Description

Watches of Switzerland Group (WOSG) is a well-positioned UK-based luxury retailer of high-end Swiss watches with high net worth tailwinds trading at 20x FWD earnings (FY22, FY ends April 30th). They have executed phenomenally in Europe (hundred year relationship with some of the top brands) and now have an ability to take a ton of market share in the US by rolling up other authorized dealers (ADs).

(As a brief aside, ADs are the only places that can sell you a Swiss watch at retail prices / with the original manufacturer’s guarantee. This is unlike buying a second hand watch from a ‘grey market’ dealer. For the top brands you generally have to be one of the AD’s preferred customers in order to get the watches that are most desired as the average AD might only get a handful of them per year. As an example, you can check out the Rolex ADs near you here. Note that there are not that many. Your average downtown jeweler taking out ads selling used Rolexes is not an AD.)

Understanding what makes a true luxury business work (versus a fashion business) is difficult and often done incorrectly. Sorry to the value investors out there but Michael Kors and Coach are not a luxury business. Rolex, Hermes, and Patek Phillippe are. For a true luxury brand, increasing prices is not an option but a necessity. Luxury sells due to its rarity, and price increases are a requirement to maintain the rarity of a brand. This is why some of the most well-known luxury items have really not changed in style in 50-100 years (e.g., Cartier Tank or Love Bracelet, Hermes Birkin or Kelly bags). The fashion industry, meanwhile, changes styles at least 4 times a year and sells as many units as possible. The goal there is to sell what is in vogue, not what is timeless. This is why people pass down nice durable hard luxury items like Swiss watches for generations, but you don’t see people wearing their great great grandma’s Gucci flip flops...

This matters for WOSG because ~75% of its revs come from the top seven watch brands---the ones that really matter. This is the part of the luxury market that is enduring and the one that investors should want exposure to. Rolex specifically contributes ~60% of group revenues, which is great. The holy trinity of Swiss watchmaking includes Patek Philippe, Audemars Piguet, and Vacheron Constantin. Beyond that Rolex is slightly more mass market but still the dominant brand. Rolex is synonymous with Swiss watchmaking and especially Swiss sports watches which grow faster than dress watches. Do your own work but my diligence tells me there is a pretty big shortage of Rolex steel sports watches, most of which is being done on purpose to make sure secondary / grey market values of Rolex steel watches stay above MSRP. It’s a brilliant, legal racket.

3 Key Reasons This Is Defensive, Growth & Potential To Be Multi-Bagger:

• Defensive growth: Swiss watch exports to UK – 9 yr CAGR of 12.4% for watches above CHF 3k (which is where WOSG really plays); Swiss watch exports to US – 9 yr CAGR of 7.3% for watches above CHF 3k.

• Supply/Demand Balance: Controlled supply vs demand means waiting lists, limited/no discounting, ability to pass through price increases & premiums in second hand market. For context, Rolex produce 1.1m units/yr, Patek Philippe 60-65k/yr & Audemars Piguet c35k/yr. Rolex demand is price inelastic. If you look at prices on Chrono24 (https://www.chrono24.com/ - largest platform for second-hand luxury watches), you will see many watches are sold at premium in second-hand mkt. As the CEO of WOSG says, everyone wants a watch even non-watch people – “if you have 2 you want 4 & if you have 5 you want 15”.

• WOSG strategy: Combination of long-standing partnerships w/brands, investment in retail distribution (stores, online, social media) & US expansion.

Detailed Thesis

·         WOSG is leading multi-channel luxury watch (defined >£1k, but can go > £1m for Patek Philippe) & jewelry retailer in the UK & select regions (FL/GA/NYC) of the US through Watches of Switzerland, Goldsmiths, Mayors (US brand) and Mappin & Webb stores, mono-brand stores & online. Product split of revs: luxury watches 84%, jewelry 9%, other 7%. Geo split of revs: UK 72% & US 28%. Over time we believe the US will provide significantly more revenue contribution.

·         Key points: (1) WOSG has ~35% market share of UK luxury watch mkt by value (40% of UK online) and just 8% of US mkt; (2) top 7 brands = 74% of WOSG and Rolex is the dominant one at 60%. Patek Philippe & Audemars Piguet are 7% of revs and strategic partner brands (Cartier, OMEGA, Breitling, TAG Heuer) 15-16% of revs; (3) revs by other channel: mono-brand boutique stores 16% & travel retail channel 10.5%.

·         Strong brand relationships: WOSG’s relationship w/Rolex dates to 1919 (100 yrs old), Cartier (68 yrs old), Longines (62 yrs), Omega (65 yrs), Patek Philippe (52 yrs), Breitling (36 yrs), Hublot (35 yrs), Tag Heuer (35 yrs), Jaeger LeCoulture (29 yrs) and IWC (26 yrs). While the contracts w/brands are technically rolling 6 months, you can see from the duration of Rolex that it is not a real risk. Our discussions lead us to believe that the brands have little incentive to screw over WOSG given how dominant they are in the UK, which is arguably the most important city for Swiss watches outside of Europe (yes Hong Kong and Macau are important but Chinese tourists often shop for Swiss watches in Europe itself while on vacation).

·         Transformation: WOSG was owned by Icelandics & then Apollo bought in 2013 (they still own ~28%). CEO & CFO joined in 2014 (CEO prev President of Ralph Lauren in Europe/ME). New strategy was built on 5 points: mgmt/systems, channel diversification/store elevation, brand partnerships, marketing & US expansion. Practically this meant investing in stores (took 3-4 yrs in UK) so they were non-intimidating & modern (unlike other retailers). New systems (SAP) meant they could access inventory nationwide (optimise product availability). Invest in marketing w/more recent focus on digital/social media.

·         CRM/Marketing: CRM investments has helped post-Covid 19. Their CRM has 5mm clients on database. They use AI for bidding (online/social media) and have sensors in ceiling in store & can tell if you clicked on an ad. When customers transact, Google matches IP address w/your email. They are way ahead of most retailers (and all watch retailers) on this front. On marketing front, WOSG strategically engage w/brands to drive demand & coordinate product launches. Investments here really helped WOSG perform well in FY2020, which ended in April and includes ~1.5 month of widespread store closures:

·         Innovative marketing: Social media is very important/influential. They are very active on Instagram. Their scale gives them efficiencies on marketing spend that smaller/independents can’t match. They hosted a dinner w/rapper Naz (flagged on social media) & did an exhibition pairing watches w/hard to get sneakers (w/Stadium Goods https://www.stadiumgoods.com/ - these are sneakers that cost hundreds/thousands). They hosting a dinner recently w/50 Cent. The CEO seems to have a real grasp of how to remain contemporary and relevant. The net of all this is in FY20 they had 2.8b media impressions.

·         US: After failed/stalled talks w/Saks (at Saks invitation), WOSG saw that the US was a huge market, underdeveloped & very fragmented (90% of mkt in hands of small groups/independents, usually long-standing family owners). Importantly, brands were keen to have WOSG enter the US. In FY18, entered US w/acq of Mayors in Florida/Georgia, Wynn stores in Las Vegas & in FY19 opened 2 stores in NYC (Soho & Hudson Yards). Their strategy has shown they can open stores greenfield (NYC) & improve acquisitions by using UK template (Mayor’s). Mgmt cited example of a Mayor’s store in Merrick Mall in Miami where redesign of store + other improvements (cocktail area, etc) increased traffic +50%. Similarly, Soho store has a cocktail bar downstairs & a curated library (https://www.watchesofswitzerland.com/stores/soho-nyc ). Prompted awareness of WOSG in NY is 84% after only 2 yrs. They are looking at other M&A opportunities in US, but would only look to buy watch businesses (not the jewellery part). Competition for assets would appear to be low given the relationship required w/the brands.

·         Online: Online is used for researching (WOSG has 30m site visits) & also to book appointments post-Covid 19 (the outcome being more productive sales staff & high conversion). There is no direct online/Amazon-type threat. To be authorized to sell Rolex online, for example, you also need to have a store.

·         High quality retail distribution: Retail distribution has historically been a weakness for Swiss watch brands who are loathe to build out their own network in the most expensive parts of the most expensive cities globally, but WOSG is the answer to that problem for the brands. WOSG is also doing mono-brand stores which improves brand presentation while allowing for a shared backspace (basically a co-location strategy that improves the retail economics for both WOSG and underlying brands):

When they do a mono-brand store in a mall, the brand will have to close 3-4 other distribution points in that mall. When brands did this on their own, they would look at stores of 1.2-1.5k sq feet or bigger, whereas WOSG does 300-400 sq ft stores and would do 2-3 next to each other (and share back store space).

·         Financials: Product margin: Rolex have the biggest productivity per sq ft therefore lowest input margin. Jewellery is higher margin than watches, but lower sales per sq ft.  Current management have increased profitability by at least 1pt per year, and they don't think that's over. It is all about driving incremental sales with fixed overheads per store, and fixed central overheads. There is no major threat in their view to the margins, and to the extent there is we do not believe it comes from the brand’s trying to extract more value because they are already getting good value by working with WOSG rather than opening stores on their own. They compete with other retailers that don't have the same level of productivity (they are more than 40% more productive than the rest of the network for Rolex as an example) - WOSG utilise their national footprint and systems. If they could get the UK productivity in the US, this would be hugely accretive to overall profitability. The higher growth they are currently enjoying in the US means a nice drop through to group profits. Historically about 2.2yrs payback on UK stores, and expect similar in the US. All of this translates to high-teens 4-wall EBITDA margins and ~15-16% returns on invested capital which is really quite impressive for a retailer. There is only a quarter turn of leverage on this business so not a huge concern.

·         Other facts: (1) to buy a Patek Philippe they qualify you and you generally are on a waiting list for a year or two depending on which model you want, or you have to buy a bunch of models you don’t really want in order to get in the good graces of the AD (!); (2) any brand they are missing ? They would like to have Richard Mille (https://www.richardmille.com/) who only produce a few hundred units/yr; (3) they estimate 7% of revs from Chinese tourists & 10% other tourists, realistically it could be more than this but it’s definitely not like ~40% of sales coming from APAC like it is for Richemont and probably Hermes; (4) historically HK was the biggest export mkt for Swiss watch exports (the redirection of that supply from HK should benefit WOSG); (5) there is no threat of disruption geographically (mkt will always be dominated by Swiss) or technology (smart watches are new entrants, but serve a different purpose & are at a lower price point).

·         Risks: Key risk is supply disruption which is normally not a concern but production is concentrated in Geneva and we are of course in the middle of a pandemic..

Overall there is underlying structural growth, a unique supply/demand ecosystem & a mgmt team that has a strategy to replicate it’s UK success in the much larger US market. This should be a long-term compounder driven by store expansion in both the UK and US, highly accretive store refurbs and improving margins through scale. Interestingly, the valuation gap between WOSG and other luxury good co’s is massive. Yes, the luxury goods brands have higher margins, but if I want luxury exposure (with a mkt share angle), WOSG at ~20x FWD EPS compares nicely vs Hermes (51x), LVMH (30x), Brunello Cuccinelli (63x), Moncler (33x), Kering/Gucci (25x), Prada (53x). 

WOSG has also held up really well during COVID including more recently despite UK lockdowns meaning UK stores were only open for 37% of normal hours. In the quarter ended Jan 24th 2021 they posted +1.5% rev growth in the UK thanks to +121% eComm sales growth and 19% FX-neutral rev growth in the US due to the opening of 8 new stores. This is probably a great COVID reopening play to the extent you care about that.

Back of the envelope return profile:

Recall that these guys are selling the more expensive Swiss watches, and the value of those has held up pretty well over time. See below that the value of Swiss watch exports for units that are above 3,000 Swiss francs (pegged / valued close to Euro) has grown 12% since 2010 in the UK and 7% in the US.

It is important to keep in mind where they are actually generating their revenues from (i.e., disproportionately from these higher-value watches). Even WOSG gives generic numbers on total Swiss watch exports in their reporting that I do not think is that instructive because it misses the point that the more desirable / expensive brands that WOSG is overindexed to has grown a lot faster than the lower end of the market (sub CHF 3k watches) that has been hit a lot harder by changing consumer tastes, smart watches, etc. So this, for example, which shows the value of Swiss watch exports at like 4-6% is lower than what I think WOSG can do:

We can think of the forward IRR for WOSG as: 5% earnings yield + 8% comps (almost all of which comes from increase in quantity and value of higher-end Swiss watch exports) + 1% new UK stores + 1% of margin / productivity increases = 15% IRR before underwriting share gains in the US. I have conviction in this model and believe mgmt will be successful in rolling up the US market so you can easily see returns in the high-teens from here.

Catalyst

Reopenings in UK will help though sales have remained quite strong anyway due to shift to eComm.