Imperfect vision is a common problem around the world. It's the basis for large businesses at Essilor (NASDAQOTH:ESLOY), Hoya, and Luxottica (NYSE:LUX), as well as contact-lens manufacturers like Johnson & Johnson (NYSE:JNJ), Novartis, Cooper (NYSE:COO), and Valeant (NYSE:BHC). Not only is providing vision care products a profitable business in its own right, which often supports double-digit returns on capital, it is a business where customers typically have to buy the product over and over again throughout their life. Add in above-average growth prospects from emerging markets and it is not too difficult to see why these businesses generally carry robust valuations.
Essilor is a hands-down leader in lenses
Essilor has something in the neighborhood of 40% global volume share in prescription corrective lenses, with even higher share in terms of value. Not only is Essilor far larger than Hoya and Zeiss (both with volume shares in the low-to-mid teens), I estimate that Essilor spends more than half of its global R&D dollars on lens R&D -- which creates a powerful moat around its business and leads to well-known products like Crizal and Varilux.
Essilor has not been shy about building its empire through M&A. The company owns over 400 prescription labs which give it secure access to opticians. Essilor has also been active in acquiring distributors around the world, which has helped to build its global presence. Management believes that about 60% of the world's population requires vision correction. While penetration rates are close to that figure in North America, Western Europe, and Japan, penetration rates are at one-third or lower in most emerging markets like Eastern Europe, Brazil, India, and China.
Looking ahead, Essilor fully intends to continue using technology to gain businesses, as it acquired PPG's stake in the Transitions lens business in 2013. Essilor is also looking at sunglasses and sun lenses as a growth opportunity; this is a large market, but it only makes up about 10% of Essilor's sales. This will bring the company into closer competition with Luxottica, which is a larger player in the sunglasses/lenses space.
Frames and lenses follow together
What Essilor is in lenses, Luxottica is in frames and sunglasses. Luxottica owns brands like Oakley, Luxottica, and Ray-Ban, and it licenses brands like Brooks Brothers, Burberry, DKNY, Prada, and Ralph Lauren. Luxottica also has a significant presence in the retail sector, as it owns LensCrafters, Pearle Vision, and Sunglass Hut.
Luxottica does offer services related to preparing prescription lenses, but this business is not nearly as driven by R&D as that of Essilor. This business is also more economically sensitive, as high-end sunglasses are much more of a discretionary purchase. While Essilor and Luxottica work reasonably well together (as you might expect from the leading producers of prescription lenses and frames), Essilor's intention to grow its sun business could alter this relationship.
Contacts seem fairly constant
Johnson & Johnson, Novartis, and Cooper have benefited from the introduction of technologies like silicone hydrogel lenses for daily use, as well as years of under-investment at Bausch & Lomb. With Bausch & Lomb in the care of Valeant, it remains to be seen if Valeant will invest the R&D and marketing dollars needed to reclaim a market share that was once closer to 20%.
Contact lenses make up about 10% of the global vision correction market. While they serve as an alternative and a threat to the prescription-glasses businesses of Essilor and Luxottica, they tend to be a trailing option -- customers in developed markets may start with contact lenses and bypass glasses altogether, but cost factors tend to significantly favor glasses in emerging markets.
The key for the contact lens companies is ongoing innovation and marketing support. Cooper made a name for itself with harder-to-make torics and multifocals, while Johnson & Johnson has been adept at mass-market daily products. Johnson & Johnson also once tried to compete in the lens business, but it could not establish any lasting traction against Essilor or Hoya.
The bottom line
It would seem improbable that any of these companies would see themselves as sellers in M&A. However, you can never really rule out companies like Valeant or Johnson & Johnson, and perhaps Essilor would see some merit in adding the Cooper contact lens business to compliment its lens business.
There are several good companies in the eye-care space, but there are not many bargains. Essilor, Luxottica, and Cooper all carry mid-teens EV/EBTIDA multiples and they don't appear all that cheap on the basis of their long-term free cash flows. Using EV/revenue multiples, though, suggests some upside to this trio although again there are no tremendous bargains in the group. What eye-care does offer, though, is good leverage to emerging market growth and much less regulatory and reimbursement risk, and that is a good reason to keep an eye on the sector.