Thursday, June 21, 2012

The Luxury Watch Industry

Market Size

As most luxury watches are Swiss made, we take the Swiss watch sales published by FH.  These are export prices; multiply by 2.5 to 3 to get the retail values. The numbers are not broken down into segments: the total covers everything from a million dollar handcrafted luxury piece to a $35 dinosaur watch.

The hard luxury industry is highly cyclical - we have a 22% decline in 09:

2011 export sales were 19.3b Swiss francs, or 16b euros.  Multiplying by 3 for retail price, gives 48b total market size.


China is an important source of demand.  29.7% of 2011 Swiss Watch sales went to HK and China, however this does not account for overseas travelers:

Mainland Chinese tourists may account for 40% of all luxury sales in Europe.  This means Mainland China may account for 30-40% of the Swiss Watch market.

China represents a huge growth opportunity and a risk.  Johan Rupert (CEO of Richemont) colorfully likened it to having a black tie dinner on top of a volcano. "There is a volcano somewhere, whether it’s this year, in ten years’ time, or in twenty years’ time. We are exposed to China.  I think they are going to travel more...I think they are going to survive....we are now a ‘China play’...Personally, I don’t think anything’s going to go wrong in China. That’s my view, but I know nothing, and I mean it. I may be too optimistic about China, but if you have differing views, remember, it’s critical."


The Players

Looking at the largest players, which price segments they operate in, and guessing their market share:
  • Swatch: Multitude of watch brands, from basic watches (like the dinosaur above) to high end luxury.  Best known brand is Omega.  For FY11, (finished timepiece) sales were CHF 5.9b, or 4.9b Euros.  Did not find their percentage of retail vs wholesale sales in the annual report, nor a breakdown of basic vs luxury.  Lets assume 75/25 wholesale/retail with 50% retail margin: gives 8.5b Euros or 17% market share.
  • Rolex. A secretive private company, only in the luxury segment.  Estimated to produce 1m pieces a year, lets assume at a retail value of US 8K each, gives total Euro 6.4b a year, or 13% market share.
  • Richemont (CH:CFR). Publicly listed company controlled by the Rupert family, owing Cartier (watches and jewelery), Van de Appels (high end jewelery), and several watch brands in the Luxury and High End luxury range.  Richemont's FY11 watch revenue was 3.3b Euros, or 7% market share.  Probably higher, as 58% of the company sales (not necessarily watches) are to wholesalers.  Lets estimate 9% market share.
  • LVMH: (Tag Huer, Zenith, Bulgari, Hublot) Lists 1.9b Euros revenue for watches and Jewelery (not broken down).  If 70% of these sales are watches, that gives 4% market share.
  • Independents: People who set up their own watch company, e.g.: Frank Muller
As I don't have the numbers, these are really rough estimates...guesses upon guesses.  Would be better to break down into different segments, as basic watches and high-end luxury items are different markets, not competing substitutes.  Except for Swatch, all these players only deal in the luxury market, and Rolex is probably the leader there

ETA Watch Movements

An estimated 2/3 rd of all Swiss made watches use movements from the Swatch group (for example).  As a near-monopoly under anti-trust regulations, it was required to provide to other companies both watch movements (to put them in a watch case and sell) or mechanical ébauches (allowing the buyer to modify the watch movement before assembly).  Swatch objected, and in 2004 was told it could stop selling ébauches after a transition period till 2008.  Swatch announced in 2009 that they would also reduce the supply of completed movements, though this has since been delayed to start in 2013.

Few alternatives Swiss companies could pick up the slack, main one is Selitta.

A harder issue is assortments (e.g.: hairsprings).  Swatch's Nivarox is the only major Swiss supplier, and they are reducing assortments by 5% in 2012.

How do the different players handle this?

Barriers to Entry

There are two main barriers to entry:

First, time and money to build the capacity to produce watch movements and assortments:

“If we have to make assortments one day, we’ll make assortments. Obviously it’s difficult. It will take money. If we have to spend $20 million or $30 million to manufacture hairsprings, we can do it. It will take time. Initially they will cost much more than Nivarox hairsprings because only 50 percent will be good. We will have to go through all the hurdles.”

Second, time and money to start a brand.  Takes years of plastering your advertisements everywhere, as well as getting celebrities to endorse (or better still, to wear because they really like it), and generating buzz to build a brand which is recognizable to 'normal' people (not just watch lovers).

 How do companies enter this business?  Some examples:

  • Franck Muller: Started designing/producing individual pieces for private clients in the 80s.  Built a tourbillon watch back when few others were able to do so; dubbed 'Master of Complications'.  House of Franck Muller started in 1993, famous for curvex shaped watch and for putting colorful numbers on the face.  Some watches use ETA movements.  Currently produces 40000 pieces a year.
  • Azimuth: Started in 2003 in Singapore, with attention-catching designs (spaceship watch, robot watch).  Very niche.  As of 2009: produce around 1500 pieces a year with selling from SGD 2.5 to 7K.  Most of their watches appear to be modified ETA movements.
  • Nomos Glashutte: started in 1990, Germany.  Watches have classical, bauhaus style design.  First watches used ETA movements, after 2005 they start to manufacture (some or all models?) fully in-house.  Very little marketing: may advertise in German watch magazines, and managed to get articles in Forbes and The Atlantic TimesFew authorized dealers, most sales done online.  Watches cost from 1000 to 5000 Euros.  Don't know their annual production.

From these examples, it seems that either you start at the very high end like Frank Muller, with limited production for individual clients, or at the low end (that is, low end for luxury goods).  Both these sidestep the advertising costs.   At the low end, they all started off using ETA movements: seem to rely on eye catching design for watch-lovers to discover their offerings (probably online).  Azimuth and Nomos are at that stage now - sort of flying 'under the radar', serving a niche market.  Frank Muller has somehow managed to move into the mainstream, where the brand is now recognizable by normal people.

Swatch's restriction on movements and assortments, as well as proposed tougher 'Swiss Made' labeling regulations may make it harder to start a new brand from scratch in the future.

Morningstar gives both Swatch and Richemont a narrow economic moat.  I agree - although hard, its possible for a brand new company to start up and go mainstream within 20 years.

Friday, June 15, 2012

Luxury Watches for Beginners

The watch industry is confusing to newcomers.  So many big words, countless brands to choose from...and why do some pieces sell for 2K and others sell for 20K? 

When you buy a watch, what do you look for? And what are you paying for?  Also useful for when I look at listed watch companies later.


Price Segments

See this link for the different price segments.

Scarcity is the main thing determining which segment a brand is in.  For example, the high end luxury brand "A Lange and Sohne" produces 5K pieces annually.  A more popular luxury brand like Rolex is estimated to produce 750K to 1m pieces annually.



The highest luxury brands are only recognized by people 'in-the-know', they mostly have unpronounceable European names - A Lange and Sohne, Vacheron Constantin, Jaeger LeCoultre.... Only the more popular(ist) luxury brands such as Rolex, Cartier, IWC are plastered all over the place.  As my wife said, whats the point of spending thousands of dollars on a watch if no one knows what it is?

Different brands give different images: e.g.: sporty, elegant, technically sophisticated.  You must decide how you want to present yourself to the world: Do you want to be James Bond, Tiger Woods, or some 5th generation European aristocrat speaking in ze funny accent?

Some brands maintain a basic style which is instantly recognizable among all models of that brand (e.g.: the numbers on a Frank Muller or Cartier watch).  Other brands are have no distinguishing characteristics in their lines (e.g.: Omega).

How is a good brand made?  After deciding on the price segment and image, its a long, slow process...5 to 10 years...of stoking demand, creating excitement, always producing slightly less than desired, and raising prices.  The company needs to make sure the goods are never 'on-sale', either by owning their retail outlets, or buying back unsellable goods from retailers to keep them off the grey market.


Most luxury watches are Swiss made, meaning the at least 50% their components (by value) are from there.  This may increase to 60 or 80% later.

A few luxury watches are German.  There may be some Japanese luxury watches, not sure if they can sell outside of Japan.  I think its possible for the industry to move production to other European countries...maybe even Japan...but they can't produce elsewhere and still maintain their class.



Hand wound, automatic, or quartz: this short video explains.  Quartz is a no-no for men, but OK for women.

In-House or ETA: 80% of the watch industry 'movements' are manufactured by ETA (owned by Swatch group).  Many watches, even for well known brands, simply design a case, put the movement i, and sell it as their own.  Watch enthusiasts prefer 'in-house' movements, where the company creates all parts of the watch by themselves.  You may pay $5000 for a watch which just has a movement slapped inside a case, when the same thing is available under another brand for $500.  Again it has to do with being exclusive.  A Honda is just as good as  a BMW...but, if you pay a BMW price for a Honda, you are being ripped off - and you have more money than taste...So if you have watch collectors for friends, take note.  (Again, it doesn't seem to matter for women.)

More Complications

Every second watch advert I see has a 'tourbillon'.  Here is an interesting 2007 interview by Frank Muller, I like his examples of how changes to the watchmaking industry affect the value of the end product:

"You are buying more of the dream, the image and the magic and less of the technicity. Indeed the technicity serves to primarily to support the reputation of the brand." ( wife was right).

 "A tourbillon is a dream. It is magic.  Because it is a dream it must be a bit inaccessible....But you make the tourbillon suddenly very accessible, do some degree you destroy the dream and you break the magic."

"A real hand made rattrapante costs minimum 50 thousand Swiss Francs and suddenly you’ve got a guy who has one on his wrist that costs less than 10 thousand Francs. How will that make you feel...? Once the dream has been broken you cannot repair it and this should be the greatest cautionary tale to what is going on with the tourbillon."

In the end, it doesn't matter what a 'tourbillon' or 'rattrapante' is... or even how to pronounce all these big words - the only important thing is that prices are falling.  All these fancy complications in a watch can become obsolete.  The brand is more important, it has a better chance of lasting.


A Nice Watch

Long time ago I went to a used watch shop with my wife.  There was row upon row of watches, each one priced from 4K onwards.  Couldn't believe how fugly most were: garish colors, 4 or 5 separate dials cluttering the watch face, studded with something a drunk rapper would wear.

After spending all this time online looking at watches, I've only came across one that strikes me as beautiful.  It looks like a watch, is easy to read, fits nicely with casual or formal wear, and comes without the marketing baggage: you don't have be James Bond or Tiger Woods to wear it:

Probably won't get it though, 5K is too much for a watch. [edit: was only SGD 3K.  A reasonable amount, but no so much that I should have spent on stocks instead...].

Friday, June 8, 2012

Dips vs Bear Markets

From "Is the Bear Around the Corner?" by Jon D. Markam.

How often does a 10% midyear "correction" go lower to become a 20%+ bear market, and what happens if it does?
  • From 1928 there were 24 10% drops - a bear market occurred only 1/3rd of the time (7 times), but for those, the S&P lost an average of an additional 38%
  • For those bear markets, after the initial 10% loss, the maximum rebound averaged +8.3% (before going south again).
His summary:
  • If the S&P 500 loses more than -5% from the Monday close, then the probability increases that we could be in the throes of a prolonged, new bear market. The line in the sand, then, is 1,214.
  • In contrast, if the market rallies more than +10% from here, to 1,405, then the chances of a bear market dramatically decrease.

Other things when looking at counter trend rallies for clues to market direction, from Barry Ritholtz:
  • A reaction rally lasts 2-7 days.   "Watch the market breadth, the volume and where we close relative to the highs and lows for some small measure of insight."
  • Counter trend rallies are powerful and euphoric.  Some of the best one day gains occur in bear markets.  Fear (short sellers being squeezed) is stronger than greed (legitimate buying).
Fundamentally, the two main questions are:
  • Are we heading for a US recession?
  • Fed intervention: occurred the last 2 times the market dropped 20%. When is QE3?  (And will the market respond to another shot of morphine?)
We won't know these two things without hindsight.

Saturday, June 2, 2012

Short Notes on Air Asia

BT, May 17th 2012, S Jayasankaran

Quick points:
  • At a time when full service carriers, incl. SIA, have begun registering losses, AA 'defied' industry trends to register 12% yoy in raw passenger traffic to 4.8m for Malaysia operations.Revenue-Passenger-kilometer (RPK) grew 9%, partially from shorter average stage length.  Maintained 80% load factor.
  • Foreigners hold 51% of the stock - most foreign held company on KLSE.
  • Impending listing (May...what happened?) of AA's 49%-owned Thai unit should cut debt considerably.
  • Indonesia listing may not happen because of regulatory changes: require company to own at least 2 planes to be listed, but AA Indonesia leases all its planes from AA (who keeps the debt on its balance sheet).
  • AA currently bears 1.9M financing attributable to Thai and Indon associates.  If removed, would reduce gearing from 1.4 to 0.9 times.  For this, the associates would have to build their balance sheets in the future and take over their own aircraft/
  • Thai AA turned around in Q4 and registered profits of 200M last year (flat yoy, in spite of floods and rising fuel costs).
  • Next quarter, AA can begin to recognize profits from AA Thai.  Currently still offsetting $330m in accumulated losses to clear. If accounted for now, would have added RM99M to AA's 2011 results.
I would not hold a large amount of Air Asia due to its debt and future capex commitments.  Maybe a smaller amount, as it is the market leader in a growing industry.  Need to go through their numbers again.  Wait for recession to buy (...hopefully they manage to spin off AA Thai before that).