COLEGIO UNIVERSITARIO DE ESTUDIOS FINANCIEROS
GRADO EN ADMINISTRACIÓN Y DIRECCIÓN DE EMPRESAS BILINGÜE
Trabajo Fin de GRADO
BURBERRY
PRIVATE EQUITY
Autor: Arizón Ribó, Gonzalo
Tutor: Arocena, Ramón
Madrid, abril de 2020
TABLE OF CONTENTS
1. INTRODUCTION ...... 3
2. SCREENING CRITERIA ...... 3
2.1 ACTIVITY ...... 3
2.2 HISTORY ...... 4
2.3 LOCATION ...... 5
2.4 OWNERSHIP STRUCTURE ...... 6
2.5 TOP LINE GROWTH ...... 7 2.5.1 Historical top line growth ...... 7 2.5.2 Company growth vs market growth ...... 9 2.5.3 Future growth levers ...... 10 2.5.4 Revenue visibility – barriers to entry ...... 10 2.5.5 Competitive environment ...... 11
2.6 COST STRUCTURE ...... 13
2.7 CASH CONVERSION ...... 14
2.8 MANAGEMENT TEAMS ...... 16
3. MACRO ANALYSIS ...... 19
4. MICRO ANALYSIS ...... 22
5. VALUATION BENCHMARK ...... 24
6. FINANCING STRUCTURES ...... 25
7. FINAL DECISION (GO – NO GO) ...... 26
7.1 BUSINESS PLAN ...... 26
7.2 ENTRY AND EXIT PARAMETHERS ...... 28
7.3 CONCLUSION AND POSIBLE LBO ...... 30
ANEX I ...... 31
BIBLIOGRAPHY ...... 32
2 1. INTRODUCTION
Burberry is an English corporation, founded in 1865 by Thomas Burberry, that operates in the fashion luxury sector. Burberry foments the creativity that has been a fundamental pillar since the beginning.
They are leaders in the production of leather goods trying to create a wide and fashionable range product offer, its flagship garment is the trench coat, for which the house is known around the world. Their philosophy is that the product comes first, focusing on the experience that the customer goes through when buying an item.
The aim of this project is to determinate whether Burberry is a good investment for a private equity fund or not. Along this paper I will analyze aspects such as the present and future situation of the company with a deep screening criteria analysis. Macro and micro economic variables will define how the company is doing compared with the luxury retail market, helping us to decide whether the expected returns of the transaction are attractive enough to go ahead with the investment.
2. SCREENING CRITERIA
2.1 ACTIVITY
Burberry is one of the leaders in the luxury fashion goods market, highlighting that it is the UK largest company in this sector based on market capitalization, with 10 billion dollars ("UK fashion industry statistics", 2021). They are focused on the sale of exclusive garments not accessible to everyone's wallet, following a design, source and manufacture process. Since 2017 they decided to follow a new strategy where concentrate on bringing out the creativity from their roots, that has led them to success. (Burberry, 2020)
Burberry´s icons are mainly leather goods and their famous Trench Coat offering, giving this last product a fresh interpretation every year. As they say, the product is the heart of the strategy, keeping a constant investment on the last textiles and highest quality materials, to delight their customers season after season.
3 They have three main channels of revenues: retail sales, that encompasses the entire part of the sales from their web page and their official stores; wholesale partners and licensing expertise for products such as Beauty and Eyewear.
Figure 1: Sales by product and channel Source: (Burberry 2020)
Innovation in the brand vision is key to inspire and lure customers, keeping in mind the idea of building a sustainable future whilst reducing the impact on the environment is one of Burberry´s commitments.
2.2 HISTORY
The designer Thomas Burberry founded his outfitting business in Basingstoke, England at the age of 21. But it was not until 1879 that the company became known thanks to the creation of its innovative “gabardine” perfect for British whether, a breathable and weatherproof product. This garment has been an icon for the past decades, thanks to its volatile use it has been carried by polar explorers, aviator and even form part of the Armed Forces. The reputation of the fabric together with the innovative design is one of the great legacies that this master has left us. He remained at the helm of his company until his death in 1926 at the age of 90. For the first time in 20 years, in 2018 the famous Burberry monogram is refreshed to celebrate the heritage of the founder.
4 In 1920 Burberry became a publicly quoted company for the first time. And it was not until 2002 when the company was listed on the London Stock Exchange (BRBY.L), currently forming part of the FTSE 100 index. I am going to base our analysis on the March 28th, 2020, at that time the share price was at £1.325,50 and the company’s revenues were £2,633 million.
2.3 LOCATION
As a British company Burberry has its headquarters in London. They set their first store at 30 Haymarket in 1891 and expanded globally in 1909 when they opened the store in Paris at 8 Boulevard Malesherbes.
Even though the firm is British, and they started in the EMEIA (Europe, middle East and Africa) market first, most of their revenues come from the Asian market. Chinese customers account for the biggest global power in the purchase of luxury garments (D'Arpizio, Levato, Prete & de Montgolfier, 2020). Only from the Asia Pacific area they generated £500 million last year, a 39,8% of the total sales.
Figure 2: Revenue by region Source: (Burberry 2020)
5
Table 1: Store portfolio Source: (Burberry 2020)
2.4 OWNERSHIP STRUCTURE
As we can observe in the following graph shares are distributed among a great variety of shareholders and institutions. I found appropriate to separate the holders that own a bigger investment rate higher than 5% of the total number of shares. Other institutions such as Baillie Gifford & Co or The Vanguard Group, Inc. do also have participations in the company but not with such a big weigh.
Figure 3: Shareholding structure Source: Own elaboration (Burberry 2020)
The top 25 shareholders, all of them corporations and a portion private investment institutions, own the 66.26% of the company. And just an 11,2% of the total flow come from the general public (Burberry Group (LSE:BRBY), 2021).
6 2.5 TOP LINE GROWTH
2.5.1 Historical top line growth
The company revenues come from the three divisions mention before, retail, wholesale and licensing. Considering these business lines, we can observe, just taking into account the past four years, that the total revenues have a negative Compound Annual Growth rate (CAGR) of -1,63%, but if 2016 is also considered, this rate would escalate up to 1,15%.
CAGR: -1,63%
Figure 4: Revenue in £ million Source: Own elaboration (Burberry 2020)
This negative figure means the company has not been having either organic or inorganic growth in the past years, as the revenues are lower along time. There are some facts that can explain this negative growth, these will be analyzed later on, but first we need to go back to previous years to explain this exponential drop in the firm's revenues.
2017 was a year of transition for the company, as a new CEO was incorporated, Marco Gobbetti, and a change in the design strategy occurred with the entry of the designer Tisci. Both with a revolutionary idea for the firm in the long run, focused on returning Burberry to a higher ranking. To achieve it, they set four strategic pillars supporting revenue growth: product, communication, distribution and digital. "Although the task of
7 transforming Burberry is still ahead, the first steps that we have implemented to restore energy to the brand are already showing their first promising signs," said Gobbetti during the presentation of results (Modaes.es, n.d.).
Furthermore, with the arrival of the new designer, Tisci, in 2019 they decided to close one out of ten stores around the world. The objective of this strategy is to be at the height of the big luxury brands such as Dior. In addition, it was intended to adapt the flagship stores to the profiles of new customers (Martinez, 2019). It was known that the closing of stores would lower the income through this channel but increasing it in the multi-brand channel.
Burberry was in a stage of growth and innovation in many internal aspects of the company, and it still is. This is the main reason why the company in 2018 and 2019 did not have impressive results, the company remarked then that "it is still in the first phase" of its multi-year transformation and repositioning plan, the affected revenue figures were warned since the released of the new strategy. Those were reduced, but the firm expressed that perceptions from new customers were changing for good, responding positively to Tisci's commercial product lines, while it continues its transformation of its distribution network (Burberry 2020). In addition, in 2018 Burberry made a collaboration with Coty, one of the largest cosmetic companies in the world. With the aim to boost its beauty market (perfumes, creams and makeup). This had a negative impact in that year sales (Deloitte, 2020).
And now we come to the hardest years for the company since its inception, the last two. Burberry was in the midst of implementing its new positioning and sales strategy when they ran into two major roadblocks on their way, Brexit and Covid 19.
Buyers know that it is not the same to buy a Burberry trench coat at its flagship store on Regent Street, than in any other store of the world. Despite the UK has not specified the Brexit measures they are going to carry on with, it is already affecting the company in different aspects. The supply chain has been impacted, it can be seen in the decline in revenues, and prices will too although there has not been any change yet. Burberry anticipates "a modest increase in costs" for reasons of fulfillment with border trade rules. As the garments are quite expensive, tourists ask for the repayment of taxes when leaving
8 the country since the return is very high. The outflow of this, would imply a loss of attractiveness of London as a shopping destination for tourists with high purchasing power (Deacetis, 2020).
Burberry begins to see the first signs of the effect of Covid, the greatest impact has already been reflected in the fiscal year of 2020. Burberry is recovering from this step by step, since the pandemic produced a large decrease in sales.
2.5.2 Company growth vs market growth
According to Deloitte´s annual 2020-year report about the luxury fashion sector, the total sales growth was 8,5% in the last year, setting Burberry way far from this figure, as they had a negative growth of 3,20%. Focusing mainly on this last year in which the pandemic has affected all companies to a greater or lesser extent, the sales drops have been catastrophic.
Sales in this sector mainly come from the “luxury tourism” where consumers like to travel to other cities and buy items, as a shopping experience. Buying the garment in an official store in the heart of the fashion world, like Paris, Milan or London is more glamorous. This has mainly affected the Asian consumers, who practice this type of tourism and are the ones that consume the most in terms of volume in this market. Also, all the events and catwalks were cancelled due to the current situation, scheduled for next year or were done online. These made sales in online channels to skyrocket during the first and second quarters of the year, which led to a larger investment in digitization and ecommerce (Deloitte, 2020).
Burberry was in an expansion phase and the Coronavirus crisis hit them harder in many aspects than other companies in the market. But not regarding revenues, other companies in the sector have not been able to handle the pandemic and therefore their impact has been worse. For instance, Prada had a -24,89% growth and Hermès -7,18% growth in revenues compared to the previous year. These figures show that despite the fact that Burberry was going through a stage of internal growth and digital expansion and therefore the growth of revenues was not its priority, they were able to maintain themselves afloat and thus the impact of the virus crisis did not hit them so hard.
9 2.5.3 Future growth levers
“Launched in November 2017, our strategy focuses on rooting Burberry firmly in luxury fashion. We believe that by fostering the creativity that has driven our brand since its inception, we will introduce Burberry to new customers while delighting our existing customer base. In doing so, we aim to deliver sustainable long-term value for our shareholders” (Burberry 2020).
Burberry has set a high standard that they want to achieve, becoming one of the top companies in the luxury fashion market, being at the level of companies like Dior or Gucci. The way they channeled this strategy was through four channels: distribution, communication, product and marketing.
Asia is where most of the sales are made, and that is why the greatest attention is paid to this continent. Their Tokyo flagship store opened in 2019, where visitors could take part in an exclusive AR experience was a success and they plan to open some more around the globe.
Always focusing on the customer and their experience because in this sector the personalized contact at the time of purchase is what customers are looking for. In 2018 they implemented their own messaging platform that was a success, this sets the customer in contact with the physical store itself, at the moment it is exclusive and can only be accessed by invitation.
Throughout the project I am going to analyze the future growth levels and enhancers of Burberry more in detail.
2.5.4 Revenue visibility – barriers to entry
Fashion is by far one of the most competitive markets in the luxury sector. Barriers are quite high; you need a large number of resources and a very special design to be able to succeed in this market. But on the other hand, there exist a lot of new facilities to enter in the market, so barriers are mixed.
10 Apart from the costumers that usually purchase in the high fashion firms, there is a large part of the population that buys luxury clothes, and especially accessories, once every many years. So, one of the highest barriers is that, why is someone going to buy your handbag and not the one from your neighboring store when they have a similar price. Design and tradition are something that these types of companies have to deal with day after day. This brings us that to succeed a strengthen in brand identity to distinguish yourself from your competition is crucial.
Many of the sold garments are the so-called “the classics” of each house, but customers want to see something new in the collections, so innovation in the garments is essential. Another significant barrier is that if being in the luxury sector, you also have to appear so, it is important to establish coherent innovation strategies that are aligned with communication and marketing campaigns, since in both cases the perception of exclusivity is key (Deloitte, 2020).
To become one of the luxury brands of all times is almost impossible, they have a unique identity, based on tradition, craftsmanship and exclusivity. But sustainability, innovation, disruption and digitization are what new luxury consumers are looking for. Therefore, despite the fact that the quality continues to be maintained, the reduction in fixed distribution costs, rental costs or real estate purchases, now makes them more competitive and more accessible to everyone.
2.5.5 Competitive environment
The competitive environment of Burberry are the top luxury firms in the market, since Burberry is in the top 20 companies in this sector (Deloitte, 2020). One of the main characteristics of this sector is that enterprises tend to group together and form absolute leading multinational conglomerates. In those the commercialization of the belonging companies is improved, the group taking care of the long-term development of each of the houses. Further being listed in the stock market, as a single group and name. Some of these cases are LVMH with firms such as Loewe and Fendi or Kering with Gucci and Saint Laurent.
11 For Burberry these groups are considered competitors, but at another level since it cannot be compared with a luxury group that encompasses different firms from different luxury sectors such as watches and jewelry, wines or cosmetics. Therefore, I will reduce the competition to a smaller group, focused on companies that operate at the same level as Burberry, those that produce luxury garments and leather products.
Competitors Burberry is facing now and can face in the future are:
- Prada, an Italian high fashion firm established in 1913, already since the begging selling luxury garments, becoming six years later the official supplier of the Italian Royal House. This contributed to stablish more the idea that the firm was producing for the aristocracy and the upper middle class. And in the early 1990 it expands the business to Asia and the USA. Note it has some business lines with their own name such as Miu Miu (Prada Group, 2021). According to Deloitte, Prada is also among the top 20 global powers of luxury goods (Deloitte, 2020), having a positive sales growth in the past years, but the Covid has affected them harder than to other firms in this sector, they had a -24,89% growth compared to the past year, 2019 (own elaboration data)1.
- Hermès, on the other hand is a French luxury fashion manufacturer founded in 1837. It is a classic family business, which is faithful to its artisan model, following a classic line generation after generation. We can highlight its famous Kelly Bag, a tribute to the princess of Monaco, and the Birkin Bag, which has been around the world. Hermès had incredible sales on 2019, an increase of 15,37% (Hermès on a ceaseless rise: 15% growth and 8.7% increase in earnings in 2019, 2020) compared to the previous year, thanks to China where they intensified their strategy, reflected in the prêt-à-porter and accessories section (Agnew, 2019). Of course, they were hit by the Covid pandemic too.
- Chanel, even though they are not in the stock exchange is one of the world powers in the world of fashion, its name says it all, is a company that sets a classic and stylish trend. It appeared in 1910, as a millinery, behind the thinking head was Coco Chanel. And it was not until 1915 that creates the first haute couture collection. Therefore, if we talk about luxury fashion, we cannot forget the Chanel Nº5 perfume and the 2.55 bag. Some
1 See in Annex
12 public information is released, so we can dive in the company figures. Revenues have increased by 10,4% in the past year, the company is in the average sales of the sector (Chanel, 2020).
As mentioned before, the fashion luxury market towards operation and management requires a huge investment and commitment, not being an easy market to enter. The competitors in this market are already well established and very strong, so the competition that exists is very powerful.
Setting the trend is the key factor to be able to succeed in this sector, which is unpredictable. Luxury market grew by 4% in 2019 (D'Arpizio, Levato, Prete & de Montgolfier, 2020) but Burberry was not able to keep up with the market growth since their growth in revenues was -3,20%.
2.6 COST STRUCTURE These types of companies, fashion luxury firms, do tend to follow a fixed cost structure, as they are rooted in the old way. They are qualified to handle substantial amounts of money, and therefore have high fixed costs and a very rigid linear cost process. Burberry is the case too, along the years we can see that the cost structure hasn’t change, being around 62% the fixed costs and the remaining the variable costs around the 38%. Other companies like Prada or Hermès do also follow this type of fixed cost structure.
Millions of £ 2017 2018 2019 2020 Variable Costs 833,0 835,4 859,4 927,60 % of Total cost 35% 36% 38% 38% Fixed Costs 1.538,8 1.487,1 1.423,60 1.516,80 % of Total cost 65% 64% 62% 62% Total Costs 2.371,8 2.322,5 2.283,00 2.444,40 Table 2: Cost structure Source: Own elaboration (Burberry 2020)
Furthermore, to follow this cost structure makes sense when sales are predictable, as this is the case. We know that there is always a small niche of the population that is behind the new trends every year, therefore to a greater or lesser extent sales are predictable. Thus, it helps obtain operating leverage, allowing companies to enjoy a higher gross
13 margin on each sale. For this market it is a good strategy, since due to the high prices of the selling items, revenues increase faster.
But as I can observe from the sales data and the compound annual growth rate, this has some downturns. Burberry has been going through a decrease in the sales figures the past years and the current situation has not helped them to recover. It has done the opposite; its strong fixed cost structure has produced bigger detrimental damages to the company.
So, we could judge whether for this type of companies, in the luxury sector, this cost structure is beneficial looking towards the future. We live in a digital age where you either adapt or you disappear, this dated model needs to evolve into a mixed cost ecosystem. Methods that company´s in this sector can come up with are the reduction in real state, as it is expensive, and reduces cash, or outsource part of the process. ("The 7 Rules For Reinventing the Luxury Business Model for Post-Pandemic Success | The Fashion Law", 2020).
2.7 CASH CONVERSION
Cash conversion indicates the quantity of debt that the company is able to pay with respect to the years EBITDA. It can be observed that Burberry had great cash conversion percentages in the past years, seeing a notable drop in it, due to the fact that their revenues have been diminished year after year. 2020 is obviously lower than the previous years due to the pandemic, being the average 82,3%, despite of this year’s situation, the company has a rather loose ratio when it comes to assuming debt.
Millions of £ 2017 2018 2019 2020 EBITDA 545,7 540,8 553 519,5 CAPEX - -104,1 -106 -110,6 -148,8 Change WO +/- 81,7 71,1 20 -79,2 CASH for debt service 523,3 505,9 462,4 291,5 CASH CONVERSION 95,9% 93,5% 83,6% 56,1% Table 3: Cash conversion Source: Own elaboration (Burberry 2020)
14 Burberry has a quite high margin, compared to the market they are doing way better, as most of their competitors have a cash conversion average around 60%, Hermès with a 61,1% or Prada with 60,4%.
This negative tendency can be explained by the internal restructuration and reallocation that the company is going through, the new model set by Gobbetti and Tisci. In this new vision of the company its main focus it’s not the EBITDA, although despite this, this ratio has been growing year after year, at the expense of the later one due to the lockdown and the closing of stores.
Capex has been going at a constant rate, with an increase of almost the 50% in this last year with pandemic. Burberry decided to implement various mitigating actions to contain costs and protect their financial position, which include a categorization of the projects by priority, focusing only on that which is essential and has the aim to strengthen the brand (Burberry, 2020).
On the other hand, the other factor affecting the cash conversion is the change in working capital, which can be explained by how the company manages to handle its payables and to collect their receivables. The data here is quite volatile, there is no fixed structure set. From 2017 to 2019 the variation in working capital is positive, being able to see that in the last of these years the figure is already much smaller. This means that Burberry is receiving form its consumers much earlier that paying its suppliers, which explains that the company has more money in hand than it theoretically owns.
Millions of £ 2016 2017 2018 2019 2020 Acc. Receivable 285,4 275,6 206,3 251,1 252,1 Acc. Payable 387,2 459,1 460,9 525,7 447,5 Revenues 2.514,7 2.766,0 2.732,8 2.720,2 2.633,1 Costs 2.111,8 2.220,3 2.192,0 2.167,2 2.113,6 Mean Av. Collection period 41 36 28 34 35 35 Av. Payment period 67 75 77 89 77 77 Table 4: Av. Days Collection/Payment Source: Own elaboration (Burberry 2020)
In table 4, the data is clear, Burberry has an average collection period of 35 days, and a mean of 77 days to pay their suppliers. Accounts receivable has been decreasing over the
15 years, except in this latest pandemic where we can see a small increase in the figure, doing the supplier account the opposite.
A part of the shorten in the EBDITA, the variation of the WC in 2020 is the major reason why the cash conversion is so small compared to previous years. Therefore, the structure that Burberry follows is prompt collection from its suppliers and instead a fairly wide payment period, which if it is not constantly monitored it can shoot up the liabilities, increasing debts with vendors.
Apart from this last year, with pandemic issues, Burberry's cash conversion ratio is excellent. In case the firm grows, cash would increase due to variations in circulating capital. As the difference between the collection period and the payment period is 42 days.
2.8 MANAGEMENT TEAMS
This business lives off what it has been creating over time, as we can see with Burberry and its trench coats or Hermès and its Birkin Bag for instance, which are called “classics”. These luxury pieces do not go out of style, and you know that when you buy them it is an "investment" in something that will last for generations. The other part of the revenues of this sector comes from the "novelty", the new collections. So, it is essential that the garments that go on sale that season become trends, being even more desired that one of your garments becomes a statement piece.
In this niche, it has been possible to demonstrate that the management teams (especially the CEO and CFO) as much as the Creative Director are fundamental pieces in the company, being this later an essential fragment for the sales. The called classic items are more predictable to know how many will be sold, but with seasonal collections everything is in the hands of the designer and hitting the trend.
In March 2020, the board of directors was composed of the Chairman, the CEO, CFO, seven independent non-executive director and one senior independent director. This board is focused on promoting Burberry’s long-term success, they provide leadership and set the strategy ensuring alignment with their culture and overseeing its implementation
16 by management. And the one focused on the day-to-day responsibilities for running the Group is the executive committee, compound by all the Chief Officers.
All of them are great professionals, but our focus goes to the four main characters in the leading and success of the company:
§ Dr Gerry Murphy - chairman, he carries this position since 12th July 2018. The Irish director has a bachelor’s in Science and a Doctorate in Philosophy, completing his studies later on with a marketing MBS. He has been jumping among different positions in all kinds of companies, from the food and beverage sector to investment banking. In many of them he held management positions such as non-executive director at British American Tobacco or CEO at companies such as DHL Logistics. He already has hold this position, as chairman, at The Blackstone Group and at Tate & Lyle plc (LinkedIn profile).
Image 1: Management team Source: Own elaboration
§ Marco Gobbetti - CEO, in the position since 5th July 2017. His previous job was Chairman and CEO at Céline, the French luxury leather group. In addition to this position, during the last decades he has found himself in managerial areas of
17 prestigious international fashion brands such as Givenchy (Chairman and CEO), Moschino (CEO) or Bottega Veneta (Marketing and Sales Director). The Italian roots CEO has been qualified in the USA with a degree in Business Administration and a Master’s in International Management (Burberry 2020). He entered the company with the aim of revolutionizing the firm and making the brand more important in the handbag market. He hasn’t revived Burberry jet, but in spite of it he keeps his head held high.
§ Julie Brown - Chief Operating and Financial Officer in charge of it since 18th January 2017. She was leading this role before at Smith & Nephew, for four years and 25 years in AstraZeneca, among which was CFO. At the same time Julie is also a Non-Executive Director and Audit Chair of Roche Holding Limited and, on the Business Advisory Board to the Mayor of London. She graduated in Business Administration with honors continuing her education later on in the finance sector, in institutions like ICAEW and INSEAD (LinkedIn profile). According to her, it’s really important to work in something you believe in and that you like, putting customers at the heart of the decision making (Archer-Zeff, 2019).
§ Riccardo Tisci - Creative Director and Designer since 2018. He doesn’t form part of the management board but is a key member in the growth of the company. He started at the age of 17 designing for Missoni, and developed his career graduating from London's Central Saint Martin’s Academy College of Art and Design. He initiated at Puma with his first contract, not bearing fruit, so he presented that year his own collection, with the help of friends (Mariacarla Boscono a top model) and family (mother and sisters), that fashion showed was a unique and triumphant according to Vogue Spain (Riccardo Tisci, n.d.). From there he took a leap, and became creative director of Givenchy, where he has been able to stand out with his multiple collections and dressing celebrities for the Oscars and the Met Gala among others. One of his main visions at Burberry is the use of social media to hook future leads, as millennials are the new buyers (Chan, 2020).
18 It can be observed that all of them in charge of Burberry´s management are professionals trained for the positions. They are related in one way or another to haute couture and have a close contact with the management of large companies in their careers.
3. MACRO ANALYSIS
The macroeconomic analysis refers to all the factors that are out of the Burberry´s control, therefore the company cannot do anything to shift them for their own benefit. These elements will affect Burberry in a positive or a negative way, so they will determine the framework where the company will be able to make its path.
The main factors that affect a corporation in the fashion luxury sector are the following: technological changes affecting this sector, fashion trends, which change from collection to collection and major global economic variables, in particular two current major threats in Europe, Brexit and Covid.
Technological changes: technological advances move at a much faster rate than the years go by. Therefore, not adapting to the ones that appear in your specific market, lefts you behind. Technology has become indispensable for fashion firms to produce and operate at the rates they are working, and this needs to continue. Adapting this technology in the production chains raises the level of productivity. So, the creation process needs to digitalize from end-to-end to make it more agile and effective, requiring a huge investment in innovative technologies (Deloitte, 2020).
First, online sales are becoming more and more popular, since it only provides facilities for the consumer and more so in the pandemic situation which we live in. And this way of buying is going to keep increasing in the near future. We can observe in figure 5 that in the next year’s sales, the online channel is expected to increase from 12% to 19% as McKinsey says. According to them, by 2025 online luxury sales in the global high-end market will triple to reach $ 91 billion (Achille, Remy and Marchessou, 2018).
19
Figure 5: Sales channel Source: McKinsey (own elaboration)
The purchases of luxury items imply a large outlay of money for the costumer, which consumers prefer to continue doing offline. In addition, the instore purchase journey is one of the hallmarks of the luxury market. The firms in this sector are very clear that although online purchases are increasing, selling items in multi-brand stores takes away their prestige and the feeling of a premium purchase (Deacetis, 2020). And even more, this need increased with the current Covid19, since this sector had a lack of contact points with the client. A necessary investment in virtual technologies needs to be made.
Additionally, millennials and Z generation are gradually becoming the new customers in this sector. The garments sold in this sector are quite expensive, but these generations are reaching the age where they can start to afford them. These generations are expected by 2025 to account for about half of all global luxury goods sales (Deloitte, 2020).
And the second aspect, becoming a greener enterprise. These companies are in the spotlight when it comes to producing sustainably. The luxury fashion industry follows a slow fashion model, this is due to its concern when creating a more sustainable and ethical supply chain highlighting the use of local resources and longer product lives.
As we have mentioned before, millennials are the future customers of these brands and they are much more demanding than their predecessor generation the baby boomers. Since 75% of millennials change their shopping habits compared to 34% of baby boomers when it comes to environmental concerns. Sustainable consumption and production are essential in today's society, and therefore companies in this sector have to adapt to it technologically. Thus, trying to achieve a neutrality in carbon production (Deloitte, 2020).
20 Fashion trends: here we find ourselves in the luxury fashion industry, so it is not about what will this year´s trend be, as these firms are the ones that set the season trends with their creations. But still, the collections have to work when they go on the catwalk, and then on sale to the public. It is unknown how designers are capable of producing these collections and then succeed in the eyes of the public, but for this reason they are considered exceptional and have such a reputation.
But the competition appears, as in all markets. Not only the sector has to fight against its luxury competitors, but also with those companies in the textile sector that mass produce, “prêt-à-porter” (ready to wear). This last corporations do supply based on consumer trends, the ones that most of the times are set in the luxury market beforehand, when the collections hit the runways.
There are platforms such as NellyRodi or WGSN that are specialized in trend prediction, they are trend consulting companies that have an international network of "coolhunters" focused on detecting them. Taking into account the fast pace of fashion, they adapt their reporting calendar to the Spring/Summer and Fall/Winter seasons. To access the information reported by these agencies is by a subscription or “trend books”. The fee to pay depends on the status of the agency and its "successes" in previous predictions (Wang, 2019).
Global economic variables: There are many economic variables that affect this market, these can determine an increase or a decrease in the number of sales, among them we find unemployment, exchange rates or salaries. So, a close look at them needs to be done.
In addition to the global economic factors that affect this market, the firm faces two current major threats. Burberry is a company that has its headquarters in London, one of the main markets for international fashion, and therefore Brexit, the exit of United Kingdom from the European Union, affects this company more than others. This political movement have some effects on the sector (Vidal and Gesta, 2020). Burberry warns of the loss of the attractiveness of the United Kingdom in the luxury trade due to the 'Brexit', among others because the VAT refund will no longer be allowed to tourists from outside the EU. They will have a disadvantage compared with Paris or Milan. As on the other hand for other fashion firms, London is a cherished destination to begin its expansion in
21 Europe, since it is the second largest market in fashion sales, after Germany (Wood, 2020).
The other dominant factor affecting the current situation is the pandemic caused by the Covid-19. As we have mentioned before, one of the characteristics of this business is the in-store sales, which is still the channel with the highest weight in this market. For this reason, after the entire world population has been in quarantine for more than three months and then with quite strong restrictions for businesses, this sector has been highly affected. Some renowned firms announced that they were breaking away from the traditional calendar of runways, eliminating some or delaying them. This has forced them to move to the digital world, increasing its online sales strategy and presence in social networks, where we have been able to see in streaming the catwalk collections (Martínez, 2020).
The global pandemic has set some international travel restrictions and many of the purchases of luxury garments were made on these trips, mainly from the Asian population, due to the lower prices on the European continent and shopping has become an integral part of the travel experience. Furthermore, the basis of global luxury-goods is Italy, more than 40% is produced here. Being this one of the European countries that has been most affected by the virus crises, leaving factories and small business temporarily shut down (Achille and Zipser, 2020).
4. MICRO ANALYSIS
From what we have been able to observe in the macroeconomic analysis of the market, there are variables that influence Burberry in a negatively way. In this section we are going to focus on how Burberry fights them and what are the competitive advantages they have over its opponents. Those help the firm maintain their position in the market and protect the long-term profits and the market share.
The microeconomic variables are the ones that are not out of the company’s control, so Burberry needs to take advantage of them. Firstly, as we mentioned in the previous section, digitization is just around the corner, and therefore those who do not run are left
22 behind, and this is not Burberry´s case. The investments that the firm makes in digitalization of new processes and in the sales channels are outstanding in the sector (Deloitte, 2020). Burberry´s commitment to digital innovation is strong and they work in it year after year, being their latest project, the bet on Augmented Reality (AR). Aiming of connecting, engaging and inspiring clients. At the beginning of 2020, they release an AR shopping tool through Google Search technology, allowing consumers to experience Burberry´s products virtually first handed. When searching for Burberry items on Google Search on their phones, they could see an AR version of the product in their own physical space, going over the detail and sizes (Burberry 2020).
Image 2: AG Burberry- Google Source: Burberry.com
The management of the sales channels is essential in this business, since it is the way to obtain benefits, Burberry stands out for its partnership with Farfetch. In 2018, it reached an agreement with this e-commerce platform specialized in luxury fashion to boost its presence in online sales channels, among them are the sales made through wholesales, that account for 18% of its total sales in 2020 (Deacetis, 2020) (Burberry 2020). This enabled them to respond more quickly to the latest market impulses, moreover It has produced that during the Covid lockdown, this sales channel strengthens.
Through social media is the way the new generations, and therefore the leads, communicate among them, the correct handling of it can be a great advantage, and so it is for Burberry. The firm stresses that its followers and engagement in social networks have grown in double digits around the world, also during the crisis (Burberry 2020). The fashion industry is becoming more omnichannel, as the offline sales still carry an important weight for clients. Burberry mentions the implementation of some aspects in their strategy; however, the game plan has not fundamentally changed (Burberry 2020).
23 We all need a coat; it is an essential piece in our wardrobe. Burberry has the advantage that its most popular item are its trench coats, the firm has become famous for them. Hence at the end, when someone sees a trench coat, they associate it directly with the ones from this house, with its checked lining known all over the world. It is a weapon that they have to take pull off, and so they do, every year they release a more modern version of this garment, keeping the classic always on sale. The latest update is that they can be customized.
5. VALUATION BENCHMARK
An analysis needs to be made in order to evaluate how Burberry is doing in the market compared to its main competitors. We are going to compare the EV/EBITDA ratio to see how these companies are going and determine if Burberry is doing better or worse. For this analysis, Hermès, Prada, Michael Kors and Moncler are chosen as they are all listed firms with similar business purposes as Burberry. I decided not to include luxury agglomerations such as LVMH or Kering, as their figures would be much higher taking into account that multiple firms (also form multiple luxury sectors) form part of it.
Company name Market Cap EV EBITDA EV/EBITDA Burberry Group PLC 5.343 4.756 762 6,24x Hermès International 92.007 87.290 2.252 38,8x Prada group SpA 13.835 14.145 804 17,6x Michael Kors Holdings Limited 1.743 3.330 1.004 3,32x Moncler SpA 12.674 11.818 601 19,7x
Avarage 30.064,75 29.145,75 1.165,25 19,86 Median 13.254,50 12.981,50 904,00 18,65 *each of them in their own currency *in Millions Table 3: EV/EBITDA Comparison Source: Own elaboration
The average and the median are calculated with the comparable competitors, they are trading at an average of 19,86x and a median of 18,65x. It can be observed that Burberry is not over those figures, meaning that the company is trading at a discount compared to the market. The market is not stable at this moment, due to the pandemic share prices have increased exponentially, but the EBITDA is not doing so great as sales have decreased in the past year comparted to the previous ones.
24 To conclude we can say that this may be not the best opportunity to buy. Burberrys top line growth is not doing so well either, shown in the negative CAGR, and the ratio EV/EBITDA is below the average compared to these rivals. Future returns may not be secured in Burberry.
6. FINANCING STRUCTURES
The aim here is to check how much debt can Burberry handle for a possible Leverage Buyout. As we are suffering from a global pandemic crisis, we have decided to normalize in order to make a truer view of how much debt can de company face. This is the normalization for the past four years, from 2017 to 2020, assuming we buy the company in this last year.
Million £ FY2020E EBITDA 519,5 CAPEX -148,80 (+/-)Change WC -79,2 FCF for debt service 291,5 (-) Margin of safety 15% 43,725 FCF for debt service after MS 247,78
Table 4: Normalized Repayment Capacity Source: Own elaboration
Cash available for debt services has been decreasing for the past four years, but as the normalized is chosen we are going to deal with £480,5 million. The profit margin is set at a rate of 15%, this decision was made due to the fact that the company has been having a negative CAGR of -1,63% so it will take some period to recover and to become stable again. The luxury fashion sector is in a way quite secure as it generates lots of sales every year but on the other hand as it has been explained in the micro and macro that the season fashion collections may not work, so it is quite unpredictable.
The company generated cash enough to repay £408,43 million on interest and principal, leaving a safety margin of £72,075 million. With this information we are going to assume that two debts are taken. Debt A a 7-year amortizing loan with a fixed interest through the period of 3%, and the other half, debt B also a 7-year loan with no amortization and fixed interest of 6%.
25 Million £ FY2021E FY2022E FY2023E FY2024E FY2025E FY2026E FY2027E Type A 3% Initial balance 1.050 900,00 750,00 600,00 450,00 300,00 150,00 Interest 31,50 27,00 22,50 18,00 13,50 9,00 4,50 Amortization 150,00 150,00 150,00 150,00 150,00 150,00 150,00 Ending Balance 900,00 750,00 600,00 450,00 300,00 150,00 0,00 Type B 6% Initial balance 1.050 1.050 1.050 1.050 1.050 1.050 1.050 Interest 63 63 63 63 63 63 63 Amortization 0 0 0 0 0 0 1.050 Ending Balance 1.050 1.050 1.050 1.050 1.050 1.050 0 Total debt Payment 244,50 240,00 235,50 231,00 226,50 222,00 1.267,50
Total interest 94,50 90,00 85,50 81,00 76,50 72,00 67,50 Total amortization 150,00 150,00 150,00 150,00 150,00 150,00 1.200,00
Table 5: Debt payments Source: Own elaboration
The calculations brough us to the conclusion, that Burberry has a repayment capacity of £408,43 million with a 15% margin of safety applied. So, it can be established that the firm can sustain a total debt of £2.100 millions.
7. FINAL DECISION (GO – NO GO)
7.1 BUSINESS PLAN
In this section we are going to project Burberry figures, see and analyze how are they going to evolve in the following years after the purchase, done in 2020. All the data has been calculated taking into account the aforementioned, all the external and internal factors that directly and indirectly affect Burberry and the high fashion luxury market. After checking the data found out in the following table, we are going to make the decision is the firm does fit an LBO or not.
26 Historial financials Budget Business Plan
Consolidadted 2017 2018 2019 2020 2021 2022 2023 2024 2025 Total revenues 2.766,0 2.732,8 2.720,20 2.633,10 2.469,85 2.650,15 2.830,36 3.005,84 3.174,17 % Growth n.a. -1,2% -0,5% -3,2% -6,2% 7,3% 6,8% 6,2% 5,6% Gross Margin 1.933,0 1.897,4 1.860,8 1.705,5 1.682,5 1.793,7 1.903,3 2.012,6 2.142,6 % Margin 69,9% 69,4% 68,4% 64,8% 68,1% 67,7% 67,2% 67,0% 67,5% EBITDA 545,7 540,8 553,0 519,5 622,4 596,3 583,1 604,2 628,5 % of Revenues 19,7% 19,8% 20,3% 19,7% 25,2% 22,5% 20,6% 20,1% 19,8% - Capex 104,10 106,00 110,60 148,80 143,25 159,01 178,31 165,32 168,23 % of Reveneus 3,8% 3,9% 4,1% 5,7% 5,8% 6,0% 6,3% 5,5% 5,3% - Change in WC 81,70 71,10 20,00 -79,20 -44,82 23,14 7,73 -12,47 -10,71 % of Revenues 3,0% 2,6% 0,7% -3,0% -1,8% 0,9% 0,3% -0,4% -0,3% Operating Cash Flow 523,30 505,90 462,40 291,50 523,97 414,13 397,01 451,32 470,97 % of EBITDA 96% 94% 84% 56% 84% 69% 68% 75% 75% - Interest Expense 94,50 90,00 85,50 81,00 76,50 - Debt Amortization 150,00 150,00 150,00 150,00 150,00 Free Cash Flow 523,30 505,90 462,40 291,50 279,47 174,13 161,51 220,32 244,47 Net Debt 2.100 1.855,50 1.615,50 1.380,00 1.149,00 922,50 x Leverage 0,25 0,34 0,37 0,42 0,53 0,68
Table 6: Business plan Source: Own elaboration
I am going to break down the information from the previous table for the correct understanding of it and that a clear conclusion can be drawn from the calculations.
§ Revenues: As we have already remarked before, the firm's sales have been in decline for a few years, this is due to the business plan that they prepare for the future and also the impact of Covid in the last year, both to the company and to the entire market. I have based the future forecasts on the growth percentages from year to year and obtained the sales figure from that calculation. Due to the current situation, I foresee that in the first year after the purchase of the company, there will continue to be a great impact of the pandemic and that the recovery will not be immediate, and therefore an estimate of a negative growth of 6,2% in relation to the past year. Hence, I foresee that the company, thanks to its investments in digitization and its intention to be at the top of the market, in addition taking into account that it would have already had four years of negative growth, would hit the sales, reaching a growth by 7,3%. From there on, a continuous positive growth, stabilized with the one they had before this drop in revenues. § The gross margin since it has remained stable despite the drop in sales of the past years, the fixed cost structure is deeply rooted in the company, an average of 62%, so I have decided to calculate the margin by making an average of the previous four years and multiplying it by the sales. § The EBITDA, the own sales and costs will be the ones that determine the EBITDA in our forecast. Therefore, according to what was mentioned in the revenue’s
27 figures, the EBITDA margin will have the same structure, with an increase in these first years thanks to the future plans of the company and stabilizing over time. § CAPEX, we know that the firm is very clear about its objectives setting themselves at the same level as companies such as Dior or LVMH, for these, future investments are key. Leading us to the conclusion that they will continue with the structure that they have been caring out, boostinf the percentage of fixed asset investments over the upcoming years. § The oscillation in working capital, was obtained with sales estimates, company cost structure and payment and collection periods. Analyzing the averages and the trend of what the company had been doing until now I have obtained the following figures. What produces that the company will completely change its strategy due to its increase in sales in the coming years due to its business plan, reaching negative working capital. § The debt is calculated in the previous session, with the financing plan of the amount of debt that the company will assume each year.
Which leads us to see that the company still has a tough year ahead, 2021, in terms of sales and with large amounts of investments in fixed assets. After that, the fruits of the changes that are conducting will be reflected, having favorable positive growth and figures in the future.
7.2 ENTRY AND EXIT PARAMETHERS
It is necessary the amount of debt and the form of entry and exit that we are going to carry out. We are going to go forward with our las year EBDITA a quantity of 519,50 million and the EV/EBDITA rate obtained in the financial analysis. Calculating an enterprise value of 3.241,68 million pounds.
Entry Parameters Entry EBITDA multiple 519,50 EBITDA at entry 6,24x Enterprise Value 3.241,68
Table 7: Entry parameters Source: Own elaboration
28 In this following tables, we can observe more in detail how the company will be bought and were will the finance come from, from both points of view. The quantity of debt that needs to be refinance is £538,2 million, a 16,6% of the total value, being the rest of the enterprise value a quantity of £2.703,48 million as the price that will need to be bought to the shareholders. In the other part of the table, the sources, 50% of the debt will be from tranche A through a method of amortizing debt and the other 50% with tranche B, following a subordinated debt, coming both from loans. And the investment of £1.142 million will be financed by sponsors, the 35,22%of the enterprise value.
Uses Sources Equity value for the seller 2.703,48 Sponsor Equity 1.142 Net debt for the refinder 538,2 Tranche A - debt 1.050 Tranche B - debt 1.050 Total EV 3.241,68 Total 3.241,68
Table 8: Uses and Sources of Funds Source: Own elaboration
Being analyzed that and having declare the total amount of debt that Burberry can handle and the repayment capacity of the firm, future returns need to be determined.
Returns (millions £) 2021E 2022E 2023E 2024E 2025E EBITDA at exit 523,969 414,132 397,012 451,320 470,966 Exit EBITDA multiple 6,24x 6,24x 6,24x 6,24x 6,24x Enterprise value 3.269,566 2.584,185 2.477,352 2.816,235 2.938,830 Net debt at Exit 1.855,50 1.615,50 1.380,00 1.149,00 922,50 Esponsor Equity at exit pre MIF 2.127,886 1.442,505 1.335,672 1.674,555 1.797,150 Equity invested 1.141,680 1.141,680 1.141,680 1.141,680 1.141,680 IRR % 86,38% 26,35% 16,99% 46,67% 57,41% CoC 1,71x 1,86x 2,08x 2,57x 2,92x
Table 9: Returns Source: Own elaboration
In table 9 is where all the previous data gets together. It is determined how much investment is generated every future year of the plan, following an EBITDA multiple of 6,24x calculated when we bought the company. We can conclude that the LBO offers us solid returns, with an internal rate of 57,41% and a cash-on-cash ratio of 2,92x. In the next phase of the project conclusions if the operation is worth doing or not.
29 7.3 DECISION OF THE POSIBLE LBO
These output parameters determine the amount at which the company will be sold after the investment years, having obtained the calculated returns. We are taking here the EBITDA of Y2025E from the business plan. This will bring us to see if the plan continues as we have calculated, a figure of £3,921.72 million would be obtained at the time of the sale of the firm.
Exit Parameters Exit EBITDA multiple 628,48 EBITDA at exit 6,24x Enterprise Value 3.921,72 Table 10: Exit parameters Source: Own elaboration
With all the research from the first’s sections of the project and this last part where all the future growth levels have been calculated, there is enough information to determine a final conclusion.
We could say that Burberry has not passed the valuation criteria with flying colors. But the numbers in the end do not reflect the strategic plan that the company has been carrying out and still is, which foresees future growth, and it is focused on the long run.
On the other hand, the numbers we have taken from the business plan for the future growth of the company, determine that they are going to boost in the market. Therefore, as a result of this investigation and with some hesitation I believe that the purchase of the firm should be pursued.
30 ANEX I
Burberry Prada Hermés 2020 2.633 million GBP -3,20% 2020 2.423 million EU -24,89% 2020 6.389 million EU -7,18% 2019 2.720 million GBP -0,48% 2019 3.226 million EU 2,67% 2019 6.883 million EU 15,37% 2018 2.733 million GBP -1,19% 2018 3.142 million EU 2,81% 2018 5.966 million EU 7,51% 2017 2.766 million GBP - 2017 3.056 million EU - 2017 5.549 million EU -
Revenue’s growth Source: Own elaboration
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