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Falling Off the Lap of Luxury


Along Paris' swank Avenue Montaigne, shop windows still glitter with jewelry, handbags, and the latest in haute couture. But just down the street, at the headquarters of luxury-goods giant LVMH Mo?t Hennessy Louis Vuitton (LVMHY), the picture is anything but sparkling. Hard-hit by the global economic slowdown and a sharp fall in tourism since September 11, LVMH has issued three profit warnings in the past two months. Management now predicts operating profits will be down 10% to 15% this year, to about $1.5 billion, and some analysts think even that is too optimistic. "It's clear that our market is down sharply," acknowledges chairman Bernard Arnault, seated beneath a portrait of Christian Dior.

Is Arnault, the global luxury king, losing his Midas touch? It's starting to look that way. True, nearly all luxury-goods purveyors are hurting, as shoppers lose their appetite for expensive baubles. But LVMH's woes go deeper. Over the past five years, Arnault, 52, has taken LVMH on a world-class shopping spree, moving it into everything from airport duty-free shops to cosmetics retailing to art auctions. Sales have nearly doubled, to a projected $10.7 billion this year, more than four times the total of its closest rival, Gucci Group (GUC). The trouble is, most of these acquisitions aren't making money. LVMH still draws nearly all its profits from old stalwarts, mainly Louis Vuitton leather goods and its drinks division, which boasts such brands as Hennessy cognac and Veuve Clicquot champagne.

The newer ventures, by contrast, look pretty risky. Duty-free retailer DFS, acquired in 1997 for $2.5 billion, has increased LVMH'S exposure to the downturn in travel. With sales down 35% since September, analysts expect it to lose nearly $100 million this year. Sephora, a cosmetics and perfume retailer acquired in 1998 for $260 million, is expected to lose another $100 million or so following a costly U.S. expansion. And while Sephora is likely to move into the black in a year or two, as a mass-market retailer it will never match the juicy 20%-plus margins of LVMH's leading businesses. "The brutal truth is, the newer investments have not paid off," says John Wakely, an analyst at Lehman Brothers Inc. in London.

Many industry-watchers think it's high time LVMH unloaded some of this deadweight. Yet Arnault dismisses speculation that he's about to put anything on the block. DFS is central to LVMH's strategy of tightly-controlled distribution of its products, he says. And while he doesn't rule out an eventual sale of Sephora, he says the chain is on track to produce 8% to 9% profit margins within three years. Another recent acquisition, auction house Phillips, de Pury & Luxembourg, is already selling more Impressionist and modern art than either Sotheby's (BID) or Christie's and will be in the black by 2002. Far from weakening LVMH, Arnault maintains, diversification is a key strength: "We're the only group that has the ability to manage different activities that cover the entire range of the luxury business."

STAR BRAND. Certainly, LVMH's competitors are hurting, too. Gucci Group, Bulgari, and Richemont (RCHMY), which owns such brands as Cartier and Mont Blanc, have all issued profit warnings in recent weeks. Others, such as Prada and Burberry, have had to shelve planned stock offerings. LVMH has some cause for cheer. Its star brand, Vuitton, is on course to reach $1 billion in operating profits this year. And the group reaped an $806 million windfall from the September sale of its 20% stake in Gucci to the Paris-based Pinault-Printemps-Redoute group, ending a two-year battle for control of the fashion house.

Yet LVMH shareholders clearly could use some reassurance. The stock is down 33% this year. A major worry is that LVMH draws an estimated 36% of its revenues from sales to travelers, a higher share than any other major luxury group. It also relies on the U.S. for a larger proportion of sales (26%). "Compared to other luxury groups, they're more cyclical," says Scilla Huang Sun, who manages the Zurich-based Clariden Luxury Goods Equity Fund.

POTENTIAL SUITOR. If Arnault decides to slim down LVMH, he would probably start with Sephora. Since 1999, the retailing chain has lost nearly $300 million, as LVMH invested heavily to open 79 stores in the U.S. Sephora has proved to be a hit, especially with younger shoppers who like the vast product range and self-service format--a welcome change from stuffy department stores. The chain is also drawing attention from potential suitors. One is Parfumeries Douglas, a German retailer that is looking to expand in the U.S. Although the companies are not in talks, sources close to Douglas say that it is clearly interested.

Finding a buyer for DFS would be tougher. It's swimming in red ink, prompting a current push to seek nearly $80 million in savings by renegotiating leases and airport concessions. Besides, DFS's more than 150 duty-free shops in airports and center-city "gallerias" selling a wide range of brands are not an easy fit for most global retailers.

Still, it wouldn't be a bad time for LVMH to get back to basics. It recently acquired U.S. fashion label Donna Karan and needs to invest to leverage the brand globally. Arnault might soon have more opportunities to beef up his stable of brands. Debt-ridden Prada, for example, could try to raise cash by selling its 25.5% stake in Fendi to LVMH, which already owns 25.5% of the Italian handbag maker. Even venerable family-owned companies such as leather-goods maker Salvatore Ferragamo might eventually seek tie-ups with a bigger group such as LVMH. As the luxury business has consolidated, it has become harder for small companies to raise the money they need to advertise and build global distribution networks, says Armando Branchini of Milan luxury consulting firm InterCorporate Group. "Only the biggest companies have the financial strength to resist the ups and downs of the market," he says. Arnault needs to use his financial strength to do what he does best. By Carol Matlack in Paris


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