Luxottica Placed On CreditWatch Positive

Delfin, Italian eyewear maker Luxottica’s controlling shareholder, and lens maker Essilor have announced the signing of an agreement to merge Luxottica and Essilor. The combination of the two companies should happen through an exchange of shares and without any significant cash payout. The merger will create the largest vertically integrated group in the eyewear industry, which will have a unique global leading position.

S&P Global Ratings said that it had placed its ratings, including its ‘A-‘ long-term and ‘A-2’ short-term corporate credit ratings, on Italian eyewear maker Luxottica Group SpA on CreditWatch with positive implications.

The CreditWatch placement follows Luxottica’s controlling shareholder Delfin’s announcement that it had signed an agreement to merge Luxottica with Italian lens manufacturer Essilor. The merger will happen through the exchange of about 62% of Luxottica’s shares owned by Delfin into newly-issued Essilor shares. This will happen on the basis of an exchange ratio of 0.461 Essilor shares for one Luxottica share. Essilor will launch a public exchange offer for the remaining about 38% outstanding Luxottica shares at the same exchange ratio applied to the 62% contributed by Delfin. Delfin will be the largest shareholder with a stake of 31%-38% and its voting rights will be capped at 31%. The company resulting from the merger will be named EssilorLuxottica. The deal is expected to be closed in the second half of 2017 and is subject to some regulatory approvals, including from the antitrust authorities.

We note that the merger will create the largest integrated player by far in the eyewear industry, with about €15 billion in revenues and about €3.5 billion in EBITDA. We expect that the combination will result in the group having stronger competitive positioning because both Essilor and Luxottica are global market leaders in their respective industries and the new group will offer a full product proposition based on the production of ophthalmic lenses and optical instruments and on the production and distribution network of frames, branded prescription glasses, and sunglasses. The group will continue to draw strength from strong brand recognition, resilient operating performance reflecting common strategy of innovation capabilities, and roll-out of high-end products in the mature western markets, while value products will enable expansion in the emerging markets. However, we are aware of the challenges related to integration following large mergers. As such, we would view a proven ability to successfully integrate the two companies and translate their potential into profitable growth as one of the conditions that could lead us to revise up our currently strong assessment of the business risk profile.

We note that the geographic exposure will be skewed toward the U.S., which will represent more than half of combined revenues, and that the concentration on mature markets, which has historically proven to be a positive, could in the current environment limit future growth. We believe that the group will continue to generate solid free operating cash flow in line with Essilor’s and Luxottica’s track records and on the basis of the current information that the deal will be completed through an equity swap. Based on this information, we assume that the group’s financial risk profile will remain in the modest category and the adjusted debt to EBITDA will not exceed 2x.

We view the eyewear industry as relatively low risk, reflecting our forecast for the group of positive revenue growth in the low- to mid-single digits over the medium term, with stable operating margins. Further support stems from favorable industry demographics, with aging populations and improved diagnostics, alongside growing sales of sight aids to the middle classes in developing economies.

On the basis of these assumptions, we believe that our long- and short-term ratings on the merged group could be at least in line with our current rating on Luxottica and that there is potential upside.

We plan to resolve the CreditWatch listing in the upcoming months as we receive more details about the evolution of the merger, the final capital structure, the realization of the synergies, and the potential impediments to the completion of the transaction. Given the friendly nature of the deal, we do not expect any issues regarding the main points already agreed by Delfin and Essilor. We believe that, given both players’ leading position and their strong market shares in some mature markets, the antitrust approval will be an important step in the whole process.