The Biggest Risks Behind a Luxottica-Essilor Merger

There is a lot to like in the upcoming stock-for-stock transaction which will combine eyewear industry leaders Luxottica Group (LUXTY) and Essilor International (ESLOY -1.10%) into a single company later this year. Despite positive trading on the announcement and significant synergies, the deal is not without risk.

In the following segment from Industry Focus: Consumer Goods, Vincent Shen and Asit Sharma break down potential pitfalls for shareholders to consider.

A full transcript follows the video.

This podcast was recorded on Jan. 24, 2017.

Vincent Shen: 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?

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.