This $16 Billion Merger Is Suddenly in Doubt

By Berna Barshay

Wednesday, June 3, 2020
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The proposed marriage between LVMH and Tiffany is on the rocks…

Yesterday, in the last hour of trading, reports surfaced that French luxury goods giant LVMH (LVMHF) – owner of high-end fashion brand Louis Vuitton, Veuve Clicquot and Dom Perignon champagnes, and Hennessy cognac – was reconsidering its $16 billion deal to acquire iconic American jeweler Tiffany (TIF).

Tiffany traded down as low as $111 after spending months trading around $128, a small discount to LVMH’s $135 offer price in a deal which should close later this year. Today, shares traded around $115, down around 10% from pre-rumor levels. This is a huge move for an acquiree with no financing or antitrust risk.

The plunge in Tiffany was due to a Women’s Wear Daily (“WWD“) report that the LVMH Board was holding an emergency meeting in Paris last night to discuss deteriorating conditions in the U.S. market. According to the report…

It is understood board members of the luxury giant are concerned about the impact of not only the coronavirus pandemic, which has claimed more than 100,000 lives in America and wreaked widespread economic damage, but also the growing social unrest over the death of George Floyd at the hands of Minneapolis police…

In addition, these sources said, LVMH board members voiced concerns about Tiffany’s ability to cover all its debt covenants at the end of the transaction, which was expected to be concluded mid-year.

Tiffany made no mention of any change of status for the deal at its virtual shareholder meeting on Monday. When LVMH reported earnings in April at peak pandemic, CFO Jean-Jacques Guiony assured investors, “We will stick to the contract, full stop.”

While I have no special insight into the report’s validity, it seems strange that LVMH would abandon the deal at this point, when stores are theoretically getting closer to reopening.

LVMH is a luxury giant with a market cap of more than $200 billion. Through organic growth and strategic acquisitions, the stock has nearly quintupled over the last 10 years, making its Chairman Bernard Arnault the third-richest man in the world along the way. When Arnault buys companies, he’s interested in their long-term prospects, not a quick short-term pop in earnings.

Tiffany was in the middle of a tumultuous multiyear turnaround when LVMH came knocking…

Tiffany was in the doghouse when LVMH made its bid last October. The sole American player in the global luxury goods sector, Tiffany had only grown its topline at a 1% rate in the last five years, a time when many of its peers were experiencing high-single-digit or low-double-digit growth. Tiffany’s home U.S. market was experiencing saturation and the company had failed to grow in China as dramatically as its primary rivals, like Richemont’s Cartier.

Tiffany also suffered from a bit of positioning schizophrenia. While the jeweler regularly offers pieces running into the hundreds of thousands or even millions of dollars, it also does a large business in sterling-silver items that retail for less than $300, some even less than $100. Its competitors don’t offer anything at these lower price points, which has led some to question whether the two product lines are ultimately compatible.

The company was making inroads in elevating its marketing, refreshing its product line, renovating its famed 5th Avenue flagship store, improving its global ecommerce capabilities, and reviving consumer interest under the leadership of new CEO Alessandro Bogliolo, who joined in late 2017.

Under Bogliolo, Tiffany managed to string together three quarters of accelerated revenue growth (between 9% and 15%) from late 2017 to mid-2018, which prompted a rally in its shares early in the new leadership’s tenure.

But topline growth soon slowed again, with revenue declines in the three quarters preceding the acquisition announcement. During 2019, sluggish tourism to the U.S. and civil unrest in Hong Kong weighed on results. Toward the end of 2019, after LVMH’s bid, results improved somewhat, with notable strength in China, where sales were up double-digits in the fourth quarter.

Under LVMH, Tiffany is a more compelling story…

Arnault knew that Tiffany would take time to nurture and grow back to health. When the deal was announced, Arnault explained, “Our goal is to provide Tiffany with the ideal environment to further invest and grow.”

Delisting the company and allowing it to grow within the LVMH umbrella would remove the focus on short-term results, increasing Tiffany’s odds of successfully executing its ever-elusive turnaround.

The deal also allowed LVMH to strengthen its positioning in jewelry, where it trails Richemont in market share. LVMH has a long history of successfully integrating and growing acquisitions, including French fashion label Christian Dior, Italian jeweler Bulgari (where Bogliolo once was COO), and beauty retailer Sephora. And its huge, profitable leather goods juggernaut Louis Vuitton brand gives it ample profits to incubate and nurture smaller brands elsewhere in its portfolio.

LVMH’s size and success also help it attract the best consumer goods talent in the world and give it operating experience in every major retail center globally. These are all resources LVMH could offer to the turnaround effort at Tiffany.

Suddenly, Tiffany shares are trading at a 14% discount to the $135 deal price, offering an exceptional annualized return if the deal closes as expected this year…

But Tiffany needs LVMH more than LVMH needs Tiffany. If LVMH walked away, Tiffany shares could tumble as low as $75. The stock bottomed around $80 last summer, when the world (and particularly the Americas, where Tiffany sources 43% of revenues) was in better shape.

My downside target may prove conservative. This morning, the analyst covering Tiffany at Credit Suisse predicted the stock could trade as low as $60 if the deal fell through.

The prospect of LVMH bidding for Tiffany always put an implicit floor under its stock. A few others could conceivably consider stepping in to buy it, including Richemont or Kering (PPRUY), another French luxury conglomerate and parent of Italian fashion house Gucci. But these deals make less strategic sense than LVMH/Tiffany, and given Arnault’s unparalleled record in deal-making, even the most confident competitor would take pause in stepping into a deal he walks away from.

If the deal does fall through, downside is probably around $40 versus $20 of upside (if the deal closes as negotiated at $135). Merger arbitrage specialists will play these kinds of odds all the time, provided they’re confident the deal will close.

Perhaps the most likely outcome is that the deal goes through, but LVMH negotiates a lower revised purchase price – reflecting the change in market conditions in the U.S. The long-term prospects for Tiffany under LVMH ownership are unchanged… but the amount of time for the company to realize these returns may be pushed out, thus justifying a lower price.

To be comfortable buying Tiffany shares here, I’d need to think the deal is 80% likely to close at the current price of $135. I’m not there yet, but folks who are can get a 17% return in a few months, or more than 50% on an annualized basis.

Despite the coronavirus-related market volatility and economic turmoil, few merger and acquisitions (M&A) deals have blown up this year…

The most prominent deal that got scrapped was Boeing’s (BA) $4 billion bid for Brazilian regional jet maker Embraer (ERJ). Boeing abandoned the deal in late April, citing falling jet demand.

And as I wrote in the May 22 Empire Financial Daily, L Brands (LB) saw private equity walk away from an agreement to acquire a majority stake in Victoria’s Secret for $525 million.

But some hedge funds are betting we’ll see an uptick in the number of announced deals that fall through.

According to an article in Monday’s Wall Street Journal, risk arbitrage funds – which typically make money buying the shares of an acquisition target and betting they rise as the deal ultimately closes – have adopted the unorthodox strategy of shorting the target in acquisitions, betting they will fall as either deals are abandoned or the perceived risk of deals increases, thus widening the discount between the target’s bid price and where it trades.

The Journal relayed the story of one merger-arbitrage fund manager who has radically shifted his strategy…

Merger-arbitrage manager Raj Vazirani thought his January bet on a $5.5 billion Texan bank merger was a safe one. He felt confident as David Brooks, Independent Bank Group’s chief executive, extolled the deal with Texas Capital Bancshares on a conference call that month.

Three months later, Mr. Vazirani reversed his view on Texas Capital, after Mr. Brooks repeatedly declined to comment on the tie-up during an earnings update in April. Mr. Vazirani exited his long position in Texas and started selling the stock short.

Of 20 positions, Mr. Vazirani would normally hold around 17 as long holdings and the rest as shorts. Today, that breakdown is about even.

The “strategy of buy and hold worked for nine years,” during the bull market, said Mr. Vazirani, chief investment officer of New York-based Vazirani Asset Management. “I don’t think it will work this year.”

His move to short Texas Capital stock proved prescient. The banks last week called off the merger, citing the Covid-19 pandemic.

One M&A deal trading with a wide spread, indicating the market thinks it might not get done, is mall real estate giant Simon Property Group’s (SPG) proposed acquisition of trophy asset mall owner Taubman Centers (TCO) for $52.50 per share.

TCO is trading around $43, an 18% discount to the deal price, suggesting that temporary store closures and the resultant missed rent payments that accompanied them have some investors skeptical the deal will go through at the negotiated terms.

Today, one reader asks for investment and allocation guidelines, while another has some ‘constructive’ thoughts about Empire Financial Daily

Of course, I’m always looking for feedback – both good and bad – and while I can’t reply to every note individually, I do read through everything. What’s on your mind? Let me know at [email protected].

“Hi Berna, extremely pleased that you joined Empire! Loving every daily piece. Can’t wait to read each. I live in Singapore. So, it’s the first thing I wake up to and choose to read each morning. Before that, it was Whitney’s mail (but then, if it’s any consolidation for him, he sends his earlier so yours appears first on my email list). Whitney might get jealous. Love how you drill deep into each sector/ industry each day with good insights and plain language. Can’t wait for your inaugural subscription piece. I would like to know your principles for investment and allocation based on what you write.” – Michael C.

Berna comment: Thank you for the kind words, Michael. I could literally write a book on my thoughts on investing and portfolio allocation. I think allocations are inherently linked to risk tolerance and time horizon… so there’s no single right answer.

The process for me starts with an honest assessment of what I think could be a one-year base case for upside and downside prices and a best-case upside price. From there, I calculate the risk versus the reward. For example, if my base case for a $20 stock is that it will be $30 in a year, but if everything goes wrong, it will be $15, that’s $10 upside to $5 downside.

I try to get at least a two-to-one reward-to-risk ratio in all my investments, although it’s admittedly harder after a long bull market. I size stocks with a three-to-one reward-to-risk ratio bigger than stocks with a two-to-one ratio.

Lastly, if the downside is 50% or more, I’ll reduce the position size, even if reward-to-risk is great. And if something has a fantastic best-case return, I might size it a little bigger.

That’s my general framework on allocation/portfolio construction. Hope that helps!

“Get your crystal ball out of the shop and get cracking. We don’t need you to tell us what has gone way up, we need you to tell us reliably what is or will be going up tomorrow, next day or next week, like Whitney was doing. He actually told us what he bought, what day and they were the right moves.” – Revman Z.

Berna comment: Hi Revman, I do try to pack every issue of Empire Financial Daily with unique insights and in some cases, an investment takeaway. But it wouldn’t be fair to our paying subscribers if I simply gave away all my best ideas in a free e-letter. I am a regular contributor to our Empire Investment Report and Empire Stock Investor newsletters and have fully researched picks in those portfolios. Later on down the line, I’ll launch a paid service of my own.

But it seems like you might want to be reading Empire Financial Daily a little closer…

I have indeed made some recommendations along the way. In my first newsletter on April 27, I highlighted TJX Companies (TJX) as a retail survivor. That stock is up 15% in five weeks. And on May 18, I told readers about Revolve Group (RVLV). It’s up about 19% in two weeks.

Of course, the recommendations I give away in the daily are instinctive picks based on my 20-plus years in the markets. They don’t have the same level of vetting as what makes it to our paid portfolios. (And if any Empire Financial Daily readers have made money on any of the ideas I’ve featured in here, please e-mail me and let me know at [email protected]!) 

Regards,

Berna Barshay
June 3, 2020

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About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to nearly $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor’s degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

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