Luxury Goods

Baselworld 2017 Insights – Soul-Searching in Watches

We recently organised an investor trip to Baselworld to visit the watch fair and to meet industry leaders, sector experts and company executives. We present in this report the key themes that emerged from these discussions. We look forward to hosting you on one of our next field trips.

 

The prolonged category crisis is prompting soul-searching in the industry

Everything is changing: 1) prices and product mix are falling back; 2) direct retail is being questioned; 3) digital distribution is seen as an opportunity for the future; 4) mid-price brands are pressured by mega-brands; 5) smart watches cast a shadow on LT relevance and particularly so on entry price points; and 6) even the Basel fair itself seems less relevant.

 

No clear answers emerge on any of the issues – especially for seasoned incumbents

Entry-level brand Daniel Wellington has shown one can build a major watch brand through social media and distribute it online. Very few incumbents have started to scratch the digital surface to distribute products; many more are using digital marketing tools to build their brands and monitor their effectiveness.

 

A number of clever ideas

2017 has not been a year of stunning innovation. Yet, we could see a number of very clever ideas: 1) Bulgari’s Skin collection seems brilliant; 2) many brands are pondering the adoption of magnetic card warranty activation to keep track of sell-out; 3) smaller brands like Corum are making the most of mega-brands moving back into the CHF 3-7k space, to attack the CHF 50k space, where offer seems limited; and 4) niche players are always on the lookout for any room on the fringes to create a distinct reason why for themselves.

 

Things are getting better

All brands admit that 2017 is off to a better start than 2016 and that the trough is behind them. We expect to see this reflected in FHS statistics soon. Watch stocks have anticipated a rebound already and we expect ST support for both CFR and UHR.


The investment recommendation was finalised at 05:15 on 30 Mar. 2017 (London Time). It may differ from the date and time of broad dissemination on the website. Click here for Analyst Certification, Important Disclosures and Non-US Research Analyst disclosures.





Executive Summary

We recently organised an investor trip to Baselworld to visit the watch fair and to meet industry leaders, sector experts and company executives. We present in this report the key themes that emerged from these discussions. We look forward to hosting you on one of our next field trips.

The prolonged category crisis and the clouds ahead are prompting soul-searching in the industry

Everything is changing: 1) prices and product mix are falling back to earth, after the rise of the recent past; 2) direct retail is being questioned, but multi-brand wholesale continues to shrink; 3) digital distribution is seen as an opportunity for the future, but abundant wholesale inventory and lack of price discipline pose a formidable challenge; 4) mid-price brands (CHF 1-3k) are pressured by mega-brands pushing their entry price points downwards; 5) smart watches cast a shadow on long-term relevance and particularly so on entry price points; and 6) even the Basel fair itself seems less relevant. SIHH (in Geneva, in January) would be a way to intercept wholesale clients sooner (chosen by Kering, for example), while wholesale clients are ordering less of their total volumes at annual fairs anyway (Baselworld orders account for c.30% of yearly volumes vs. 50-60% in the past). Given very high costs for Baselworld (c.CHF1m for a mid-sized booth), a number of brands are opting to invest these funds in consumer marketing.

No clear answers emerge on any of the issues – especially for seasoned incumbents

New entry-level brands like Daniel Wellington have shown the world that one can build a major watch brand through social media and distribute through the internet. But very few incumbents are just starting to scratch the digital surface: a few bold pioneers like Corum are partnering with Amazon to sell their products online; lower-end brands in the Richemont portfolio are using the ‘in-house’ YNAP facility to digitally distribute products; many more are using digital marketing tools to build their brands and monitor their effectiveness (Bulgari is a case in point in this respect). Most brands are nevertheless still stuck in the old world multi-brand wholesale model, between the Scylla of poor direct retail productivity and the Charybdis of a fragile price discipline in the market.

Mechanical movements and components sourcing does not appear to be a problem

Swatch’s decision – in agreement with the Swiss anti-trust authority – to limit movements and components supplies to competitors has prompted material capacity investment by ETA peers and brands as well. The slowdown of the past few years has caused a material overcapacity problem. If securing movements was an issue five years ago, most brands are making the most of the current abundant supply to secure long-term volumes well into the early and mid-20s (ie, past the transitory regime demanded by the CH anti-trust authority, expiring in 2019). Sellita has risen as an alternative to ETA. Swatch had taken a stance that it would be better off as an oligopolistic player in a free market, than as a monopolist in a regulated market – the bet has not paid off. Tudor striking a deal to source movements from Breitling is a major setback to Swatch’s ambitions.

A number of clever ideas

2017 has not been a year of stunning innovation. Yet, we could see a number of very clever ideas: 1) Bulgari’s Skin collection seems brilliant – as it squares the circle of offering significant consumer choice through combination and personalisation, while maintaining a tight grip on inventory commitment in store; 2) many brands are pondering the adoption of magnetic card warranty activation (same as Rolex and Breitling) to keep track of sell-out; 3) smaller brands like Corum are making the most of mega-brands moving back into the CHF 3-7k space, to attack the CHF 50k space, where offer seems limited; and 4) niche players are always on the lookout for any room on the fringes to create a distinct reason why for themselves (eg, video game and icon series at Romain Jerome).

Things are getting better

We saw no fireworks at Baselworld, and listened to some moaning. However, when push comes to shove, all brands admit that 2017 is off to a better start than 2016 and that the trough is behind them. We expect to see this reflected in Swiss watch exports soon, as – slowly but surely – inventory overhang reduces in the wholesale channel. Watch stocks have anticipated a rebound already – we reckon short-term prospects are nevertheless improving and expect short-term support for both CFR and UHR. We see more questions on UHR’s long-term position and strategy, and maintain long-term structural reservations on this name (SWATCH GROUP B: If we were running ... Swatch).


The prolonged category crisis and the clouds ahead are prompting soul-searching in the industry

Everything is changing: 1) prices and product mix are falling back to earth, after the rise of the recent past; 2) direct retail is being questioned, but multi-brand wholesale continues to shrink; 3) digital distribution is seen as an opportunity for the future, but abundant wholesale inventory and lack of price discipline pose a formidable challenge; 4) mid-price brands (CHF 1-3k) are pressured by mega-brands pushing their entry price points downwards; 5) smart watches cast a shadow on long-term relevance and particularly so on entry price points; and 6) even the Basel fair itself seems less relevant. SIHH (in Geneva, in January) would be a way to intercept wholesale clients sooner (chosen by Kering, for example), while wholesale clients are ordering less of their total volumes at annual fairs anyway (Baselworld orders account for c.30% of yearly volumes vs. 50-60% in the past). Given very high costs for Baselworld (c.CHF 1m for a mid-sized booth), a number of brands are opting to invest these funds in consumer marketing.

Figure 1: Everything is changing in the industry: 1) prices and product mix are falling back to earth, after the rise of the recent past (1/5)

Average Wholesale Price – Luxury segment (3MMA)

Enlarge
https://cube.exane.com/demat/img/2017/376041/image3-enlarge.png

Source: Exane BNP Paribas estimates, FHS<BR/>Note: Luxury segment includes gold, platinum and gold-steel watches; mid-range includes gold plated, steel and silver; low-range includes others


Figure 2: Everything is changing in the industry: 1) prices and product mix are falling back to earth, after the rise of the recent past (2/5)

% share of total Swiss Watch exports (value)

Enlarge
https://cube.exane.com/demat/img/2017/376041/image4-enlarge.png

Source: Exane BNP Paribas estimates, FHS<BR/>Note: Luxury segment includes gold, platinum and gold-steel watches; mid-range includes gold plated, steel and silver; low-range includes others


Figure 3: Everything is changing in the industry: 1) prices and product mix are falling back to earth, after the rise of the recent past (3/5)

% share of high-end watches on total Swiss Watch Exports

Enlarge
https://cube.exane.com/demat/img/2017/376041/image5-enlarge.png

Source: Exane BNP Paribas estimates, FHS<BR/>Note: High-end watches= Wholesale price &gt; CHF3,000


Figure 4: Everything is changing in the industry: 1) prices and product mix are falling back to earth, after the rise of the recent past (4/5)

Swiss Watch Exports – CHF wholesale price evolution (Log scale)

Enlarge
https://cube.exane.com/demat/img/2017/376041/image6-enlarge.png

Source: Exane BNP Paribas estimates, FHS<BR/>Note: Luxury segment includes gold, platinum and gold-steel watches; mid-range includes gold plated, steel and silver; low-range includes others


Figure 5: Everything is changing in the industry: 1) prices and product mix are falling back to earth, after the rise of the recent past (5/5)

Ballon Bleu de Cartier 33mm 18k female pink gold price change (Mar. 2017 vs. Jan. 2014)

Enlarge
https://cube.exane.com/demat/img/2017/376041/image7-enlarge.png

Source: Company website


Figure 6: Everything is changing in the industry: 2) direct retail is being questioned; 3) digital distribution is seen as an opportunity for the future; and 4) mid-price brands (CHF1-3k) are pressured by mega-brands pushing their entry price points downwards
Source: Exane BNP Paribas
Quotes from meetings at Baselworld
Enlarge
Watch companies opened too much premium space and are now starting to rationalise space. Moves were too audacious and now reining it in. […] Leading multi brand retail chains will take on some of the single brand space with the blessing of the brand owners given strong in-store retail experience. This could reduce excess retail capacity.
Brands need to support distributors and independent retailers or push themselves further into online.
Everyone's watch products are already available online - either liquidator or wholesaler with excess inventory. More and more will move online due to greater reach and cost efficiencies of being online. […] Challenge managing price points online versus its wholesale customers. End goal would be to own direct to consumer space online. None of the big brands can afford to cut off traditional retail and wholesalers yet.
Super high-end continues to sell relatively well. More challenging selling at the mid-market price points.
Enormous pressure on prices at Basel 2017. Only way to grow is through volumes.
Instead of buying brands, Large Groups are repositioning. Richemont is a good example of that. Prices have to go down. Jaeger-LeCoultre is also reducing prices; IWC is also introducing lower priced watches.


Figure 7: Everything is changing in the industry: 5) smart watches cast a shadow on long-term relevance and particularly so on entry price points (1/3)

Michael Kors New Access smartwatches – prices start at USD350

Enlarge
https://cube.exane.com/demat/img/2017/376041/image8.jpeg

Source: digitaltrends


Figure 8: Everything is changing in the industry: 5) smart watches cast a shadow on long-term relevance and particularly so on entry price points (2/3)

Samsung Gear S3 Classic – EUR400

Enlarge
https://cube.exane.com/demat/img/2017/376041/image9.jpeg

Source: Company website


Figure 9: Everything is changing in the industry: 5) smart watches cast a shadow on long-term relevance and particularly so on entry price points (3/3)

Samsung Gear S2 by de GRISOGONO in gold, diamonds and black galuchat strap (limited edition) – USD15,000

Enlarge
https://cube.exane.com/demat/img/2017/376041/image10.jpeg

Source: Company website



No clear answers emerge on any of the issues – especially for seasoned incumbents

New entry level brands like Daniel Wellington have shown the world that one can build a major watch brand through social media and distribute through the internet. But very few incumbents are just starting to scratch the digital surface: a few bold pioneers like Corum are partnering with Amazon to sell their products online; lower-end brands in the Richemont portfolio are using the ‘in-house’ YNAP facility to digitally distribute products; many more are using digital marketing tools to build their brands and monitor their effectiveness (Bulgari is a case in point in this respect). Most brands are nevertheless still stuck in the old-world multi-brand wholesale model, between the Scylla of poor direct retail productivity and the Charybdis of a fragile price discipline in the market.

Figure 11: New entry-level brands like Daniel Wellington have shown the world that one can build a major watch brand through social media and distribute through the internet (1/2)

Daniel Wellington

Enlarge
https://cube.exane.com/demat/img/2017/376041/image11.jpeg

Source: Company website, Bloomberg


Figure 12: New entry-level brands like Daniel Wellington have shown the world that one can build a major watch brand through social media and distribute through the internet (2/2)

Enlarge
https://cube.exane.com/demat/img/2017/376041/Picture31.png

Source: Instagram


Figure 13: Richemont portfolio are using the ‘in-house’ YNAP facility to digitally distribute products (1/2)

IWC products on Net-a-porter

Enlarge
https://cube.exane.com/demat/img/2017/376041/image13.jpeg

Source: Net-a-porter.com


Figure 14: Richemont portfolio are using the ‘in-house’ YNAP facility to digitally distribute products (2/2)

Piaget on Net-a-porter

Enlarge
https://cube.exane.com/demat/img/2017/376041/image14.jpeg

Source: Net-a-porter.com



Mechanical movements and components sourcing does not appear to be a problem

Swatch’s decision – in agreement with the Swiss anti-trust authority – to limit movements and components supplies to competitors has prompted material capacity investment by ETA peers and brands as well. The slowdown of the past few years has caused a material overcapacity problem. If securing movements was an issue five years ago, most brands are making the most of the current abundant supply to secure long-term volumes well into the early and mid-20s (ie, past the transitory regime demanded by the CH anti-trust authority, expiring in 2019). Sellita has risen as an alternative to ETA. Swatch had taken a stance that it would be better off as an oligopolistic player in a free market, than as a monopolist in a regulated market – the bet has not paid off. Tudor striking a deal to source movements from Breitling is a major setback to Swatch’s ambitions.

Figure 15: Swatch’s decision to limit movements and components supplies to competitors has prompted material capacity investment by ETA peers and brands as well
Source: FT, Reuters, “When corporatism leads to corporate governance failure: the case of Swiss watch industry” (IsabelleSchluep Campo and Philipp Aerni), “How firms profit from acting in networked environments” (Charlotte Steffen)
Swatch timeline on phasing-out deliveries of watch movements
Enlarge
  
Jul-02ETA declares it would reduce delivery of unfinished movements (ebauches) to companies outside the Swatch Group as of January 2003 and cease deliveries in 2006, focusing on assembled movements only.
 Two watchmakers file complaint against ETA with WEKO/COMCO (Swiss Competition Commission), which starts an investigation.
Nov-04WEKO and Swatch Group reach a mutual agreement, where ETA would supply customers with ebauches for mechanical watches until the end of 2010, gradually reducing delivery volumes.
 From the investigation, ETA resulted as the only supplier of mechanical movement blanks for prices below CHF300 and that 75% of Swiss mechanical movements contain movement blanks from ETA.
 Considering a market share for movement blanks of 95% at that time, WEKO concluded that a phase out time of three years was too short for the Swiss watch companies that relied on movement blanks from ETA.
2009WEKO once again looked at ETA’s dominant market position and whether it discriminated against independent watch companies compared with intra-group companies.
 The investigation was interrupted in 2011, when WEKO started to inspect Swatch Group as a whole.
2011New investigation on Swatch Group by WEKO, investigating on the company’s dominant positioning.
2013WEKO announced that it did not find sufficient evidence for discriminatory behaviour by ETA and therefore decided to let ETA’s supply
obligation for mechanical movements expire at the end of 2019.
 Over the next two years, Swatch is expected to deliver just 75% of parts to rival companies from average levels between 2009 and 2011. The supply of parts will then be dropped further to 65% in the years 2016 and 2017 and to 55% in 2018 and 2019. Swatch will not be allowed to pick and choose which customers it supplies, but must treat all equally.
Jul-14WEKO also closed its investigations into ETA’s pricing policy for mechanical movements that had been in place since 2009.
Oct-16In early FY2016, Swatch started negotiations with COMCO/WEKO (Swiss Competition Commission) to understand if it could supply more mechanical movements to its customers than was set out in the 2013 agreement on phasing out deliveries. However, in October the Commission left the 2013 agreement unchanged.


Figure 16: Sellita has risen as an alternative to ETA

Sellita Company Profile

Enlarge
https://cube.exane.com/demat/img/2017/376041/image15-enlarge.png

Source: Company website, L’Hebdo


Figure 17: Tudor striking a deal to source movements from Breitling is a major setback to Swatch’s ambitions

Tudor Black bay Chrono and Breitling Superocean Heritage

Enlarge
https://cube.exane.com/demat/img/2017/376041/image16.jpeg

Source: watchpro.com, hodinkee, company website, watchesbysjx



A number of clever ideas

2017 has not been a year of stunning innovation. Yet, we could see a number of very clever ideas: 1) Bulgari’s Skin collection seems brilliant – as it squares the circle of offering significant consumer choice through combination and personalisation, while maintaining a tight grip on inventory commitment in store; 2) many brands are pondering the adoption of magnetic card warranty activation (same as Rolex and Breitling) to keep track of sell-out; 3) smaller brands like Corum are making the most of mega-brands moving back to the CHF 3-7k space, to attack the CHF 50k space, where offer seems limited; and 4) niche players are always on the lookout for any room on the fringes to create a distinct reason why for themselves (eg, video game and icon series at Romain Jerome).

Figure 18: Bulgari’s Serpenti skin collection features for the first time a leather and interchangeable strap

Bulgari Serpenti Skin collection

Enlarge
https://cube.exane.com/demat/img/2017/376041/image17.jpeg

Source: Company website


Figure 19: Many brands are pondering the adoption of magnetic card warranty activation to keep track of sell-out

Rolex magnetic warranty card

Enlarge
https://cube.exane.com/demat/img/2017/376041/image18.jpeg

Source: TheCounsel.com


Figure 20: Smaller brands are making the most of mega-brands moving back into the CHF 3-7k space, to attack the CHF 50k space, where offer seems limited

Corum

Enlarge
https://cube.exane.com/demat/img/2017/376041/image19.jpeg

Source: Company website, timetransformed, Amazon.com


Figure 21: Corum launched a ‘Moschino’ like provocation with its ironic "disconnected watch"

Corum Bubble Disconnected watch

Enlarge
https://cube.exane.com/demat/img/2017/376041/image20.jpeg

Source: Instagram


Figure 22: Niche players are always on the lookout for any room on the fringes to create a distinct reason why for themselves

Romain Jerome – Video game series Pac-Man

Enlarge
https://cube.exane.com/demat/img/2017/376041/image21.jpeg

Source: Company website



Things are getting better

We saw no fireworks at Baselworld, and listened to some moaning. However, when push comes to shove, all brands admit that 2017 is off to a better start than 2016 and that the trough is behind them. We expect to see this reflected in Swiss watch exports soon, as – slowly but surely – inventory overhang reduces in the wholesale channel. Watch stocks have anticipated a rebound already – we believe short-term prospects are nevertheless improving and expect short-term support for both CFR and UHR. We see more questions on UHR’s long-term position and strategy, and maintain long-term structural reservations on this name (SWATCH GROUP B: If we were running ... Swatch).

Figure 23: We expect an improvement in Swiss watch exports soon, as – slowly but surely – inventory overhang reduces in the wholesale channel (1/4)

Swiss watch exports – Value y/y % chg

Enlarge
https://cube.exane.com/demat/img/2017/376041/image22-enlarge.png

Source: Exane BNP Paribas estimates, FHS


Figure 24: We expect an improvement in Swiss watch exports soon, as – slowly but surely – inventory overhang reduces in the wholesale channel (2/4)

Swiss Watch Exports – Value y/y % chg 3MMA

Enlarge
https://cube.exane.com/demat/img/2017/376041/image23-enlarge.png

Source: Exane BNP Paribas estimates, FHS


Figure 25: We expect an improvement in Swiss watch exports soon, as – slowly but surely – inventory overhang reduces in the wholesale channel (3/4)

Swiss Watch Exports to the US – Value y/y % chg 3MMA

Enlarge
https://cube.exane.com/demat/img/2017/376041/image24-enlarge.png

Source: Exane BNP Paribas estimates, FHS


Figure 26: We expect an improvement in Swiss watch exports soon, as – slowly but surely – inventory overhang reduces in the wholesale channel (4/4)

Emperor Watches – Evolution in the number of stock turnover days

Enlarge
https://cube.exane.com/demat/img/2017/376041/image25-enlarge.png

Source: Company data


Figure 28: Watch stocks have anticipated a rebound already

UHR and CFR indexed perf. 19/7/2016=100

Enlarge
https://cube.exane.com/demat/img/2017/376041/image26-enlarge.png

Source: Datastream








Disclosures

Analyst Certification

We, Melania Grippo, Guido Lucarelli, Luca Solca, (authors of or contributors to the report) hereby certify that all of the views expressed in this report accurately reflect our personal view(s) about the company or companies and securities discussed in this report. No part of our compensation was, is, or will be, directly, or indirectly, related to the specific recommendations or views expressed in this research report.

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