Vice President: Yug Serai
Analysts: Heison (Cheng Hei) Chan, Kester Low, Saumya Shah, Henry Wareing
Deal Overview
Acquirer: Estée Lauder Companies (LON:0JTM)
Acquiree: Tom Ford
Deal Size: $2.8 billion
Buy Side advisors: Perella Weinberg Partners LP (financial), and Paul, Weiss, Rifkind, Wharton & Garrison LLP(Legal)
Sell Side Advisors: Goldman Sachs & Co. LLC (financial) and Skadden, Arps, Slate, Meagher & Flom LLP (Legal)
Introduction
In a press release on 15 November 2022, Estee Lauder Companies Inc. (ELC) announced that it would acquire the Tom Ford brand, a global leader in luxury and fashion. This deal would mean that Estee Lauder would be the sole owner of the Tom Ford brand and all of its intellectual property. The deal is currently subject to some regulatory approval but will be completed by the first half of 2023. It is the largest deal in the luxury market this year, signifying the importance and the scale of the transaction. Although a massive cosmetics company like ELC would not have the expertise to maintain the existing business of Tom Ford in the fashion industry, it would still work closely with partners like Zegna and Tom Ford itself to see the acquisition going forward. The aim of this whole acquisition is to expand its online presence and enter fast-growing and emerging markets such as China. Together with Tom Ford, ELC would be able to achieve these goals.
Estée Lauder Overview
ELC is one of the largest cosmetic companies in the world, founded in 1946. It is also one of the leading manufacturers and marketers of skincare, makeup, fragrance, and hair care products. With the acquisition of Tom Ford, ELC added one more prestigious brand to its existing highly decorated list of brands including Bobbi Brown, Clinique, and MACcosmetics. In 2022, ELC generated annual revenue of more than $17.7 billion, an increase of more than 9% from its previous year. The net sales of ELC have been increasing year on year, with its 5-year CAGR reaching up to 8.4%, significantly higher than most competitors. ELC has also been profitable, with net income for 2022 reaching around $2.4 billion. ELC began to expand primarily in the 1990s. During this period, ELC went from a family-owned business to a publicly traded company listed on the New York Stock Exchange in 1995. In the same decade, ELC did numerous acquisitions and partnerships, including a deal with Tommy Hilfiger that assisted hugely in its growth. ELC is currently present in approximately 150 countries and territories, with its three main geographic regions being ‘Asia-Pacific’, ‘Europe, Middle East and Africa’, and ‘the Americas’. Currently, the ‘Europe, the Middle East and Africa’ region is the biggest contributor to ELC’s income and sales, contributing around 43% to net sales. The Americas is the second largest, but Asia-Pacific is its fastest-growing market. ELC’s emerging markets today include Turkey, India, and South Africa, with the hope of expanding and penetrating these markets.
Tom Ford Overview
Tom Ford is a luxury fashion house founded by Tom Ford in 2005, and since then it has become a significant player in the fashion house industry. In 2021, it generated sales of $1.7 billion and a profit of $96 million. In 2005, ELC and Tom Ford signed a deal to sell the ‘Tom Ford for Estée Lauder’ line at ELC counters. Later, Tom Ford launched a separate beauty line in 2006 under the agreement. The deal with ELC allowed Tom Ford to launch its first fragrance, called Black Orchid which was manufactured by Estée Lauder. Black Orchid was a successful product, generating more than $40 million in its first year. This was believed as a starting point for Tom Ford in the industry when it gained its reputation of selling high-quality products. The Tom Ford brand has grown due to continuous partnerships with other businesses. As mentioned before, Tom Ford partnered with ELC in 2006 to launch its own line of products and sell ELC’s products. Moreover, after the formation of the company, Tom Ford announced a partnership with Marcolin, a global leader in the eyewear sector, which allowed Marcolin to sell glasses under the Tom Ford brand. In 2017, Tom Ford decided to expand into luxury watches and partnered with Bedrock Manufacturing Co. Founded by Tom
Kartsotis, who also started Fossil and Shinola. These partnerships were vital to make Tom Ford a top-most luxury fashion house.
Deal Structure
In a press release on 15 November 2022, Estée Lauder Companies Inc. (ELC) announced that it would acquire the Tom Ford brand, a global leader in luxury and fashion. This deal would mean that ELC would be the sole owner of the Tom Ford brand and all its intellectual property. ELC will pay $2.8 billion, with a mix of debt, cash and $300 million in deferred payments. This would allow ELC to benefit from securing long-term cash flows from owning the Tom Ford Beauty brand, rather than having its license which would expire in 2030. Moreover, it would allow ELC to make other licensing revenue streams using the brand and generate further synergies. According to the business, ELC expects this transaction to be dilutive to adjusted diluted EPS in fiscal 2023 by $0.05 to $0.15, primarily from one-time acquisition-related costs. Under the agreement, Tom Ford, Founder and CEO of Tom Ford International, will continue to serve as the brand’s creative visionary through the end of the calendar year 2023. The deal is subject to certain regulatory approvals and is expected to be completed by the first half of 2023. Several existing licensing agreements are also to be extended. For instance, the brand's current license with Marcolin will be substantially extended, by Marcolin paying $250 million to ELC. Moreover, the deal will extend and expand
the Tom Ford brand’s longstanding relationship with Ermenegildo Zegna, an Italian luxury fashion house, to include a long-term license for all men’s and women’s fashion as well as accessories and underwear.
Industry Analysis
The deal primarily lies in the cosmetic, luxury beauty and fashion industries. The COVID-19 pandemic had an adverse effect on this industry, as shown in the graph below. In 2019, the market size was around $90 billion, but fell to around $72 billion the next year, solely attributed due to decreasing demand during the pandemic.
However, there has been steady growth since then. The cosmetic industry has a global market size of more than $93 billion USD in 2022 and is estimated to reach around $125 billion in 2027, as shown in the graph below. The industry grows at an annual growth rate of around 3.8%, signifying potential growth opportunities for companies like ELC. This deal was one of the biggest deals in the industry this year. The luxury beauty and fashion industry will reach a market value of more than $75 billion by 2029 (1) and is likely to grow at a CAGR of 6.4% from 2022 to 2029. Growth in this market is aided by the disposable income in developing countries, especially India, China, Brazil, and South Africa. Growth opportunities persist due to the new e-commerce channels, and this has led to increasing sales since it allows vendors to advertise their products with attractive offers and discounts.
However, this industry has never been clear of threats. Increasing awareness among consumers regarding chemicals and the harms of cosmetics, and regulation from the government is a matter of concern in this industry, which could affect the sales of any brand. Another factor that affects this industry is the state of commerce. Traditionally, physical stores were the point of purchase. However, more and more people today are shopping for such products through the internet. For ELC itself, 28% of the sales in 2022 were online, representing an 11% growth from the previous year (2). It is believed that online shopping is the way ahead for this industry, considering the young population. Emerging markets present a big opportunity for the cosmetics industry, with more and more people from countries like China, India, Brazil, and South Africa feeling the need for skincare and cosmetics.
China is expected to have a market size of $45 Billion in 2026 (3). According to an analysis by McKinsey, the luxury market will grow between 5-10% this year, attributed to the demand push in China. Therefore, companies in the industry must capture these emerging markets to their benefit.
Revenue of Cosmetics market worldwide from 2014-2027 (in $billions)
Source: Statista (4)
Deal Valuation and Financial Analysis
Estée Lauder Financial Analysis
Key Financials (in USD) (as of 08/03/2023)
Tom Ford Financial Analysis
Key Financials (in USD) (as of 08/03/2023)
Deal Financial Details
The deal is valued at USD $2.8 billion (EUR 2.63b) (USD 1 = EUR 0.940), including debt, and is Estée Lauder’s largest acquisition ever. The deal transaction will be paid by both cash and debt, as well as $300 million worth of deferred payments by 2025.
Comparable Company Analysis
Based on available information, Tom Ford would have an EV/Revenue ratio of 2.86, which is relatively good compared to the median and mean ratios amongst comparable companies. This hints to a positive valuation of Tom Ford that makes it a good acquisition target. However, since there are few comparable companies that have a similar profile, EV and revenue, it could be quite difficult to pinpoint whether the acquisition price was justified just from this information. Nonetheless, it is likely that Estée Lauder has decided that the deal is well justified from its own calculations of non-publicly available information.
Implied Valuation and Premium Paid (based on mean EV/Revenue)
Based on available information, the implied valuation of Tom Ford's business is $1,988,350,000 ($1.98 billion) which is calculated by multiplying the mean EV/Revenue (2.47) by the latest publicly available revenue reported of Tom Ford ($805 million). This valuation implies the perceived value of Tom Ford's future cash flows by the acquirer.
The purchase price of the business $2.3 billion, which is 16% higher than the implied valuation, meaning that the premium paid is $311,650,000 ($311.65 million). This premium could mean that Estée Lauder believes that Tom Ford's business has significant growth potential or strategic value that is not fully reflected in the implied valuation, and that 16% is a reasonable premium that would be covered by future growth and synergies. The premium may also have reflected the competitive bidding process among other potential buyers.
It is important to note, though, that this analysis is based on limited information available, and other factors may also influence the purchase price and premium paid, resulting in differing valuations.
Precedent Transactions
LVMH’s acquisition of Tiffany & Co.
Completed in 2021, the acquisition worth $15.8 billion valued the company with a premium over 30%, despite the lowered price from the original bid of $16.2 billion. The acquisition was a strategic one, allowing it to rise to the world’s third largest jeweller after first entering the market through acquiring Bulgari in 2011. The acquisition proved impactful and has helped LVMH outperform the industry. Tiffany & Co. remains the group’s second largest brand.
G-III Apparel Group’s acquisition of Karl Lagerfeld
G-III Apparel Group purchased the remaining 81% stake of the Karl Lagerfeld fashion brand for €200 million in an all-cash deal in 2022. Fitting of G-III’s goal to diversify its brands and pursue global expansion, G-III plans to help the Karl Lagerfeld brand achieve more than $2 billion in global retail sales. Previously, it helped build the Karl Lagerfeld brand’s North American business after acquiring a minority stake in 2015.
Authentic Brands Group’s acquisition of Ted Baker
Authentic Brands’ acquisition was worth $254 million and valued the firm at £1.10 per share, approximately 18% premium of its closing price then. The move was due to many factors, including induced financial pains from the pandemic, as well as the weakening British pound that benefitted the US firm in acquiring Ted Baker. Riding on a wave of increasing demand for luxury globally, Authentic Brands have capitalised on the acquisition of brands outside of the US to diversify and reinforce presence in the UK, Europe, and Middle East.
Deal Rationale
Cost synergies
The acquisition of Tom Ford by ELC is expected to result in significant cost synergies. Since it is a purchase of a company in the same industry that operates at the same level of the value chain (so-called horizontal integration), the acquisition allows the companies to benefit from economies of scale, which will lead to cost savings. The achievement of economies of scale can be attributed to many factors. One of the reasons is in the supply chain. The combined company can negotiate better prices from suppliers and benefit from reduced transportation costs, which can be a huge benefit to the companies as the production of products such as fragrances, cosmetics, and skin care products requires lots of raw materials. Following this, since the demand for luxury goods is usually inelastic, the price will remain high even as costs decrease, contributing to a significant increase in their profits. However, since Estée Lauder is already the second-largest cosmetics company by revenue in the world, its size going too big may lead to it suffering from diseconomies of scale, causing an increase in long-run average costs.
When Estée Lauder acquired Tom Ford, the two companies likely had some overlapping functions and operations, such as administrative tasks, finance, and HR. By combining these functions and streamlining their production processes, the merged company can eliminate redundancies and reduce overhead costs. For example, there may have been two separate finance teams in each company that handled similar tasks. By consolidating these teams into a single unit, the company can reduce the costs associated with having multiple teams. Similarly, the administration and HR functions of both companies can be streamlined to reduce duplication and cut costs. According to Deloitte's Global Shared Services Survey 2017, streamlining operations can lead to significant cost savings. The study found that companies that streamline operations can reduce their costs by up to 20% (5) by identifying and eliminating redundancies in their operations, companies can improve their efficiency and profitability. However, there may be cultural differences and resistance to change among employees, which can create challenges when trying to streamline operations.
Another area where cost synergies can be achieved is in manufacturing and distribution. By combining their resources, the two companies can share manufacturing facilities and distribution centers, which can lead to cost savings. For example, the combined company may be able to reduce the number of distribution centers needed, resulting in lower transportation and storage costs.
Additionally, the combined company can optimise production processes by using the same suppliers and manufacturing equipment. However, there may be regulatory or legal requirements that the combined company needs to comply with.
Revenue synergies
The acquisition is also expected to result in revenue synergies. One example of revenue synergies is cross-selling. By offering both Estée Lauder and Tom Ford products, the combined company can take advantage of cross-selling opportunities. For example, a customer who purchases a Tom Ford fragrance may also be interested in Estée Lauder skincare products. According to Accenture's report "Improving the Odds: Building a Business Case for Cross-Selling", cross-selling can lead to revenue increases of up to 20%. (6) However, there is no guarantee that customers will be interested in purchasing products from both brands or that significant investments in marketing and sales are needed to implement effective cross-selling strategies.
Another revenue synergy that can result from the acquisition is the expansion of the combined company's customer base. Tom Ford can be leveraged by Estée Lauder to reach new demographics and markets. There are several previous examples regarding this: L'Oreal acquiring The Body Shop, Estée Lauder acquiring MAC Cosmetics, etc. Tom Ford has a significant presence in the men's grooming market, which is an area where Estée Lauder has less of a foothold. According to a report by Euromonitor International, the global men's grooming market is expected to grow at a compound annual growth rate of 5% from 2019 to 2024, reaching a value of $78 billion by 2024. (7) Furthermore, Tom Ford has a strong presence in Asia, particularly in China, where the brand has experienced significant growth. According to Euromonitor International, China is the world's second-largest market for luxury goods, and the country's luxury goods market is expected to grow at a compound annual growth rate of 8% from 2019 to 2024. (8) By leveraging Tom Ford's strong presence in the Chinese market, Estée Lauder can gain access to a new demographic and increase its revenue. This can be seen as a strategic move as the global luxury market is expected to grow, driven by strong demand from emerging markets like China. However, current inflation pressures may affect customer demand. While luxurious clothing lines may not be affected as customers are willing to pay more for them, the beauty and fragrance industries could be affected a lot.
Finally, by combining the reputations and brand equity of Estée Lauder and Tom Ford, the combined entity can enhance its overall brand appeal and generate more revenue. For example, the acquisition of Tom Ford could help Estée Lauder appeal to younger consumers, who may be more interested in Tom Ford's edgier brand image. However, the acquisition may change the companies’ brand image, preventing revenue synergy.
Revenue share in the apparel market between 2017 and 2025: online vs offline channels.
Source: Statista (9)
Other rationale
The acquisition is expected to provide Estée Lauder with more creative control over Tom Ford Beauty, as well as the potential to expand its online presence. Estée Lauder's growth goals for Tom Ford Beauty will be strengthened, and new doors will open. The agreement will also create new revenue opportunities from licensing and make royalty payments unnecessary. This acquisition is part of Estée Lauder's strategy to invest more in e-commerce, as customers are increasingly turning to online channels to purchase beauty and personal care products. As shown in the diagram below, the revenue share of online channels in the apparel market has been increasing in recent years, and it is also expected to continue increasing in the future. Finally, the acquisition was motivated by the success of Tom Ford's beauty business, which encompasses fragrance, cosmetics, and skincare. Tom Ford's luxurious fragrances, such as Black Orchid and Tuscan Leather, regularly top best-seller lists and sell for over $100. By building a solid reputation and a devoted following over the years, Tom Ford has established itself in the market for luxury fragrances. Some of the Tom Ford fragrances are now considered iconic signature fragrances and true staples in their perfume cabinets.
Risks
Many of the risks associated with this deal are not related to Tom Ford and Estée Lauder themselves, but instead the market within which they operate, and because of this risk nature many of the risks involved in this deal are outside the control of both Tom Ford and Estée Lauder, and instead come due to exogenous factors, such as geopolitics, market influences, and international trade.
This low source of endogenous risk comes from the pre-existing relationship that these two companies have; Tom Ford and Estée Lauder have been in a long-term partnership since 2006, as they have had licensing agreements pertaining to Tom Ford’s fragrance collections. Therefore, there is unlikely to be any managerial issues or firm philosophy problems, as these two firms are familiar with each other’s operations and business approach. In addition to this, Tom Ford himself agreeing to stay on at Tom Ford as a ‘creative visionary’ until the end of 2023 should smooth over any potential issues that may arise, as he will help his firm navigate this acquisition and the relationship between them and their new owners. So, in this way, the risks in this deal do not come from management troubles, or synergy issues. Instead, they come from the wider macroeconomic landscape, and the luxury market itself.
The first major risk with this deal is the fact that both firms operate in the ‘personal luxury goods’ market. This is a market that is highly cyclical, and therefore highly susceptible to volatile fluctuations in demand. This comes from the nature of luxury goods relying on high disposable incomes, and luxury goods being one of the first things that consumers cut back their spending on during a slump. This volatility is seen in the graph below, as it shows how during the Covid-19 pandemic, a huge €61bn of value was wiped out from the total personal luxury goods market, confirming its volatility in relation to macroeconomic trends.
This risk is particularly relevant in this deal due to the current macroeconomic state of play in the global economy being one of uncertainty, risk, and high volatility. As of January 2023, UK inflation sits at 8.8% (11), the highest that it has been in decades, which quantifies and qualifies the current market uncertainty and issues faced. This links back to Tom Ford and Estée Lauder, as the success of this deal could be entirely derailed if their new partnership fails to bring in increased revenues and turn profits for shareholders, which is a possibility given the negative future economic outlook, and how closely correlated the luxury personal goods market is to this negativity.
Source: Statista (10)
Another possible risk in this deal is the reliance of the personal luxury goods market on Chinese demand. As of 2021, Chinese consumers accounted for 21% of luxury consumer spending in the global luxury market. While this does not present an inherent risk, the risk in relation to this deal comes from the current political tension between China and the West, over their apparent support of Putin in his Ukrainian invasion, and the ongoing conflict between China and Taiwan. Either of these issues becoming overly problematic could engage China and the US in a trade conflict, resulting in tariffs and quotas, which would clearly alienate luxury Chinese consumers and hence wipe out a large portion of the market. This could present issues to Tom Ford and Estée Lauder, as it would decrease their total revenue, and hence limit the success of the deal overall.
Furthermore, the graph below shows that this trend is expected to continue, with Chinese consumers accounting for just under half of the spending in the luxury market by 2025 – this risk is not set to go away. While the forecast is based off a small sample size (n=3) it is still in line with Statista’s official forecast of 40% by 2025, showing how it is still reliable in predicting future market trends. Therefore, this is a risk which is unlikely to go away and will instead need to be minimised by the easing of geopolitical tensions, which is easier said than done in the current climate.
However, Chinese consumers making up a significant portion of the market is still good news in other ways, as the Chinese economy is projected to grow by 5% in 2023 according to Deloitte (13), which could stimulate further luxury goods demand and therefore boost the combined revenues of Tom Ford and Estée Lauder, contributing to the deal’s success overall. So therefore, this factor poses both a risk, but also an opportunity for Tom Ford and Estée Lauder to capitalise upon, depending on how these geopolitical tensions develop throughout the year.
Source: Statista (12)
Finally, another risk which is inherent in this deal is the issue of supply chain disruption. Tom Ford and Estée Lauder are both companies with complex, global supply chains, which makes them highly vulnerable to supply chain disruption. Unfortunately for this deal, KPMG (14) predicts that the supply chain disruption that has plagued the world economy in the last couple of years is set to continue, due to inflationary pressures, geopolitics, and the current recessionary environment in the global economy. This presents significant risk to this deal, as it could limit firm integration and disrupt the production, shipping and sale of new products offered under the newfound partnership, which would counteract the main mechanisms by which an acquisition succeeds.
KPMG goes on to say that the keyway to combat supply chain disruption is to have sophisticated planning, agility, and end-to-end visibility of the supply chain a firm uses. This could therefore be a huge problem for Tom Ford and Estée Lauder, as their existing supply chains are likely to be disrupted by this deal anyway, and therefore they will need to put in extra work and manhours to manage this risk effectively and ensure that it does not derail this entire deal.
Overall, the risk profile of this deal should be medium, as while there are exogenous risks present to the companies involved, these are risks which are present to many similar businesses to Tom Ford and Estée Lauder, and therefore it is unlikely that Tom Ford and Estée Lauder will be disproportionately affected should any of these risky scenarios occur.
Conclusion
To conclude, this deal represents an exciting opportunity for both ELC and Tom Ford to grow their businesses and attract larger market share in the luxury market. Provided that the risks in this deal do not affect the deal too much, it should provide new revenue streams for both companies and build on their existing long-standing relationship, which has a strong track record of success and prestige.
In addition to this, the relatively low acquisition premium of 16% shows that ELC obtained a good deal on Tom Ford, which should further boost its shareholders’ confidence in the deal, as this premium is low, especially given the level of preexisting relationship between these two firms that may have commanded a higher goodwill premium.
The plethora of cost and revenue synergies that both companies obtain from this deal should further boost confidence, as it will allow both companies to effectively navigate the tricky market conditions which plague the global economy in 2023, and therefore outcompete their competitors and obtain a larger market share in the luxury goods market. However, should geopolitical issues continue too long or worsen in 2023, these synergies may be wiped out and the two firms could suffer from this deal, as larger macroeconomic trends could wipe out market value, similarly to what happened in 2020 – this would be a major issue which could derail this entire deal.
Overall, this deal should be a sign of the positive upswing in M&A activity after a difficult 2022, and should be treated with a generally positive outlook, as it shows how both companies and investment banks are starting to enter dealmaking once again, which can only be a positive sign for the industry. Apart from a few risks such as geopolitics and market troubles, this deal should yield value and higher revenues for both firms moving forward.
References
2022 Report on the Top 5 Emerging Countries in Skincare to 2026: China is the Leading Country Among the Emerging Nations With Market Revenues of $35.6 Billion in2021ountries-in-Skincare-to-2026-China-is-the-Leading-Country-Among-the-Emerging-Nations-With-Market-Revenues-of-35.6-Billion-in-2021---ResearchAndMarkets.com
Accenture, (2005), Improving the Odds: Building a Business Case for Cross-Selling
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