Friday, March 7, 2014

Sartorial Statements: A Match Made in Fashion & Business Heaven

Photo from London Ethnic's LFW Runway Show

By now everyone who follows the fashion/luxury goods industry knows that the well-known private equity firm Blackstone has purchased a 20% stake in the renown Italian fashion house Versace. Vanessa Friedman, the Style editor of the Financial Times, theorized that Blackstone purchased the stake in Versace because Blackstone wants to expand its hotel group. She argues that Blackstone has an interest in developing its portfolio in the hospitality sector, particularly since it just launched Hilton back into the public with its IPO in December, and currently has no boutique brand. Given that the fastest-growing area of luxury is luxury experiences (meaning hotels, travel, excursions, etc.), and that Versace has dipped its toe into that market with one Versace hotel in Australia and another opening in Dubai, Friedman believes that Versace may be Blackstone's boutique hotel brand.

While Blackstone may choose to expand Versace's hotel offerings, Blackstone's decision to purchase Versace has more to do with the changing face of private equity investments than any strategy to add boutique hotels. Private equity firms originally made most of their money through leveraged buyouts. Leveraged buyouts work like this: the private equity firm picks a company it thinks will be profitable, ideally one with strong cash flows. The private equity firm goes to a bank and borrows most of the money it will take to buy the company, and then adds in a little bit of its own money. Once the private equity firm buys the company, it restructures it by changing the management, selling off non-performing product lines, etc. – paying down the debt and trying to make the company more valuable (or at least appear more valuable) to potential investors. In about three to five years, the private equity firm takes the company public again through the IPO process, sells it to a larger company, or to another private equity firm or the own company’s management.

It used to be that only a few private equity firm existed. In recent years, however, private equity firm have become prolific as an alternative to working at a traditional investment bank like Goldman Sachs. Therefore, there is much more competition when private equity firm try to buy attractive companies. In addition, they can no longer easily find companies that just need a few product lines sold off or new management installed. Private equity firms must, therefore, branch out into new areas of industry and try to find new types of companies that can be made profitable.

The luxury goods industry was, for a long time, ignored by private equity firms. The firms left those companies to run themselves, or to be scooped up by luxury conglomerates like Gucci Group or LVMH who purchased the companies as part of a business strategy. However, fashion/luxury goods are a billion-dollar industry that is massively popular in China, India, South America and other hot emerging markets. It only makes sense that private equity firms would eventually turn to the fashion/luxury goods industry as a new source of purchasable companies. It also helps that fashion/luxury goods companies are now interested in the benefits of being temporarily acquired by a private equity firm, rather than permanently by a luxury group.

Fashion houses that are not part of the luxury conglomerates are often family-owned. Families are made up of people who age and eventually pass away. As the owners of these houses get older, they may not know what to do with their empires. Private equity firms can provide the support and knowledge to help transition a fashion house from being a family-run business into an international mega-company. This is probably one reason why Versace chose to sell to Blackstone - Donatella is getting older and may be looking for ways to ensure that Versace will continue when she is no longer at the helm. This is evidenced by the fact that the Financial Times quotes the chief executive of Versace as stating that Blackstone's help will enable Versace to prepare for an IPO in 3-5 years. Doing an IPO ensures that Versace will have the necessary infrastructure in place to continue growing as a corporation even beyond Donatella's tenure.

Blackstone's 20% stake in Versace does not appear to be driven by the hope of gaining some marginal benefit by using the Versace name for a line of hotels. Rather, Blackstone acquired shares in Versace because Blackstone wants to be a first-mover, buying into an industry that has enormous profitability potential for the private equity firms. For its first foray into the fashion/luxury goods industry, Blackstone has made an extremely safe and highly profitable choice, as Versace is a red-carpet mainstay with obvious growth potential. It is also owned by a family whose matriarch wants to ensure that what she and her brother built will endure past her lifetime. Like finding the perfect pair of shoes for a favorite dress, this is definitely a match made in fashion - and business - heaven.

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