Emerging markets, in particular China, are protecting the luxury sector from the worst of the global economic downturn.
The global economic downturn hit the luxury sector hard. Joelle de Montgolfier, head of the luxury sector at the consultancy Bain & Co in Paris, go so far as to say that 2009 was the worst year in decades. "The sector had seen continued growth since 1995, even after 9/11 or the SARS crisis. Then, in 2009, revenues declined by 8%. It was unprecedented, and it really shook the market," he says.
Luxury companies went into crisis-mode, shedding staff, restructuring debt, and digging in for a long, cold recession. But then, much to everyone's surprise, the crisis passed. Pierre Mallevays, former head of mergers and acquisitions for Louis Vuitton Moet Hennessy and now the managing partner of mergers and acquisitions boutique Savigny Partners, says: "During the crisis, all the big luxury groups were heavily restructuring. They didn't know how long the recession would last. Now, they're in the happy situation of having a lean cost base while sales go through the roof."
What's behind this surprising bounce-back? One of the answers is what Mr. Mallevays describes as the "insatiable" desire for luxury goods among Chinese high-net-worth individuals. Antoine Colonna, luxury analyst at the asset manager Carmignac Gestion in Paris explains that for the leading luxury groups, emerging markets now account for 25-30% of revenues, and approximately 25-30% of profits. "And this clientele is growing much faster than G7 markets. By the end of 2015, emerging markets should account for more than 50% of luxury sales. This isn't evolution. It's revolution," she says.
New Money, Old Luxury
The axis of luxury has shifted east. This is according Faiza Seth, the Indian born chief executive of the luxury interior design firm Casa Forma. "Chinese high-net-worth individuals are 20 years younger than their western counterparts. They're self-made, and they're flashier," she says. "They want to show the world how much money they have. And they love luxury brands that tell the world that. They're prepared to queue for two hours to get into its Shanghai store, which is the company's largest store by revenues."
According to Bain & Co, the Chinese luxury market grew by 30% in 2010. Revenues are just $9 billion out of a global total of $157 billion - that's the same as the city of New York. But analysts point out that much of the luxury spending in New York, London, Paris and other western capitals is done by tourists from emerging markets. Burberry, for example, estimates that one-third of its U.K. sales come from Chinese shoppers - and it is already employing Mandarin-speaking staff in its London shops.
"Why is European luxury consumption rebounding? It's not - it's Asian tourists. Today in Europe, half of Richemont's sales are with non-locals, and that number will continue to increase," says Ms. Colonna.
Other BRIC markets are almost as important. Russia sales are half that of China, and Middle East sales are just behind Russia's. India is the exception. Ms. de Montgolfier says: "India has a very small international luxury market. Consumers tend to go for local products, local craftsmen. There's not much hype around western brands, and the retail market is quite regulated, with few premium locations." Not all western luxury companies are feeling the BRIC effect equally. Ms. Colonna says: "It's a huge struggle to get your name known in emerging markets if you're not one of the 'magic brands'. Not everyone is making money in China." Mr. Mallevays agrees. "It's not easy to set up stores in China. It's expensive, and there's a shortage of quality locations. The firms that didn't set up there five years ago are struggling now. While those who did - LVMH, Chanel, Richemont, Hermès - can't keep up with demand."
This is likely to lead to a wave of consolidation in the luxury sector, and some deals have already started happening. Big deals aren't very likely at the top end of the market, because stock market valuations are so high. But Mr. Mallevays says: "At the smaller end of the market, among the midcap companies, there will be a lot of deals, because these smaller companies can't benefit from emerging market expansion like the larger firms."
Ms. Colonna agrees that there are "way too many" brands right now. "First off, kill the small guys," she says. "And what we're seeing happening is that emerging market magnates are trying to buy into companies with long histories, but small bank balances." For example, in November 2009, Megha Mittal, the daughter of Indian steel tycoon Lakshmi Mittal, bought the insolvent German luxury clothing company, Escada, for an undisclosed price. In another example of BRIC companies buying struggling European luxury firms, Chinese clothing company Trinity bought Luxembourg luxury retailer Cerrutti for €52 million in December 2010.
The challenge for BRIC conglomerates is getting hold of bigger brands. "The best luxury brands are already taken, and are owned by private families who don't want or need to sell. All that's left is smaller brands," Ms. Colonna says. "For example, I know of one Chinese sovereign wealth fund who wanted to buy Rolex, but they were told it's not for sale. A Middle Eastern investor also approach Patek Philippe, but they don't need to sell, because they're achieving double digit growth as it is."
One possibility for a big upcoming acquisition is the controversial bid by LVMH for luxury rival Hermès. LVMH revealed in October 2010 that it had cunningly acquired 15% of Hermès stock through equity derivatives. By December 2010, it has increased the stake to 20%, driving up Hermes' share price as the market speculated a bid for the whole company was in the pipeline. The asset hungry LVMH also took controlling stake in Italian luxury goods firm Bulgari this month. Meanwhile, at the other end of the luxury league, smaller companies are scrambling to find a Chinese, Russian or Brazilian partner to save them from insolvency and help them take the Bling Bling to Beijing.