An Instant Catalyst for Safilo

INDEPENDENT RESEARCH Safilo 23rd May 2013 Worth taking another look at! Luxury & Consumer Goods Fair Value EUR15 (price EUR13.89) BUY Coverage initiated

Bloomberg SFL IM We are initiating coverage of Safilo with a Buy recommendation and a Reuters SFLG.MI FV of EUR15 (DCF). The world no. 2 in premium/upscale eyewear is 12-month High / Low (EUR) 13.9 / 4.2 finally benefiting from better prospects now that it has cleaned up its Market capitalisation (EURm) 858 Enterprise Value (BG estimates EURm) 1,043 balance sheet and this should enable it to strengthen its portfolio of Avg. 6m daily volume ('000 shares) 195.7 licences while continuing the global roll-out of its three main brands Free Float 44.5% (Carrera, Safilo and Polaroid). In our view, Safilo is ideal for playing 3y EPS CAGR 32.6% Gearing (12/12) 25% the growth stock and recovery stock themes in the Optical sector. Dividend yields (12/13e) NM  Blue skies on the horizon again for Safilo! After facing financial YE December 12/12 12/13e 12/14e 12/15e difficulties in 2009-10 and losing one of its main licence for G. Armani in Revenue (EURm) 1,175 1,160 1,218 1,290 2011-12, the global no. 2 now offers promising 2013-15 prospects with: EBIT(EURm) 73.88 81.79 99.53 120.12 (i) a growing portfolio of licences (76% of sales), (ii) the integration of Basic EPS (EUR) 0.43 0.55 0.74 1.00 Diluted EPS (EUR) 0.43 0.55 0.74 1.00 Polaroid which should boost sales and margins in the future and (iii) a EV/Sales 0.9x 0.9x 0.8x 0.8x cleaned up balance sheet since the arrival of new key shareholder HAL EV/EBITDA 9.3x 8.7x 7.2x 6.0x EV/EBIT 14.5x 12.7x 10.2x 8.1x (global no. 2 in eyewear distribution with, for instance, the retail banner P/E 32.5x 25.4x 18.7x 13.9x GrandOptical), which has a 42% stake since 2012. ROCE 4.1 4.7 5.7 6.8 th Closing price and data as of 20 May  The Q1 13 performance was well ahead of market expectations. 15/5/13 280 With this excellent Q1, the group proved it had dealt with the post- 260 Giorgio Armani period perfectly, with organic growth of 11.2% in its 240

220 brand portfolio, which remains the largest in the sector behind Luxottica 200 with licences such as Gucci, Dior, Marc Jacobs and Hugo Boss and five 180 own-label brands (Carrera, Safilo, Polaroid, Smith Optics and Oxydo). 160

140 Furthermore, growth in EBITDA margin (+50bp to 11.7%) testifies to 120 the positive operating leverage expected in 2013 and beyond. We are 100

80 forecasting organic sales growth of 7.6% and a 50bp widening in M J J A S O N D J F M A M SAFILO GROUP STOXX EUROPE 600 E - PRICE INDEX EBITDA margin to 10.3%, which points to the start of a more Source: Thomson Reuters Datastream virtuous cycle expected between 2012 and 2015.  Safilo: an attractive alternative for investors who find the two sector leaders, Essilor and Luxottica, fully valued. Safilo also offers very solid growth prospects (2012-15 CAGR of 17.6% for EBIT and 32.7% for EPS) combined with a fairly attractive valuation (2013 PEG of 0.7x vs. 2.5x for Essilor and 1.8x for Luxottica.

Analyst: Consumer Analyst Team: Cédric Rossi Loïc Morvan 33(0) 1 70 36 57 25 Peter Farren [email protected]

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Safilo

1 350 9 1 300 8 Income Statement (EURm) 2010 2011 2012 2013e 2014e 2015e 1 250 7 Revenue 1,080 1,102 1,175 1,160 1,218 1,290 6 1 200 Change (%) 6.8% 2.0% 6.7% -1.3% 5.0% 6.0% 5 1 150 Gross Profit 630 652 680 673 712 761 4 1 100 3 EBITDA 108 123 115 120 140 163 1 050 2 EBIT 67.8 86.2 73.9 81.8 99.5 120 1 000 1 Change (%) -% 27.1% -14.3% 10.7% 21.7% 20.7% 950 0 Financial results (39.6) (34.0) (29.3) (25.0) (22.5) (17.5) Pre-Tax profits 28.8 51.2 44.0 57.3 77.5 103 Sales Organic growth (%) Tax (24.2) (20.1) (17.4) (21.5) (29.5) (39.2) 140 10,0 Minority interests (3.8) (3.2) (0.74) (2.0) (2.1) (2.2) 9,5 120 Net profit 0.73 27.9 25.9 33.8 46.0 61.7 9,0 100 Change (%) -% 3 711% -7.2% 30.7% 36.0% 34.2% 8,5 80 8,0 Cash Flow Statement (EURm) 60 7,5 Operating cash flows 44.6 67.5 67.8 74.1 88.4 107 40 7,0 Change in working capital (53.1) (1.3) 3.0 3.5 13.6 17.1 20 6,5 Capex, net 29.2 24.7 28.8 34.8 36.5 38.7 0 6,0 Financial investments, net (5.9) 6.7 58.4 5.8 6.1 6.5 Dividends 0.0 0.0 0.0 0.0 0.0 6.2 EBIT EBIT margin (%) Other (257) 19.4 (45.3) 0.0 0.0 0.0 Net debt 256 238 215 185 153 115 Company description Free Cash flow 68.6 44.1 36.1 35.8 38.3 50.8 With 2012 sales of EUR1.17bn, Safilo is Balance Sheet (EURm) the second-largest player in luxury & Cash & liquid assets 88.3 90.4 59.4 89.4 122 160 Other current assets 552 525 531 524 548 578 premium eyewear. The Italian group has Tangible fixed assets 204 208 205 201 197 194 a Wholesale-oriented business model Intangible assets 564 576 604 604 604 604 (93% of sales) which concerns the Other assets 67.1 75.5 93.0 93.0 93.0 93.0 design, production and marketing of Total assets 1,475 1,476 1,491 1,512 1,564 1,628 LT & ST debt 344 329 275 275 275 275 prescription glasses and sunglasses Other liabilities 364 331 354 351 361 374 thanks to a wide portfolio of licences Shareholders' funds 767 816 863 886 928 979 (Dior, Gucci, Marc Jacobs, Hugo Boss...) Total liabilities 1,475 1,476 1,491 1,512 1,564 1,628 and three major house brands (Carrera, Capital employed 1,055 1,051 1,086 1,079 1,089 1,102 Polaroid and Safilo). Financial Ratios Retail (7% of sales) consists of a single Gross Margin (% of sales) 58.33 59.20 57.83 58.00 58.50 59.00 EBITDA margin (% of sales) 9.99 11.13 9.79 10.35 11.48 12.62 U.S. retail banner: Solstice, which is EBIT margin (% of sales) 6.28 7.82 6.29 7.05 8.17 9.31 exclusively positioned in upscale Tax rate 84.13 39.31 39.59 37.50 38.00 38.00 sunglasses distribution. Net Margin 0.07 2.53 2.20 2.91 3.77 4.78 Since April 2012 the main shareholder ROE (after tax) 0.10 3.46 3.02 3.84 4.98 6.34 ROCE (after tax) 1.02 4.98 4.11 4.74 5.67 6.76 with a 42% stake is HAL, a holding- Gearing 33.40 29.21 24.95 20.92 16.50 11.74 company which also owns the 2nd Pay out ratio 0.0 0.0 0.0 0.0 13.43 15.01 largest optical distribution network. The Number of shares, diluted 49,529 56,948 60,477 61,934 61,934 61,934 lion's share is mainly composed of Per share data (EUR) European retail banners (GrandOptical, EPS 0.01 0.49 0.43 0.55 0.74 1.00 Pearle Vision Europe, Solaris, etc.) with Restated EPS 0.01 0.49 0.43 0.55 0.74 1.00 % change -101% 3 215% -12.6% 27.6% 36.0% 34.2% almost 4,800 stores. The Tabacchi BVPS 15.49 14.32 14.27 14.30 14.98 15.81 family's holding company (Only 3T) now Operating cash flows 0.90 1.19 1.12 1.20 1.43 1.72 only has a 9% stake. Hence free float FCF 1.38 0.77 0.60 0.58 0.62 0.82 amounts 45% Net dividend 0.0 0.0 0.0 0.0 0.10 0.15

Source: Company Data; Bryan, Garnier & Co ests.

Safilo

Table of contents

1. Investment Case ...... 4 2. Valuation: upside of 10% ...... 5 2.1. HAL: a key shareholder synonymous with stability ...... 5 2.2. An attractive price/growth ratio ...... 6 2.3. DCF valuation ...... 7 3. A pure Wholesale player ...... 8 3.1. Turbulent recent history ...... 8 3.2. Business model focused on Wholesale ...... 9 3.3. The second most attractive brand portfolio in the world ...... 10 3.4. Production widely outsourced ...... 12 4. Blue skies finally on the horizon for Safilo! ...... 14 4.1. Clearly improved visibility in licensing (76% of group sales) ...... 14 4.1.1. The risk of non-renewal of a key licence has been pushed back to 2015 ...... 14 4.1.2. Competitive pressure set to ease ...... 15 4.1.3. Strengthening the synergies with HAL’s Retail business ...... 16 4.2. Polaroid: an instant catalyst for Safilo ...... 17 4.3. A healthier balance sheet thanks to HAL ...... 18 5. Our 2013 and 2014 forecasts ...... 19 5.1. Q1 2013 performance confirming a recovery ...... 19 5.2. Sales forecasts: the main catalysts for 2013 and 2014 ...... 20 5.2.1. 2013: Particular focus on remaining brands and the roll-out of Polaroid ...... 20 5.2.2. … to which one or several new licences could be added in 2014...... 21 5.3. Profitability: significant operating leverage! ...... 22 5.3.1. 2013: heading for wider margins despite the loss of G. Armani ...... 22 5.3.2. Significant medium-term potential to increase gross margin and EBIT margin .... 23 Bryan Garnier stock rating system...... 27

Safilo

1. Investment Case

The reason for writing now After facing a number of financial and operating difficulties between 2008 and 2011, the outlook for the no. 2 player in upscale/premium eyewear has improved considerably, as shown by earnings publications over the past nine months. Safilo can now rely on: 1/ the sector's second most attractive portfolio of licences (Dior, Gucci, Hugo Boss, etc…) and own-brands (Carrera, Polaroid, Safilo) behind Luxottica, 2/ the integration of the polarised lens inventor, Polaroid, which is set to boost sales and margins as of 2013 and 3/ a cleaned up balance sheet which should help the group refinance its global development.

Valuation Despite performing extremely well since the beginning of the year (+111%), the share's valuation remains attractive in view of the other Optical sector leaders. Indeed, the share is trading on a 2013 PEG multiple of 0.7x vs 2.5x for Essilor and 1.8x pour Luxottica, in view of very robust growth prospects (2012-15 CAGR of 17.6% for EBIT and 32.7% for EPS).

Catalysts Q2 2013 and H1 2013 earnings are due out on 1st August after trading. In addition, Safilo's management has suggested that new licence agreements could be signed shortly. An announcement would clearly be beneficial for Safilo, which derives 76% of sales from licence agreements.

Difference from consensus In view of poor visibility, we remain cautious since our 2013-15 sales estimates are in line with the consensus figures although our EBIT estimates for the period are 2% lower than market expectations on average. Note that our 2015 estimates are also more cautious than the revised 2015 guidance set by the group (ie. after the loss of G. Armani but prior to the acquisition of Polaroid): 1/ sales of around EUR1.25bn vs. our forecast for EUR1.29bn (o/w Polaroid) and 2/ EBITDA margin of around 13.5% vs. our 12.6% estimate.

Risks to our investment case The main source of risk likes in licence agreements not being renewed, as seen when the share was de-rated at end-2011 following the announcement that it had lost the G. Armani licence. This risk is now low since no major licence is due for renewal before 2015. In addition, Luxottica is currently focused on integrating recent acquisitions (Tecnol, Alain Mikli…) and on organic growth rather than on conquering new licences. Finally, country risk concerning Italy should not be neglected in view of the group's exposure to southern Europe (~15% of sales) and Safilo's listing in Milan.

Safilo

2. Valuation: upside of 10% 2.1. HAL: a key shareholder synonymous with stability Since its creation in 1934, Safilo (Società Azionaria Fabbrica Italiana Lavorazione Occhiali) was long a family-owned company managed by the Tabacchi family, which was the main shareholder until March 2010 when the Dutch fund HAL Holding took a 37.2% stake in the capital. In April 2012, HAL financed the majority of the Polaroid acquisition via a reserved rights issue of EUR44.3m, thereby increasing its stake to 42.2%. The Tabacchi family's holding company (Only 3T) now only has a 9% stake and the family is longer involved in the operations of Safilo.

HAL has the specific feature of being another holding company 68%-owned by the Van der Vorm family, which owns numerous stakes in various sectors (port infrastructure, oil services with a stake in SBM Offshore, etc.). In addition, HAL is no stranger to the optical world, which it entered in 1996 with a stake in Pearle Europe, followed by the acquisition of GrandVision (including Grand Optical) in 2002.

With GrandVision, which houses all of the European banners, HAL owns the second largest optical distribution network with almost 4,800 stores in 39 countries. 2012 sales totalled EUR2.370bn, the lion's share of which is generated in Europe with the main banners Pearle, GrandOptical and Solaris (specialised in sunglasses distribution). Why is HAL a guarantee of stability that should reinsure investors?

(i) Significant financial means: the new key shareholder has provided its financial clout by taking part in the recapitalisation of Safilo and then by financing the acquisition of Polaroid. Thanks to HAL, the group's balance sheet has been cleaned up and Safilo can now focus on its development strategy.

(ii) Unlocking synergies with HAL's Retail segment: the close ties between the Retail and Wholesale segments are one of the keys to the success of Luxottica. It is therefore totally in the interest of HAL and Safilo to strengthen their relationships, especially since Safilo has refocused almost exclusively on the Wholesale segment.

(iii) A long-term shareholder: HAL has been present in the Optical market since 1996 and we believe it is a long-term shareholder in Safilo with the intention of remaining as long as it takes to unlock the above-mentioned synergies and enable Safilo to expand on a global basis.

Fig. 1: Safilo shareholding structure (on 31st December 2012):

Free Float HAL Holding 45% 42%

Financière de l'Echiquier 2% Norges Bank Only 3T 2% 9% Source: Company Data

Safilo

2.2. An attractive price/growth ratio Despite performing very well over the past six months (+111%), the two tables below show that the Safilo stock still boasts an attractive price/growth ratio, especially in terms of margins (2012-15e CAGR in EBIT of 17.6%) since positive operating leverage is set to be one of the main catalysts in our investment case. As such, Safilo is trading on 2013 EV/EBIT to growth of 0.7x, vs. 1.8x and 1.5x for Essilor and Luxottica respectively.

Fig. 2: EV/EBIT to growth multiples in Optical sector:

2013e EV/EBIT 2014e EV/EBIT EBIT CAGR EV/EBIT to growth Companies Market Cap (EURm) (x) (x) 2012-2015e (%) 2013e (x) Essilor 19,029 20.0x 17.9x 11.1 1.8x Luxottica 19,470 18.4x 16.2x 11.9 1.5x Safilo 858 12.7x 10.2x 17.6 0.7x Source: Bryan, Garnier & Co ests

The high growth in EPS expected between 2012 and 2015 (+33%) is likely to be driven by the significant improvement in EBIT margin, as well as by a gradual cut in debt (thereby generating a positive impact on financial items). This enables Safilo to offer a highly attractive PEG multiple of 0.7x based on 2013 P/E of 25.4x, compared with 2.5x and 1.8x for Essilor and Luxottica respectively.

Fig. 3: PEG multiples in the Optical sector:

2013e P/E 2014e P/E EPS CAGR PEG ratio Companies Market Cap (EURm) (x) (x) 2012-2015e (%) 2013e (x) Essilor 18,142 28.1x 25.1x 11.1 2.5 Luxottica 18,551 29.3x 25.4x 16.3 1.8x Safilo 759 25.4x 18.7x 32.7 0.7x Source: Bryan, Garnier & Co ests

In view of this attractive price/growth duo, Safilo seems to be the most relevant alternative for investors interested in the excellent medium/long-term fundamentals harboured in the Optical market, but who believe that the two market leaders (Essilor and Luxottica) have more strained valuations.

Safilo

2.3. DCF valuation For 2013, we are forecasting a 1.3% decline in sales, with organic growth at 7.6%. We expect organic growth to amount in 2014 and 2015, 5% and 6% respectively, driven in particular, by an extension in the licence portfolio (Bobbi Brown as of 2014, new brands could be announced shortly) and the global roll-out of Polaroid which started in Q1 2013. As of 2017, we have gradually reduced our sales growth estimates in order to reach our estimate of growth to infinity of 2.5%.

Theoretical FV stands at EUR15 EUR and is obtained by taking into account an EBIT margin to infinity of 11% as of 2018. Although this assumption implies significant operating leverage relative to 2012 (+470bp), this normal average level remains lower than the record level of 11.5% hit in 2007.

In view of a cost of capital of 9.7% (beta of 1, risk-free rate of 3.4% and a risk premium of 6.4%) and a cost of debt of 5.5%, our WACC estimate works out to 9.6%.

Fig. 4: DCF valuation:

EURm 2013e 2014e 2015e 2016e 2017e 2018e 2019e 2020e 2021e 2022e Net Sales 1,160.5 1,217.9 1,290.4 1,380.8 1,463.6 1,544.1 1,621.3 1,694.3 1,762.0 1,832.5 % change -1.3% 5.0% 6.0% 7.0% 6.0% 5.5% 5.0% 4.5% 4.0% 4.0% EBIT 81.8 99.5 120.1 138.1 153.7 169.9 178.3 186.4 193.8 201.6 EBIT margin (%) 7.0% 8.2% 9.3% 10.0% 10.5% 11.0% 11.0% 11.0% 11.0% 11.0% Income taxes -21.5 -29.5 -39.2 -52.5 -58.4 -64.5 -67.8 -70.8 -73.7 -76.6 Tax rate (%) 37.5% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% Operating profit after taxes 60.3 70.1 80.9 85.6 95.3 105.3 110.6 115.5 120.2 125.0 +Depreciations 38.3 40.3 42.7 44.2 46.8 49.4 51.9 54.2 56.4 58.6 -Change in WCR 3.5 13.6 17.1 13.8 14.6 15.4 16.2 16.9 17.6 18.3 -Investments in fixed assets 34.8 36.5 38.7 41.4 43.9 46.3 48.6 50.8 52.9 55.0 Operating cash flow 60.3 60.3 67.8 74.6 83.6 93.0 97.6 102.0 106.1 110.3

PV of terminal value 639 +PV of future cash flows (2011-20) 506 = Enterprise Value 1,145 Net debt (2013e) 185.3 Other liabilities 67.7 Minority interest 5.1 Financial assets 11.2 Theoretical value of equity 898 Number of shares (m) 61.7 Theoretical FV per share (€) 15

Source: Bryan, Garnier & Co ests

These various assumptions enable us to reach a DCF valuation of EUR15.

Safilo

3. A pure Wholesale player 3.1. Turbulent recent history The chart below illustrates the various difficulties encountered by the Italian group since summer 2007. The first stemmed from the Optical market which was hit massively by the financial crisis, provoking extensive stock rundowns as of 2009. As such, Safilo's sales plunged 11.9% (-13.1% same- currency) during that year. Note that Luxottica was not spared either by these stock rundowns since Wholesale sales fell 6.8% same-currency in 2009.

This period of stock rundowns came just as the group's balance sheet was in a fragile state. Indeed, net debt/EBITDA totalled 8.9x at end-2009, thereby amplifying investor concerns as they began to fear the company's bankruptcy. Note that this situation was not new since the high net debt in 2004 had already prompted the Tabacchi family to refloat Safilo in order to get out of debt (EUR479m in 2005 vs. EUR807.2m in 2004). This high net debt stemmed from the numerous acquisitions of optical chains made by Safilo in the early 2000s.

Luxottica also suffered significant stock rundowns and high debt levels following the acquisition of Oakley in 2007 (net debt/EBITDA of 2.7x at end-2009), provoking a 67% plunge in its share price between July 2007 and March 2009. Why did Luxottica emerge from the crisis more quickly?

(i) A more defensive status thanks to the Retail segment: it accounted for 62% of 2009 sales at Luxottica, but has never represented more than 11% of sales at Safilo. However, while same-currency Wholesale sales dropped 6.8% at Luxottica, Retail sales fell by just 1.8% LFL. Safilo therefore suffers from a far more cyclical business compared with Luxottica.

(ii) Hefty weight of own brands: these own brands only represented 23% of Safilo's sales vs. 60% for Luxottica. The risk of non-renewal was therefore more present at Safilo than at the world no. 1 player.

(iii) Balance sheet under control: despite a net debt/EBITDA multiple of 2.7x at Luxottica, this remained below covenants and was quite controllable given the size of the group, which was not the case for Safilo with a multiple of 8.9x.

Fig. 5: Safilo share price since 2006 (adjusted for share operations):

80 Safilo was badly hit by the crisis in the optics industry: 70 - Destocking phase: 2009 sales dropped 11.9% - US exposure (36% of 2009 sales) - 2009 net debt/EBITDA: 8.9x (vs. 2.7x for 60 Luxottica)

30 Loss of the G. Armani Prospects become license more promising

Source: Datastream, Bryan, Garnier & Co ests

Safilo

3.2. Business model focused on Wholesale Although the Retail segment was never significant for Safilo, accounting for 11% of 2009 sales at most, the arrival of HAL led to the Italian group refocusing on its core business, namely the Wholesale segment, with virtually all of the optics distribution banners sold to the key shareholder as of end-2009 (Loop Vision in Spain, Just Spectacles in Australia, Sunglass Island and Island Optical in Mexico). We consider this refocusing legitimate given the following factors:

(i) HAL already boasts historical know-how in optical distribution, since it has been present in the business since 1996 and has 4,800 stores spread over 39 countries (sales of EUR2.4bn in 2012).

(ii) Safilo was lacking critical mass: indeed, the various banners were spread out geographically, without boasting sufficient critical mass for an individual market, like Luxottica in the US for example. This therefore limited potential synergies and explains why Safilo's Retail business generated an operating loss during 2009 (-EUR6.7m, vs. sales of EUR106.8m).

Safilo nevertheless held onto Solstice, its banner specialised in sunglasses, which it bought from LVMH in 2002 and which only had six stores at the time. Since then, Safilo has expanded the banner in North America and in 2012 had 136 stores generating sales of EUR80.7m (7% of sales). Given that Solstice is exclusively positioned in upscale sunglasses, it provides a genuine distribution circuit and a showcase for a brand portfolio including numerous luxury brands (Gucci, Dior, etc.) for which sunglasses account for 56% of sales.

The right-hand chart below indeed shows that sunglasses account for the majority of the Wholesale division, given the importance of own-brand Carrera (~10% of sales) which derives the lion's share of sales from sunglasses, but also from numerous luxury brands since consumers look for sunglasses as a priority (access luxury). Note that the recent acquisition of Polaroid is integrated into this segment.

Note also that the sports segment (6% of Wholesale sales) is made up of the Carrera Sport component, one of the European leaders in sports eyewear and ski goggles, and Smith Optics, a major player in the US in sports eyewear (glasses and ski goggles, motorbike and protective glasses etc.).

Fig. 6: Breakdown of Safilo 2012 sales:

Geographical breakdown Product breakdown Asia-Pacific 17% RoW 6% Prescription 37%

Europe North America 40% 37% Sunglasses Sport 56% 6% Other 1%

Source: Company Data, Bryan, Garnier & Co ests

Safilo

3.3. The second most attractive brand portfolio in the world Despite losing one of its main licence, Giorgio Armani, as of 1st January 2013 (around EUR130-140m or 13% of sales), Safilo's licence portfolio remains one of the most attractive in the industry, enabling the Italian group to consolidate its world no. 2 position behind the unmovable Luxottica. Including Giorgio Armani brands, the group generated almost 76% of its sales with these licences.

As the table below shows, this portfolio is made up of the main brands of the Kering (ex-PPR) Luxury division, such as Gucci, Bottega Veneta and YSL, as well as a number of brands from the LVMH galaxy (Dior, Céline, Marc Jacobs), albeit without being able to obtain the LV brand since this is the only one in the industry, along with Cartier, to keep eyewear production and distribution in- house. In July 2012, Safilo renewed in advance its Hugo Boss licences until 2020. Growth in the licence portfolio should therefore be driven primarily by these brands given their huge success internationally.

Safilo also has a number of more trendy US brands such as Banana Republic and Kate Spade, which are strategic for winning market share in the US Optics market and to better negotiate with US distributors. Furthermore, these “diffusion” brands (Marc by Marc Jacobs, BOSS Orange, etc.) also have a midscale/premium positioning, which offers a complementary positioning to the luxury brands. Note that the group has signed a licence with cosmetics brand, Bobbi Brown (Estée Lauder), for Safilo to produce the first range of eyewear. This new licence is interesting for the Italian group, since the Bobbi Brown cosmetics brand is very fashionable in the US and is set to enjoy robust growth in coming years, especially in the US.

Carrera (~10% of sales) is Safilo's main own-label brand. While we do not believe Carrera can achieve the same level of reputation as Ray-Ban, it is nevertheless a significant source of growth thanks to its premium positioning (price-tags from USD95) and its fashion image, which could enable it to grow rapidly in emerging markets and in the U.S. and depend less on southern Europe. Finally, Polaroid (2012 consolidated sales of ~EUR30m over 9 months) should be one of the main catalysts for 2013 (double-digit growth expected), thanks to the promising polarised lens segment (see section on Polaroid) and international expansion.

Fig. 7: Portfolio still widely dominated by licences:

Amount Sales split Brands

Own 5 24% of net sales Carrera, Oxydo, Polaroid, Safilo, Smith Optics brands: Alexander McQueen, Banana Republic, Bobbi Brown *, Bottega Veneta, Céline, Dior , Fossil, Giorgio Licenced 20 76% of net sales Armani **, Gucci, Hugo Boss, Boss Orange, Jimmy Choo, Juicy Couture, J-LO, Kate Spade, Liz brands: Claiborne, Marc Jacobs, Marc by Marc Jacobs, MaxMara, Pierre Cardin, Saks, Tommy Hilfiger, YSL * From 1st January 2014) // ** Terminated on 31st December 2012 Source: Company Data

The table on the following page shows that Safilo owns the second-largest brand portfolio in the world, in terms of both quantity (26 licences, but 25 excluding G. Armani) and quality, with a number of luxury brands. The table also illustrates the fact that Luxottica is the only player to derive the majority of its sales from optical retailing (61% of sales in 2012) followed by De Rigo (41%), which has a 42% stake in UK chain, Boots Opticians, and has a number of banners in the Iberian Peninsula and in Turkey.

Safilo

Fig. 8: Comparison between Safilo and three other main manufacturers:

Safilo Luxottica Marchon Eyewear De Rigo Country Italy Italy US Italy 2012 net sales – EURm 1,175 7,086 ~450 ~390 Weight of retail 7% 61% 0% 41% Weight of wholesale 93% 39% 100% 59% Number of brands 26* o/w 5 own brands 27* o/w 12 own brands 19 o/w 3 own brands 15 o/w 3 own brands * including G. Armani * excluding G. Armani

Source: Company Data; Bryan, Garnier & Co ests

In view of the significant weight of licences (76% of 2012 sales), Safilo needs to take other measures in order to reduce the risk of non-renewal of its licence contracts in addition to developing its own- label brands:

(i) Extending the duration of licences: the average duration of contracts has tended to increase in recent years to now stand at eight/10 years on average, as shown by the two latest prolongations: Hugo Boss (expiring in 2020) and MaxMara (expiring in 2019).

(ii) Segmenting the various brands: this segmentation could be undertaken in terms of: 1/ image: luxury (Gucci, Dior…) or fashion (Tommy Hilfiger) and 2/ different price positioning within a same brand, as for BOSS, BOSS Orange and BOSS – HUGO BOSS, in order to access the widest client base possible.

(iii) Strengthening ties with the HAL network: in 2012, HAL accounted for 5.5% of Safilo sales (3.5% en 2009), thereby proving the strengthening of commercial ties between HAL and Safilo (i.e. Retail/Wholesale synergies). This strategic partnership with the world's second-largest optics distributor could favour the signing up of new brands.

Fig. 9: Segmentation of Safilo portfolio brands:

Source: Company Data, Bryan, Garnier & Co ests

Safilo

The weight of own-label brands is set to increase to 29% of Wholesale sales (vs. 24% in 2012) by 2015, under the combined impact of the loss of Giorgio Armani (around EUR130-140m in 2012) and the full-year integration of Polaroid (~EUR67m expected in 2013). Apart from the lack of non- renewal risk, Polaroid is set to have a positive impact on margins (from 2014) given its far higher profitability than Safilo (EBITDA margin close to 14% vs. 9.8% for Safilo) and the lack of royalty payments.

Fig. 10: Weight of own brands set to increase in 2013

2012 Sales breakdown 2015e Sales breakdown

Licensed brands Licensed 76% brands 71% Own brands Own brands 29% 24%

Source: Company Data; Bryan, Garnier & Co ests 3.4. Production widely outsourced Contrary to Luxottica which has always favoured the integration of its production facilities under the framework of its vertical integration strategy, Safilo has the specific feature of only producing 40% of its frames and sunglasses in its seven plants, whereas the remaining 60% is entrusted to outsourcers located in Italy, the US and Asia.

The new strategic plan presented in September 2011 prompted an increased specialisation of each of the plants (by material or by product) in order to guarantee: (i) an improvement in production efficiency (2015 target for more than 10% at Italian plants) and (ii) a maximum occupancy rate, thereby increasing profitability at each site.

Given the numerous Luxury brands (Gucci, Dior, Hugo Boss, etc.), the Italian plants remain strategic for maintaining the Made in Italy label on all upscale brands. Note that the Vale plant in the US already belonged to Polaroid, which is specialised in the production of polarised lenses. Finally, the Chinese plant is fairly new (2008) and currently only produces metal or acetate components, but not entire pairs of glasses. Over the medium-term, Safilo could produce a number of collections in China (Carrera?) destined for the domestic market, thereby avoiding customs duty (more competitive prices) and improving lead time. On our estimates, the European and US plants represent around 85-90% of internal production.

Fig. 11: Organisation of seven Safilo plants:

Plant Country Production Santa Maria di Sala Italy Plastic semi-finished & finished goods Longarone Italy Metal semi-finished & finished goods Martignacco Italy Plastic and metal finished goods Ormoz Slovenia Plastic semi-finished & finished goods, ski goggles Vale UK Polarised lenses Salt Lake City US Ski goggles Suzhou China Acetate, plastic and metal semi-finished goods Source: Company Data

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The comparison set out in the table below shows clearly how the two global leaders have distinct strategies. The world no. 1, Luxottica has undertaken a full vertical integration with the Retail business whereas Safilo is focused on its core business, the Wholesale segment. This difference explains why Safilo is six times smaller than Luxottica today (2.4x when only comparing the Wholesale businesses).

Given its still-weak Retail business, Safilo has never managed to unlock vital synergies for increasing margins. From now on, with HAL as the key shareholder, Safilo has a genuine opportunity to rely on a sizeable distribution network (4,800 stores) to increase the penetration of its brand portfolio in HAL banners and to attract new licences thanks to this key partner.

Fig. 12: Comparison between Safilo and Luxottica:

Safilo Luxottica - Worldwide #2 in Frames & sunglasses (premium, sports & - Leader in Frames & sunglasses (premium, sports & luxury World position in… luxury segment) segment) and leader in Optical retail

2012 sales – EURbn 1.1 7.1

North America (37%), Europe (40%), North America (58%), Europe (19%), Geographical mix (2012) Asia-Pacific (17%) and RoW: 6% (mainly LatAm) Asia-Pacific (13%) and RoW: 11% (mainly LatAm)

Wholesale / Retail (2012) Wholesale: 93% // Retail: 7% Wholesale: 39% // Retail: 61%

House brands / House brands: 24% Proprietary brands: 70% Licensed brands (2012) Licensed brands: 76% Licensed brands: 30% PARTIALLY YES - Design, quality control and distribution are integrated (either - Design, production and distribution are integrated (either for for house brands or for licence brands) Vertically-integrated? house brands or for licence brands) Production is 60% outsourced and 40% integrated - Optical retail operations: ~7,000 stores worldwide - Small optical retail operations: 136 Solstice stores in the US (LensCrafters, Sunglass Hut, etc.) BUT: HAL retail network runs ~4,800 stores

Plants 7 11

Production units (2012, m) N/A 75

2013e Net gearing 21% 34%

2013e net debt / EBITDA 1.5x 1.0x

Source: Company Data, Bryan, Garnier & Co ests

Safilo

4. Blue skies finally on the horizon for Safilo! As mentioned above, Safilo has had to get over a number of obstacles since 2008 including massive destocking in its Wholesale operations, financial difficulties and the loss of the key Giorgio Armani licence (13% of 2012 sales), which raised serious concerns among investors regarding the group’s business model.

In our view, Safilo’s prospects are now much more attractive:

(i) Visibility on the licence portfolio has improved significantly: the next major licence expiries (Marc Jacobs, Tommy Hilfiger) are due in 2015, which gives Safilo plenty of time to negotiate renewals of existing deals, while seeking new brands for its portfolio.

(ii) The Polaroid effect: the polarised lens segment offers favourable prospects and Safilo plans to roll out the brand in the US, Asia and LatAm regions, where its presence has been limited to date. This is the key factor underpinning the double-digit sales forecast for 2013. Moreover, the highly profitable Polaroid brand should boost Safilo’s operating margin from 2014.

(iii) A healthier balance sheet: now that HAL is the company’s key shareholder, banks and investors have regained a degree of confidence in the stock, as reflected in the recent rating upgrades by S&P (March 2013) and in the company’s ability to reduce the average cost of its bank debt.

4.1. Clearly improved visibility in licensing (76% of group sales) Enhanced visibility in the Wholesale business, and particularly in licensing, is a pre-requisite for dispelling market uncertainty, since investors are concerned about the weight of licences in Safilo’s overall sales (76% of group sales). In our view, the more favourable outlook can be put down to three key factors: (i) no major licence is due to expire before 2015, (ii) the competitive environment should be less disadvantageous for Safilo, as Luxottica now considers that it has sufficient brands in its portfolio and (iii) HAL and Safilo should continue to unlock the synergies between them in order to increase the penetration of Safilo’s brands in HAL’s retail outlets.

4.1.1. The risk of non-renewal of a key licence has been pushed back to 2015 For the first time in several years, particularly since the loss of the Giorgio Armani licence was announced in November 2011, Safilo does not have to manage the risk of losing a major licence. This risk has been pushed back to 2015, given that brands such as Fossil or Juicy Couture, whose contracts expire this year, make only limited contributions to overall Wholesale sales.

The key licences set to expire in 2015 are Marc Jacobs, Tommy Hilfiger. However, we are fairly confident that Safilo should be able to extend these deals, especially now that competitive pressure has eased (see section 4.1.2). The Italian group is also actively seeking new licences, as shown by the

Safilo

contract signed with Bobbi Brown in February 2013 and the CEO’s affirmation during the conference call that the group is targeting “one or two licences, each of which could represent EUR80m in sales”.

The group is therefore poised to emerge from its period of “crisis management” and implement a genuine medium/long-term strategy for its brand portfolio. In particular, it plans to take advantage of the complementary fit offered by its brands, as illustrated by the launch of the “Carrera by Jimmy Choo” capsule collection next September.

Fig. 13: Portfolio licence expiries:

Brand 2013 2014 2015 2016 2017 2018 2019 2020 Alexander McQueen Banana Republic Bobbi Brown Bottega Veneta Céline Dior Fossil Gucci Hugo Boss Jimmy Choo Juicy Couture J-LO Kate Spade Liz Claiborne Marc Jacobs MaxMara Pierre Cardin Saks Tommy Hilfiger YSL

Source: Company Data

4.1.2. Competitive pressure set to ease It should be made clear from the outset that we expect Luxottica to continue to gain market share worldwide, particularly thanks to the two latest additions to its licence portfolio: Coach (2012) and, above all, Giorgio Armani (2013). In recent years, Safilo has lost two licences to its main rival: Ralph Lauren (2006) and Giorgio Armani in 2013.

We now expect competitive pressure to ease. Luxottica is set to focus on organic growth in its Wholesale operations rather than on acquiring new licences, in order to:

(i) Successfully integrate and roll out its new licences: since 2011, the Wholesale activity has obtained two new licences (Coach, Giorgio Armani) and integrated Tecnol and Alain Mikli. The priority must now be to integrate the two latest acquisitions, with a focus on deploying Coach and, especially, Giorgio Armani, which carries high stakes since Luxottica is targeting sales of EUR130-140m for the brand in its first year.

(ii) Avoid the risk of cannibalisation: with over 20 brands, the risk of overlap is greater and further synergies cannot be unlocked. For example, integrating Gucci would certainly lead to

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the cannibalisation of sales of the Prada, Chanel or even Bulgari brands, which also target high-end female customers.

(iii) Optimise the portfolio and supply chain: with frame volumes up 25% in three years, Luxottica is constantly seeking to optimise its production by focusing on brands and regions that generate strong demand. In view of this, Luxottica may even shed a few brands deemed non-strategic in the medium term, in order to free up capacity for fast-growing brands.

For these reasons, Luxottica is no longer focusing on the quest for new licences and Safilo stands to benefit on several fronts:

(i) Licence renegotiations: no royalty inflation. Since Luxottica is unlikely to compete with Safilo for future licence renewals, Safilo should find it easier to extend its current licensing deals, without the threat of royalty inflation. The early renewals of the Hugo Boss and Max Mara licences seem to be a sign of this new state of affairs.

(ii) Safilo is well placed to sign with new brands: should certain luxury or cosmetic brands decide to diversify into eyewear, Safilo would be well placed to win the licence, as illustrated by the agreement signed with the leading Estée Lauder cosmetics brand, Bobbi Brown.

(iii) Why not acquire Luxottica’s former licences? Although Safilo did not sign with Ferragamo in 2011 after it dropped its licence with Luxottica and signed with Marchon, we believe that Safilo is now better equipped to attract brands that decide not to renew with Luxottica, in its role as the world’s second-largest player and owned by HAL which boasts a network of close to 4,800 stores. This is particularly true of “medium” brands, which could feel more highly valued in a leaner licence portfolio.

4.1.3. Strengthening the synergies with HAL’s Retail business When HAL bought into Safilo in 2010, the stores owned by the Dutch fund represented around 3.5% of Safilo’s sales. In 2012, this share increased to 5.5%, as the effects of closer collaboration between the two companies began to kick in.

In HAL’s stores, synergies can be achieved in the form of exclusive or temporary collections at GrandOptical, prime in-store locations allocated to Safilo’s brands, or stock management thanks to the Smile project (automatic re-assortment system among key partners), which boosts margins and minimises the risk of stock rundowns.

For Safilo, the aim of exploiting these Wholesale/Retail synergies is to increase the penetration rate of its portfolio with positions in key stores, which improves visibility on both orders and production (economies of scale). Knowing that Safilo now has privileged access to the 4,800 boutiques in HAL’s network, certain brands could be tempted to sign licence agreements with the Italian group. The potential for distribution synergies is significant, since (i) HAL owns 4,800 stores almost exclusively in Europe and (ii) this region is Safilo’s main market, representing 40% of sales.

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As an example, the table below presents the synergies between Luxottica’s Wholesale business and its Sunglass Hut stores: when it was acquired in 2001, Luxottica’s brands accounted for 20% of SGH’s sales. This share surged to 80% in 2009 (boosted by the acquisition of Oakley in 2007) and to at least 90%, we estimate, in 2012. Although Safilo is unlikely to be able to attain such a high share in the HAL network (less brands, primarily generalist stores), it could still build on the 5.5% market share obtained in 2012.

Fig. 14: Luxottica’s share of SGH sales (%):

2001 2009 2012 ~20% ~80% ~90%

Source: Company Data, Bryan, Garnier & Co ests 4.2. Polaroid: an instant catalyst for Safilo Announced in November 2011, the acquisition of Polaroid was completed in April 2012 for around EUR65m, of which EUR44m financed by HAL and the balance (EUR21m) by Safilo. The Polaroid brand, founded in 1937 in the US by Edwin Land, who invented polarised lenses in 1929, became one of the world’s leading manufacturers of polarised sunglasses, with 2012 consolidated sales estimated at EUR30m (over 9 months).

As mentioned above, the polarised lens segment offers attractive prospects, since this type of lens is increasingly used by eyewear brands thanks to numerous benefits: anti-glare protection (not provided by standard sunglasses), improved colour contrast and relief and lighter lenses that offer 100% UV protection. As shown in the two photos below, polarised lenses are ideal for strong sun exposure, especially near water or snow, where the glare is stronger.

Fig. 15: Comparison between standard and polarised lenses:

Standard lens Polarised lens

Source: Polaroid

Various potential synergies between Safilo and Polaroid The two companies complement each other in various ways:

(i) R&D synergies: Safilo’s entire offering of sunglasses stands to benefit from Polaroid’s expertise in polarised lenses, which should allow Safilo to bring out new models for its licences or even for Carrera. Acquiring expertise in sunglasses and polarised lenses was also one of the reasons behind Luxottica’s acquisition of Oakley in 2007.

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(ii) Distribution synergies: the Polaroid brand is under-developed outside Europe and stands to benefit from Safilo’s distribution network to expand rapidly in international markets. During Safilo’s Q1 2013 earnings presentation, the group said that it had launched the brand in the US and Asia in March. This international expansion should drive Safilo’s growth in the coming quarters.

4.3. A healthier balance sheet thanks to HAL In 2009, Safilo came close to bankruptcy, with net debt reaching EUR588m (net gearing of 132%), following a stream of acquisitions of retail brands since the early 2000s. As shown in the chart below, Safilo’s net debt has improved constantly since HAL came to the rescue in H1 2010, reaching EUR215m at end-2012, representing net gearing of 25%. Thanks to its improved operating performances, the group’s cash generation should increase, reaching EUR106m in 2015 (vs. ~EUR68m in 2012), which should help to pay down Safilo’s debt.

At the beginning of 2013, Safilo also set up a new credit facility for EUR100m maturing in 2015 (EUR60m granted by senior lenders and EUR40m underwritten by a company in the HAL group). Following the redemption of high-yield bonds (~EUR128m) maturing on May 15, these funds will support the Group’s business development needs.

This extended debt maturity and brighter operating prospects prompted S&P to upgrade its rating on the stock in March. Moreover, the change in the debt mix will also reduce the average cost of Safilo’s debt by around 30-40%. This reduction in net debt and the lower average cost of debt (down from 6.3% in 2012 to around 4.8% from 2014) should clearly enhance Safilo’s earnings from this year onwards.

Fig. 16: Safilo’s net debt from 2007 to 2015e:

700 8

588 600 570 6 515 500 4

400 2 300 256 238 215 185 0 200 152 114 -2 100

0 -4 2007 2008 2009 2010 2011 2012 2013e 2014e 2015e Net debt (EURm) Net debt / EBITDA (x) Source: Company Data, Bryan, Garnier & Co ests

Safilo

5. Our 2013 and 2014 forecasts 5.1. Q1 2013 performance confirming a recovery At end-April, Safilo reported Q1 13 earnings ahead of the consensus, both in terms of sales and margins. The market's main fear concerned Safilo's ability to manage the "post G. Armani" period since this Q1 was the first in which the licence was no longer consolidated. These results therefore proved that the Italian group has come off very well, with organic sales growth coming in at 3.7%!

In the Wholesale segment, sales from the portfolio of existing brands (excluding G. Armani and Polaroid) rose by 11% in organic terms, thereby helping to offset the negative impact from the lost Armani licences. Growth was driven by the main licences (Gucci, Boss, Marc Jacobs, Dior, etc.), as well as by the two main own-label brands, Carrera and Safilo. Sales in the division therefore rose by 3.9% same-currency.

Although the Retail segment only accounts for 6% of the group's sales, same-currency sales rose by 1.7%. Note that this division now only comprises Solstice, the US banner specialised in sunglasses distribution.

The most welcome news from this publication was the 50bp increase in EBITDA margin to 11.7%, whereas the market was expecting a 30-40bp narrowing, again fearing the impact of the deconsolidation of Giorgio Armani in the Wholesale division (+30bp in Q1 2013). This increase was possible thanks to an optimisation of production facilities, as well as growth of 11% in existing brands, with these additional volumes having partly offset those lost with Armani. Another positive point was that management confirmed that these buoyant factors could be extrapolated to coming quarters and this should calm the initial fears of investors concerning Safilo's ability to manage the post Giorgio Armani period.

Fig. 17: Q1 2013 performance by business:

EURm 9M 2012 Q4 2012 Q1 2013 Wholesale channel Net sales 800.9 293.7 279.6 Change at constant FX (%) -1.6 14.4 3.9 Reported change (%) 2.9 17.1 3.0 EBITDA 76.9 28.3 32.9 % of sales 9.6 9.6 11.8 Change (bp) -370 -30 +30 Retail channel Net sales 61.5 19.2 17.4 Change at constant FX (%) 1.8 5.6 1.7 Reported change (%) 11.6 9.7 0.9 EBITDA 9.0 0.9 1.8 % of sales 14.6 4.7 10.2 Change (bp) 180 330 460 Group total Net sales 613.3 312.9 297.0 Change at constant FX (%) -1.6 13.8 3.7 Reported change (%) 3.5 16.6 2.9 EBITDA 70.7 29.2 34.7 % of sales 11.5 9.3 11.7 Change (bp) -180 0 50

Source: Company Data

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5.2. Sales forecasts: the main catalysts for 2013 and 2014

5.2.1. 2013: Particular focus on remaining brands and the roll-out of Polaroid The rest of 2013 is indeed set to resemble Q1, with the group focusing on:

(i) Its licence portfolio: despite losing one of its main luxury licences, Safilo nevertheless boasts other important brands in the same universe such as Dior, Gucci and Hugo Boss which could even benefit from marketing and advertising investments previously allocated to the Giorgio Armani licence. In addition, the presence of "diffusion" brands (more midscale- brand positioning) such as Marc by Marc Jacobs, BOSS Orange or Tommy Hilfiger is also positive for attracting consumers in crisis markets (trading down moves), or in emerging markets (brands that are more accessible than luxury ones).

(ii) Own brands (Carrera and Safilo): Growth at Carrera (~10% of sales) should provide a substantial catalyst for Safilo since the brand still derives 55% of sales from Europe, vs. just 38% in the Americas and 7% in Asia (BG ests). In addition to conquering new emerging markets, Safilo is to rely on its licence portfolio for developing partnerships between brands, as shown by the "capsule" collection with Jimmy Choo named "Carrera by Jimmy Choo". Like the strategies implemented by Luxury groups, ephemeral or so-called capsule collections help renew the range more frequently in order to shake-up demand. The Safilo brand should enable the group to benefit from the high development potential in the prescription glasses segment (ageing population, optics market in emerging markets etc.).

(iii) In the global deployment of Polaroid: Although Polaroid is a US brand, the majority of its sales were generated in Europe and the group was virtually absent from the US and emerging markets. Safilo therefore started to roll out Polaroid in both these regions in Q1 13 and this should enable it to post double-digit growth during 2013. Polaroid is therefore set to be a vital catalyst for Safilo during 2013.

We are forecasting same-currency growth of 7.6% in 2013, including a growth in the existing brand portfolio of 10% and stripping-out the impact of Giorgio Armani (sales of EUR130- 140m in 2012).

These three development focuses should enable Safilo to increase the penetration rate of its brands in the three global regions (Europe, North America and emerging markets), in line with the strategy presented by the group during its Investor Day in September 2011:

(i) In Europe: stepping up relations with key accounts (major optical chains) and not only those of HAL and developing these in northern and eastern Europe (especially Russia) which offer two advantages to Safilo: benefiting from higher market growth in these regions and depending less on southern Europe (~15% of sales).

(ii) In North America: as seen in the section of our sector study concerning the US market, the priority for manufacturers is specialised distribution circuits such as department stores, travel retail and Solstice since these channels are currently enjoying high growth. Like the partnership between department store Macy's and Luxottica, Safilo could also try and join

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forces with a rival chain (Saks, Nordstrom, Neiman Marcus) in order to open sunglass or optical corners whilst strengthening its leadership position among the independent opticians/optometrists channel.

(iii) Emerging markets: in Asia, while China remains a difficult market for sunglasses for cultural reasons, the travel retail circuit in Asia is in full momentum, driven by the boom in Asian tourism. Latin America is also a priority zone for Safilo (especially Brazil and Mexico) since this region is enjoying high growth thanks to the appeal of South American clients for luxury brands, the emergence of a sizeable middle class and advantageous sun levels for the solar segment.

5.2.2. … to which one or several new licences could be added in 2014.. In our view, momentum is set to remain buoyant since Safilo's growth should remain driven by its main catalysts: (i) the Wholesale portfolio, (ii) its own-label brands and (iii) Polaroid, which is set to continue its global expansion. In addition to this, at least one new licence is due to start in 2014, namely Bobbi Brown, after the partnership agreement was announced in February.

The Bobbi Brown cosmetics brand belongs to Estée Lauder and during 2012, boasted high global growth (double-digit according to Estée Lauder). The agreement with Safilo should be interesting to follow since it is the first example of a cosmetic brand's diversification into eyewear and a successful launch could prompt other brands in the sector to diversify as well. Given the lack of history, we have preferred to remain cautious and are forecasting sales of EUR10m in 2014, thereby nevertheless providing almost 1% in additional sales to Safilo's Wholesale business.

During the conference call on 2012 earnings, management also pointed out that one or two additional licences could be signed in 2013 in order to round out the existing portfolio. Without further details on the brands targeted, the CEO nevertheless stated that these licences could prompt potential sales of around EUR80m each. These declarations clearly show that Safilo has become more aggressive since its balance sheet has been cleaned up considerably.

Fig. 18: Sales estimates by business (% change and same-currency):

% change 2010 2011 2012 2013e 2014e 2015e Wholesale channel 5.3 5.5 2.1 8.0 5.0 6.0 Retail channel 15.6 14.2 2.7 2.5 3.0 4.0 Total Safilo 6.0 6.0 2.2 7.6 5.0 6.0 Source: Company Data; Bryan, Garnier & Co ests

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5.3. Profitability: significant operating leverage!

5.3.1. 2013: heading for wider margins despite the loss of G. Armani Safilo's management confirmed that the beneficial factors at play in Q1 2013 when EBIT margin widened by 70bp to 8.7% are set to continue in coming quarters. The table below highlights the origins of this improvement: (i) a 20bp widening in gross margin which benefited from the positive impact of industrial optimisation undertaken in 2012 in order to prepare for the end of the GiorgioArmani licence and (ii) a 50bp narrowing in OPEX, especially in selling & marketing expenses, which narrowed by 40bp.

Fig. 19: Change in Safilo Q1 2013 margins:

% of sales Q1 2012 Q1 2013 Net revenues 100 100 COGS -39.7 -39.5 Gross Margin 60.3 60.5 Selling & marketing expenses (excl. A&P) -30.1 -29.1 A&P expenses -10.2 -10.7 G&A costs -12.2 -11.9 Other operating income / (expenses) 0.2 -0.1 Total Operating costs -52.3 -51.8 EBITDA margin 11.2 11.7 o/w D&A -3.2 -3.0 EBIT margin 8.0 8.7

Source: Company Data; Bryan, Garnier & Co ests.

For 2013, in line with the latest declarations made by Safilo's management, we should therefore see the same trends as in Q1, namely:

(i) A 20bp improvement in gross margin to 60.5%: the industrial optimisation undertaken by Safilo in 2012 is paying off. Admittedly, contrary to Luxottica, which has virtually all of its production in-house, outsourcing (around 60% of overall production) enables the Italian group to have a more flexible production cost structure.

(ii) A 60bp narrowing in sales costs to 29%: on the back of the overhaul of sales activities and especially sales forces following the loss of the Giorgio Armani licence. Better productivity for this sale force should also help generate economies of scale in this line item.

(iii) A 40bp hike in marketing spend to 10%: despite the end to the G. Armani licence, Safilo is to increase in marketing spend in order to roll out Polaroid in the US and in Asia and also to continue the international expansion of the Carrera brand which remains too European (55% of sales vs. around 38% in the Americas and 7% in Asia). Safilo is notably set to multiply promotional events in Q2 in Beijing, Sao Paulo (Brazil) and New York in order to enhance the brand's reputation.

For 2013, we are therefore forecasting EBIT margin of 7% (+70bp), whereas EBITDA margin is set to widen 50bp to 10.3%.

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Fig. 20: Our margin estimates for Safilo in 2013:

% of sales 2010 2011 2012 2013e Net revenues 100 100 100 100 COGS -41.7 -41.8 -42.2 -42.0 Gross Margin 58.3 59.2 57.8 58.0 Selling & marketing expenses (excl. A&P) -30.6 -29.7 -29.6 -29.0 A&P expenses -9.1 -9.7 -9.6 -10.0 G&A costs -12.6 -12.0 -12.6 -12.0 Other operating income / (expenses) 0.3 0.0 -0.3 0.0 Total Operating costs -52.0 -51.4 -51.5 -51.0 EBITDA margin 10.0 11.1 9.8 10.3 o/w D&A -3.7 -3.3 -3.5 -3.3 EBIT margin 6.3 7.8 6.3 7.0

Source: Company Data; Bryan, Garnier & Co ests.

5.3.2. Significant medium-term potential to increase gross margin and EBIT margin As the two charts below show, Safilo generates gross margin well below that of the global no. 1 in the sector (57.8% vs. 66.4% for Luxottica, representing an 8.6 point difference!). This difference stems from a number of points: (i) a lower plant occupancy rate at Safilo (= production costs absorbed less well), especially since Luxottica outsources virtually nothing contrary to Safilo, (ii) a lower weight of own-brands (24% for Safilo vs. 70% for Luxottica) and (iii) the positive effects of Retail/Wholesale synergies at Luxottica which drive the group's margins.

In contrast, the weight of operating expenses is slight to Safilo's advantage (51.5% of sales vs. 52.6% at Luxottica). Note that Luxottica is handicapped in this comparison by its Retail business which represents 61% of group sales and which weighs significantly on operating costs. Although Luxottica does not provide details of costs by business, the very high EBIT margin in the Wholesale division (21.8% in 2012) testified to obviously far lower operating expenses compared with the group average.

Fig. 21: Comparison of gross margin and weight of OPEX at Luxottica and Safilo in 2012:

2012 Gross margin (% of sales)… … and OPEX (% of sales)

68 53

66 53

64 52 52 62 52 60 66.4 52 52.6 58 52 56 51 57.8 54 51 51.5 52 51 Luxottica Safilo Luxottica Safilo

Source: Company Data

In terms of gross margin out to 2015 (BG: 59%e), we believe that Safilo could restore its record level of 2006 (59.1%) thanks to three main factors:

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(i) An improvement in the price/mix in the Wholesale division: this strategy would notably involve further development of specialised distribution circuits (key accounts, Travel Retail etc.), and expansion in emerging markets, especially for the Luxury banners.

(ii) The hike in volumes: one of the keys to increasing margins concerns the plant utilisation rate. This is set to increase on the back of higher volumes of existing brands, as well as by the signing of new licence agreements.

(iii) Polaroid: thanks to its polarised lens business, which is an upscale segment, Polaroid boasts structurally higher margins. However, its international expansion in the US and in Asia, should help it generate new economies of scale, beneficial to increasing margins.

The main source of leverage boasted by Safilo for increasing EBIT margin lies in increasing sales, which would provide it a leverage effect on two operating cost items: (i) sales costs (2015e: 28.6% or -100bp vs. 2012) and administrative costs (2015e: 11.4% or -80bp vs. 2012).

In the Retail business, Safilo made the most in 2012 of restructuring work undertaken in 2010-11 (closing of unprofitable stores in the US, disposals of other banners to HAL etc.) enabling EBITDA margin to widen by 170bp to 12.3%. In the future, Solstice should continue to increase per store sales (higher volumes and price/mix) and bolster synergies with Safilo's Wholesale division in order to continue the improvement in its profitability.

Fig. 22: 2013-2014 margin estimates by business:

EURm 2011 2012 2013e 2014e 2015e Wholesale channel Net sales 1,029.3 1,094.6 1,077.8 1,132.7 1,201.8 Change at constant FX (%) 5.5 2.1 8.0 5.0 6.0 EBITDA 115.1 105.2 109.9 129.1 151.4 % of sales 11.2 9.6 10.2 11.4 12.6 Change (bp) 50 -160 60 120 120 Retail channel Net sales 72.6 80.7 82.7 85.2 88.6 Change at constant FX (%) 15.6 14.2 2.5 3.0 4.0 EBITDA 7.7 9.9 10.2 10.6 11.3 % of sales 10.6 12.3 12.3 12.5 12.8 Change (bp) 860 170 0 20 30 Group total Net sales 1,101.9 1,175.3 1,160.5 1,217.9 1,290.4 Change at constant FX (%) 6.0 2.2 7.6 5.0 6.0 EBITDA 122.6 115.1 120.0 139.8 162.8 % of sales 11.1 9.8 10.3 11.5 12.6 Change (bp) 110 -130 50 120 110

Source: Company Data; Bryan, Garnier & Co ests.

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In view of the revised 2015 guidance communicated by Safilo following the loss of Giorgio Armani (but prior to the acquisition of Polaroid), our estimates are fairly cautious since:

(i) Our 2015 sales forecast of EUR1.29bn, which includes Polaroid, is globally in line with Safilo's 2015 target that was stripping out any acquisition;

(ii) Whereas our 2015 EBITDA margin estimate of 12.6% remains 90bp below Safilo's guidance.

This caution could prove unmerited if Safilo succeeds in managing the post-Armani period over the medium term as well as it has during recent quarters.

Fig. 23: Revised 2015 goals after the loss of G. Armani in November 2011:

2015 goals Implied 2015 forecasts (EURm)… … vs. 2010 «2015 sales to be 30% above 2010 sales »* ~1,250 1,079.9 « EBITDA margin to be around 13.5% » ~ 13.5% 10%

Source: Company Data; Bryan, Garnier & Co ests * Initial sales guidance (EUR1.4bn) communicated prior to the loss of G. Armani whose negative impact is estimated at EUR150-200m by 2015.

Safilo

Bryan Garnier stock rating system For the purposes of this Report, the Bryan Garnier stock rating system is defined as follows: Stock rating Positive opinion for a stock where we expect a favourable performance in absolute terms over a period of 6 months from the publication of a BUY recommendation. This opinion is based not only on the FV (the potential upside based on valuation), but also takes into account a number of elements including a SWOT analysis, positive momentum, technical aspects and the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Opinion recommending not to trade in a stock short-term, neither as a BUYER or a SELLER, due to a specific set of factors. This view is intended to NEUTRAL be temporary. It may reflect different situations, but in particular those where a fair value shows no significant potential or where an upcoming binary event constitutes a high-risk that is difficult to quantify. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Negative opinion for a stock where we expect an unfavourable performance in absolute terms over a period of 6 months from the publication of a SELL recommendation. This opinion is based not only on the FV (the potential downside based on valuation), but also takes into account a number of elements including a SWOT analysis, positive momentum, technical aspects and the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Distribution of stock ratings

BUY ratings 50.9% NEUTRAL ratings 30% SELL ratings 19.1%

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