Did Swatch Overpay or Harry Winston Lose its Crown Jewel?

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Swatch Group AG (NASDAQOTH:SWGAY), the biggest maker of Swiss timepieces, has entered into a deal to buy the Harry Winston watch and jewelry unit for about $1 billion.

Swatch Group will pay Harry Winston Diamond Corp. (NYSE: DDC) $750 million in cash and assume $250 million in debt.

The acquisition includes Harry Winston’s production company in Geneva and 535 employees worldwide. The brand has 25 boutiques for its jewelry and 190 points of distribution for its watches.

Swatch, based in Biel, Switzerland, is listed on the Swiss Exchange in Zurich, but the controlling equity remains in the hands of the Hayek family, who founded the company and helped revive the whole Swiss watch industry in the 1980s.

Strategic-fit

The deal marks a fresh attempt by Swatch to get a foothold that will help it compete in the high-end jewelry market, which is dominated by Richemont through its Cartier brand.

Swatch group is the biggest watch maker in the world by sales, with revenues topping $8 billion, comprising brands like Omega, Tissot, Breguet and Rado.

The strong Asian demand for watches, handbags and other high-end items has given the companies enough munitions to grow its portfolio inorganically. Harry Winston’s dominant position in the U.S. and Japanese markets is an added attraction.

Harry Winston’s luxury business has also increased its revenues by 83% in value and 68% in quantity in the past three years making it a very attractive option.

Previous Misadventures

Swatch entered into a Joint venture with Tiffany (NYSE: TIF) to develop and sell watches under the Tiffany brand in an arrangement where the two companies would share the profits. Later, the companies got caught up in a legal battle accusing each other of not honoring obligations under the deal. The deal ended when the joint venture was shut down in 2011.

The original mining group acquired the Harry Winston luxury business in 2004 in order to have a presence at both the high margin areas of the diamond value chain, mining and retail. EBITDA margins for the mining business is as high as 43%, while for the retail business is around 10%.

Conservative demand forecasts show that by 2020, there will be a supply-demand gap worth $4-5 billion in the rough diamond market, demand being driven primarily by sizable consumption of diamond jewelry by India and China.

Considering the high margins involved and the huge demand-supply gap, the group decided to increase its exposure to the mining business which is its core competency. In that direction, Harry Winston struck a deal with BHP to purchase the Ekati mines and its associated mines for a consideration of $500 million.

The mining giant Rio Tinto , Harry Winston’s partner in Diavik is also reviewing its presence in diamonds, and could sell its operations including Diavik and Argyle mines in Australia to Harry Winston.

Given the availability of a broad range of diamond resource opportunities and the fact that cash has become a strategic resource for the acquisitions; this transaction represents a sound return on their investment.

Deal valuation

The acquisition values Harry Winston at an Enterprise Value (EV) of $1 billion. The enterprise value to EBITDA (earnings before interest, tax, depreciation and amortization) ratio seems to be in the range of 15-20, depending on the expected EBITDA estimates.

This compares favorably to the recent deals in this sector, the most recent being Louis Vuitton SA’s acquisition of Bulgari SpA (BULIF) in 2011. Louis Vuitton, the largest luxury goods group acquired Bulgari for a consideration of $5.2 billion, at an Enterprise value to EBITDA ratio of 23.

The price seems high but justified, considering that Swatch has ample cash reserves.

Another reason why the deal looks pricey could be the reflection of Harry Winston's profitability presently, which reflects its growth stage of production.

Synergy benefits

Harry Winston under Swatch group can be expected to ramp up its watch manufacturing from its current production of 50% to up to 90% capacity, while also increasing its revenues from the watch business to 40-45% from 25% presently. This should also improve the profitability of the brand.

The acquisition, though pricey is expected to add about 5% to the total Swatch revenues, impacting the earnings positively, especially since Swatch can pay for the acquisition with its cash reserves.

The other operational benefits would result from Worldwide Network Expansion for Retail and Wholesale, Expansion of Timepiece Sales at Retail, Broadening of Product Offer and Gain better Control over Wholesale Distribution.

Road ahead

The original mining business will remain a separate entity, and will be renamed Dominion Diamond Corporation, post the sale of the luxury business of Harry Winston. Swatch group and Dominion Diamond Corporation plan to continue to work together through a long term sourcing deal, where Dominion will supply rough uncut diamonds to Swatch group, thereby securing Swatch group’s diamond supply and providing Dominion with a ready customer over the long term. The two companies are also considering a joint diamond polishing venture in Switzerland.

Harry Winston Diamond Corporation opened up sharply by nearly 10% to $16 from its previous close of $14.5. Swatch group also opened up by 3.7% to nearly $28 from its previous close of $27. Going by the investors’  reception to the deal announcement and subsequent spikes in the share prices, it seems like a win-win for both companies involved.

As can be seen, Swatch paid for a crown jewel, and Dominion Diamond Corporation got enough cash to pursue its diamond resource opportunities, sweetening the deal for the shareholders of both companies.


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