is actually, not unlike Tim Cook, an operations guy, if he can bring his really good operational executional ability and build his own layer of vision to keep pushing the company. Let's remember, Starbucks is no longer a small company -- it's challenging McDonald's as the biggest quick service player on the block. So to keep growing, it needs at least two things. It can't stumble on execution, but it needs vision. And we saw Howard Schultz bring in the whole idea of premiumization in its Roastery concept, and just moving all of us who are dedicated Starbucks fans up this value chain of coffee, and raising the bar on what your average person is drinking. So I think prospects are good for Starbucks, but I want to see some ideation -- to use a fancy word -- I want to see some innovation coming pretty quickly from Kevin Johnson. How about you?

Shen: I think it's really important, and it's reassuring, at least, to see that Howard Schultz is maintaining his presence within the company, more as a culture and brand ambassador, sure, but still there. I think he will be equally nervous, frankly, about the transition, and how things go in the coming years, having had this experience, what was it, 10, 15 years ago? And having to come back, hopefully avoiding that this time, of course. But what you mention, I think we should give Johnson a chance and see how things turn out. But he's being handed the reins of a very effective, profitable, and growing machine that has a five-year plan already laid out. The blueprint is there. It comes down to the execution. I definitely think the current CEO is somebody that can drive that through.

Thank you very much, Asit, for joining me today. It was great to have you on, and I look forward to seeing you in the coming weeks.

That wraps up our discussion. You can reach out to us and the rest of the Industry Focus crew via Twitter @MFIndustryFocus, or send us any questions via email to [email protected]. Don't forget to check out www.fool.com/podcasts for our other awesome shows. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Thanks for listening and Fool on!