CORPORATES CREDIT OPINION 27 November 2017 Update RATINGS Essilor International (CG d'Optique) S.A. Domicile France Long Term Rating A2 Type LT Issuer Rating - Fgn Curr Outlook Positive Please see the ratings section at the end of this report for more information. The ratings and outlook shown reflect information as of the publication date. Contacts Knut Slatten +33.1.5330.1077 VP-Senior Analyst [email protected]Yasmina Serghini +33.1.5330.1064 Associate Managing Director [email protected]CLIENT SERVICES Americas 1-212-553-1653 Asia Pacific 852-3551-3077 Japan 81-3-5408-4100 EMEA 44-20-7772-5454 Essilor International (CG d'Optique) S.A. Update to Discussion of Key Credit Factors Summary Rating Rationale Essilor's positive outlook reflects the company’s announcement on 16 January 2017 that it plans to combine with Luxottica Group S.p.A. (unrated). The transaction is expected to close in the first half of 2018. The combination is credit positive for Essilor as its revenues will more than double after the combination, and it will gain access to Luxottica's global retail network and strong brand portfolio. However, differences in corporate culture and antitrust concerns could present risks, while the combined entity has yet to define its financial policies. The combination with Luxottica will enhance Essilor's business profile Exhibit 1 Essilor: revenue segmentation prior to the combination with Luxottica Exhibit 2 EssilorLuxottica: estimated revenue segmentation Lenses & Optical Instruments 87% Sunglasses & Readers 10% Equipment 3% Source: Essilor Lenses & Optical Instruments 39% Retail 34% Sunglasses & Readers 26% Equipment 1% Based on 2016 combined revenue figures Source: Essilor, Luxottica, Moody's research Essilor's stand-alone A2 rating primarily reflects (1) its long-standing position as the global leader in corrective lenses by a large distance to its competitors, illustrating the company's strong innovation capabilities and its successful integration of bolt-on acquisitions; (2) Essilor's wide offering within its product category and its vertical integration, allowing it to cater to all customers and develop strong relationships with opticians; (3) Essilor's very solid track record of steady growth and resilient operating performance; and (4) the company's strong financial profile and healthy free cash flow generation. Essilor's stand-alone rating also factors in (1) the company's concentration of sales generated by its corrective lenses and sunglasses divisions, as well as relative concentration on the US market; (2) the still subdued economic environment in some of Essilor's key markets, which
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CORPORATES
CREDIT OPINION27 November 2017
Update
RATINGS
Essilor International (CG d'Optique) S.A.Domicile France
Long Term Rating A2
Type LT Issuer Rating - FgnCurr
Outlook Positive
Please see the ratings section at the end of this reportfor more information. The ratings and outlook shownreflect information as of the publication date.
Essilor International (CG d'Optique) S.A.Update to Discussion of Key Credit Factors
Summary Rating RationaleEssilor's positive outlook reflects the company’s announcement on 16 January 2017 that itplans to combine with Luxottica Group S.p.A. (unrated). The transaction is expected to closein the first half of 2018. The combination is credit positive for Essilor as its revenues will morethan double after the combination, and it will gain access to Luxottica's global retail networkand strong brand portfolio. However, differences in corporate culture and antitrust concernscould present risks, while the combined entity has yet to define its financial policies.
The combination with Luxottica will enhance Essilor's business profile
Exhibit 1
Essilor: revenue segmentation prior to thecombination with Luxottica
Exhibit 2
EssilorLuxottica: estimated revenuesegmentation
Lenses & Optical Instruments87%
Sunglasses & Readers10%
Equipment3%
Source: Essilor
Lenses & Optical Instruments39%
Retail34%
Sunglasses & Readers26%
Equipment1%
Based on 2016 combined revenue figuresSource: Essilor, Luxottica, Moody's research
Essilor's stand-alone A2 rating primarily reflects (1) its long-standing position as the globalleader in corrective lenses by a large distance to its competitors, illustrating the company'sstrong innovation capabilities and its successful integration of bolt-on acquisitions; (2)Essilor's wide offering within its product category and its vertical integration, allowing it tocater to all customers and develop strong relationships with opticians; (3) Essilor's very solidtrack record of steady growth and resilient operating performance; and (4) the company'sstrong financial profile and healthy free cash flow generation.
Essilor's stand-alone rating also factors in (1) the company's concentration of sales generatedby its corrective lenses and sunglasses divisions, as well as relative concentration on the USmarket; (2) the still subdued economic environment in some of Essilor's key markets, which
can weigh on lenses' renewal rates or result in some trading-down by consumers; (3) the risk of a competitor making a breakthroughinnovation; (4) Essilor's active acquisition strategy which is mostly focused on bolt-on acquisitions, therefore limiting integration risks.
Credit Strengths
» Combination with Luxottica will increase scale and enhance business diversity
» Global leader in corrective lenses and sunglasses by a large distance to its competitors
» Strong innovation capabilities
» Wide customer and geographical diversification
» Track record of resilient operational performance and cash flow generation
Credit Challenges
» Execution risks related to the integration of Luxottica's activities, notably potential differences in corporate culture and antitrustconcerns
» Uncertainty about the future financial policies of the combined entity
» Revenue concentration on the eyewear market and some degree of geographical concentration on the US market
» Subdued economic environment in some key markets
» Active acquisition strategy which can impact financial profile
Rating OutlookThe positive outlook reflects Essilor’s announcement on 16 January 2017 that it plans to combine with Luxottica. The transaction isexpected to close in the first half of 2018.
We could consider stabilizing the outlook should the transaction abort or imply material differences from what Essilor outlined initiallyin its press release.
Factors that Could Lead to an UpgradeIn the coming months until closing of the transaction, we will continue to study the benefits of the stronger business profile and thecompany's new financial policy and could potentially establish new quantitative triggers for the rating.
» An upgrade would also require more clarity around future financial policies, including around the treatment of any outstandingminority shareholders, and a good execution of the envisaged transaction.
» If the transaction were not to materialise, upward pressure on Essilor's A2 rating could develop if it reaches and maintains a ratio ofMoody's-adjusted Retained Cash Flow (RCF)/net debt above 35% and a ratio of Moody's-adjusted (gross) debt/EBITDA below 1.5xon a sustainable basis.
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.
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Factors that Could Lead to a Downgrade
» If the transaction were not to materialise, downward pressure on the A2 rating could develop if the performance of the companyweakens sharply or if it undertakes sizeable debt-financed acquisitions, notably resulting in Moody's-adjusted RCF/net debt decliningto below 25% and Moody's-adjusted (gross) debt/EBITDA increasing to above 2.5x for a prolonged period of time.
Key Indicators
Exhibit 3
Key Indicators: Essilor International (CG d'Optique) S.A.
All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations.Source: Moody's Financial Metrics™
Detailed Rating ConsiderationsCombination With Luxottica is Credit Positive but Subject to Integration RisksEssilor announced its plans to combine with Luxottica on 16 January 2017. The transaction is credit positive for Essilor whose revenueswill more than double after the combination to more than €15 billion, creating a global leader in the eyewear industry. The transactionis highly complementary as Essilor will gain access to Luxottica’s leading global retail network of around 7,400 stores, including theSunglasses Hut and Lenscrafters franchises, and its strong brand portfolio in the sunglasses segment including RayBan and Oakley, butalso licensing agreements such as Prada, Chanel, Burberry and Ralph Lauren.
While the combined entity has yet to define its financial policies, we expect that it will generate free cash flows around €1 billion pre-exceptional costs related to the transaction, which should provide it with ample financial firepower to continue investing in organicgrowth and bolt-on acquisitions. The combined entity could also benefit from Luxottica's less leveraged capital structure, whichreported a net debt/EBITDA ratio of 0.5x in 2016 against 1.2x for Essilor on a stand-alone basis (before Moody's adjustments).
Whereas Luxottica displays a lower profitability with reported EBITDA margins of around 21% (against 25% for Essilor), Essilor expectsthe combined entity to progressively ramp up synergies of €420-€600 million per annum after the expected closing of the transactionin the first half of 2018.
However, the envisaged transaction also carries a certain degree of event risk linked to the closing and integration of the combinedentities. The combined entity could be affected by antitrust regulations in some markets as it will have a very strong presence acrossthe entire value chain in the eyewear market. We note, however, that the transaction has received antitrust clearance in 9 out of 20jurisdictions thus far. A significant portion of minority shareholders could be left in the structure despite Essilor's intention to make amandatory exchange offer. Essilor's research-driven corporate culture may also differ from that of Luxottica, which is more orientedtowards consumer brands and fashion, while the combined entity will have a joint management structure where the current CEOs ofLuxottica and Essilor will have equal powers. Lastly, revenues losses and/or margin pressure could arise as Essilor becomes more activein the retail segment, which may not go down well with some of its current customers.
Essilor is a Global Leader in Corrective Lenses and Sunglasses, With Strong Innovation CapabilitiesEssilor benefits from its long-standing position as the global leader in corrective lenses as well as being the most integrated player inthe optical manufacturing market. Essilor's leading position and geographical spread gives it an unparalleled scale within the correctivelenses and sunglasses markets. Once combined with Luxottica, Essilor will become the number one player by a large distance to itsmain competitors Hoya Corporation and Carl Zeiss Vision in the optical instruments market, and Safilo S.p.A. (Ba3 stable), MarcolinS.p.a. (B2 stable) and De Rigo S.p.A. in the sunglasses and prescription frames market. With the full control of Transitions Optical in
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2014, Essilor has become the leader in photochromic lenses, a highly technical product which it developed with PPG Industries (A3negative). Essilor's leadership position is intricately related to the company's strategic focus on research and development, whichrepresents 3.0%-3.5% of sales. Essilor has been at the forefront of innovation, having invented a number of key products in theindustry throughout the years, from progressive lenses in 1959 to lenses which protect from blue light in 2012.
Essilor is positioned across all price points and vertically integrated through its equipment business, allowing it to cater to all customersand develop strong relationships with opticians. Essilor has 32 production sites and a dense network of around 490 prescription labsand edging centres worldwide, which provides the company with a competitive advantage in terms of services it can offer to customersand pricing power. Furthermore Essilor's equipment business provides various types of instruments and offers training to opticians,which helps develop strong relationships with them.
Revenue Concentrated on the Eyewear Market, Despite Wide Customer and Geographical DiversificationEssilor's revenues are concentrated on the eyewear market, despite the announced combination with Luxottica. While Essilor expectsthe corrective lenses market to maintain volume growth of around 3%-4% over the medium term and the sunglasses market to growat around 6%-7%, we believe the company's high concentration on those product categories creates some risks. The market remainsfragmented and competitive pressures may increase over time, as consolidation takes place or if breakthrough innovations are made byEssilor's competitors, although this is mitigated by the very strong innovation track record of the company. Essilor's active acquisitionstrategy provided the company with new technologies and helped it maintain its innovative edge.
Essilor's product concentration is mitigated by its wide customer and geographical diversification. Essilor markets its products inmore than 150 countries around the world, with the company's North American segment representing 54% of estimated sales on acombined basis pro forma for the combination with Luxottica, followed by Europe (23%), Asia/Pacific/Middle East/Africa (17%) andLatin America (6%). As regards its customer portfolio, prior to the combination with Luxottica, Essilor's top 20 customers accountedfor 19.3% of revenues in 2016 and no single customer accounted for more than 10% of total revenues. In its annual report for 2016,Luxottica says that it does not have any significant concentration of credit risk. As such, we do not expect customer concentration forthe combined group to materially change upon closing of the merger.
Exhibit 4
Essilor: geographical revenue split prior to the combination withLuxottica
Based on 2016 combined revenue figuresSource: Essilor
In recent years, Essilor has been developing a growing presence in the non-prescription reading glasses (readers), sunglasses, andonline segments through a series of acquisitions. These segments benefit from strong growth fundamentals and play an instrumentalrole in the company's growth strategy. In 2016, Essilor expanded its fast-growing markets segment with small lens manufacturersand distributors acquisitions in Brazil, Chile, India, Mexico, Peru, Russia, South Africa, South Korea, Turkey and Vietnam. Through thecombination with Luxottica, Essilor will become the market leader in the sunglasses segment. As Essilor has been busy working on themerger with Luxottica during 2017, the company has been less active in terms of acquisitions. Only a few smaller bolt-on acquisitionshave been announced this year (see exhibit below).
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Exhibit 6
Essilor developed into new segments with strong growth fundamentalsSelected list of recent acquisitions
Creasky (2017) Stylemark (2011) Costa (2014) Vision Direct (2016) Vision Source (2015)
Opticas Exclusivas (2017) Merve (2015) MyOptique Group (2016) Opti-Port (2016)
Fabris Lane (2015) Optitrade Logistics Center
(2017)
Photosynthesis Group
(2016)
Vision Associates (2017)
Source: Essilor, Moody's research
We view risks related to product substitution as limited in the foreseeable future. Contact lenses are increasingly able to address morecomplex vision impairments. However, the prevailing share of prescription glasses in the developing world and the fact that a portion ofthe population still has difficulties wearing contact lenses mitigates substitution risks. Similarly, the high cost of refractive surgery andintraocular lenses make them a marginal competitor to Essilor's lenses business.
Track Record of Resilient Operational Performance and Cash Flow GenerationWe expect Essilor's operational performance will remain resilient over the next 12-18 months in line with historical pattern. Thecompany has over the years built a very solid track record of steady growth and resilient operating performance, helped by itsincreasingly diversified geographic spread. This has allowed the company to benefit from higher growth in emerging markets, as wellas spreading the risk of being impacted by operational weaknesses in a given market. However, operational headwinds in the US andcertain other geographies since the second quarter of 2016 adversely affected both Essilor and Luxottica. As a result, both companiesreported 2016 growth figures below their respective initial target: Essilor reported a 7.6% revenue growth (excluding currency effects),compared to an initial target of above 8%, while Luxottica's reached 3.9% against an initial target of 5%-6%.
For the nine months to September 2017, Essilor reported a revenue growth of 6.6% (excluding currency effects). In addition to organicgrowth of 2.5%, revenue growth was primarily driven by the consolidation effect of the acquisitions made in 2016 (4.1%). However, thegrowth rate in the third quarter (5.9% excluding currency effect), was negatively impacted by natural disasters in the US and Mexicoand tax reforms in India, together impacting negatively revenue growth by around 50 basis points. Essilor maintains its outlook for thefull year with organic growth of around 3% and total revenue growth of 6%-7%.
Luxottica's third quarter sales growth were up by a more paltry 0.8% (at constant currency), but the company was particularly hit bynegative operating performance in September as a large number of stores had to temporarily close because of natural disasters inthe US. For the nine months to September, Luxottica's revenues were up by 1.5% (at constant currency) underpinned by at 15% salesgrowth in the European market. Luxottica continues to expect a sales-growth in the mid-single digits for the full year.
Essilor's operating margins have, in particular, remained stable historically (Moody's-adjusted EBIT margin at around 16-17%), despitethe company's steady growth, acquisitions which had to be integrated and increasing exposure to emerging markets, where lenses aresold at cheaper prices on average. In 2016, Luxottica reported EBITDA margins of around 20%, against 24% for Essilor. Going forward,Essilor expects to mitigate Luxottica's lower profitability level by progressively ramping up synergies of €420-€600 million per annum.
Both Essilor and Luxottica generate strong free cash flows on a standalone basis. Over the years, Essilor has increased its cashfrom operations and pursued a policy of limited capex requirements and cash dividend payouts. The amount of cash dividendspaid was around €158 million lower in 2016 thanks to the introduction of a scrip dividend, which was not repeated in 2017 dueto the combination plans with Luxottica. We expect the combined entity to maintain a healthy free cash flow generation goingforward, around €1 billion on a pro forma basis, which will allow Essilor’s continued investment in its strategy of organic and externalgrowth. We however note that the combined entity has yet to define its financial policies, which could result in increased returns toshareholders.
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Exhibit 7
We Expect Essilor to Continue to Generate Strong Positive Free Cash FlowsFree cash flow before Moody's adjustments, before Luxottica acquisition
Cash Flow from Operations Capital Expenditures Dividends Free Cash Flow
Note: Free cash flow as per Moody's definition (i.e. after dividends); reflects Essilor on a stand-alone basis, prior to the combination with LuxotticaSource: Essilor (historical), Moody's (forecasts)
Acquisitions Form an Important Part of Essilor's StrategyEssilor grows its business through both organic and external growth, generally through small bolt-on acquisitions, where Essilor acquiresmajority ownership (particularly when it acquires prescription labs), leaving a minority stake in the hands of the management of thecompany. It values the continuing involvement of these entrepreneurs in their business and their local knowledge. Occasionally, Essilorcan undertake larger acquisitions when diversifying into new segments: the readers division was started with the acquisitions of FGXInternational in 2010 for $575 million and Stylemark in 2011, while the Equipment division was established with the acquisition ofSatisloh in 2008 for €360 million. We view the integration risk of Essilor's acquisitions as generally limited, given that the company hasdeveloped a track record of successful integration of acquisitions over the past years.
In 2014, Essilor's financial profile was burdened by debt-funded acquisitions, in particular that of Transitions Optical. This transactioninvolved an upfront payment of $1.73 billion, as well as a deferred payment of $125 million over five years, leading to a ratio ofMoody's-adjusted (gross) debt to EBITDA of 3.0x and a ratio of Moody's-adjusted retained cash flow (RCF) to net debt of 27.2% in2014. Strong EBITDA and cash flow growth helped the company reduce its Moody's-adjusted gross leverage ratio to 2.2x and improveits Moody's-adjusted RCF to net debt ratio to 32% in 2016, leaving it in line with the A2 rating category prior to the acquisition ofLuxottica.
We adjust Essilor's debt for the amount of put options owned by minority shareholders, given that Essilor could be subject to materialcash outflows in case of a simultaneous exercise of individually small amounts. Nevertheless, we note that these puts have rarelybeen exercised in the past, and consider that they have a low probability of being exercised in our qualitative analysis. The payment ofacquisitions can also include deferred amounts in the form of earn-outs: when they relate to businesses that Essilor fully consolidatesin its accounts we include these amounts in our adjusted debt calculation. Pro forma of the combination with Luxottica, our operatingleases adjustment to Essilor's debt for 2016 would increase by €2.1 billion due to the larger amount of operating leases stemming fromLuxottica's retail activities.
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Exhibit 8
Components of Essilor's Adjusted DebtAs of 31 December 2016
2,593
344134
485
241
-31
3,766
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
Total Unadjusted Debt Pensions Operating Leases Put Options Earn-outs Other Total Adjusted Debt
€m
illio
n
Note: Reflects Essilor on a stand-alone basis, prior to the combination with LuxotticaSource: Moody's Financial Metrics™
Liquidity AnalysisPrior to the combination with Luxottica, Essilor's liquidity was underpinned by (1) a cash balance, which amounted to approximately€594 million as of 30 June 2017; (2) free cash flow which we expect to reach around €500 million in 2017 (as per Moody's definition,i.e., after dividends); and (3) access to approximately €2.4 billion of bank facilities (undrawn at 30 June 2017). Essilor's bank facilitiescomprise a €900 million syndicated revolving credit facility maturing in December 2021 (with the option to extend by one additionalyear), as well as several bilateral facilities maturing in the 2018-21 period, which total approximately €1.5 billion. None of the facilitiesinclude financial covenants or a repeating material adverse change (MAC) clause. Essilor has a €1.5 billion French commercial paperprogramme, as well as a $2.0 billion US commercial paper programme, which are backed by the aforementioned bank facilities. Inan interim period - until closing of the transaction occurs - Essilor has put in place two new CP programmes of identical size at itssubsidiary Essilor International (the CP programmes at Essilor will remain inactive during this period).
These liquidity sources more than cover the company's pre-combination capital expenditures, which averaged 4-5% of its sales, cashdividends of around €370 million in 2017 and €1.0 billion of short-term debt as of 30 June 2017.
Structural ConsiderationsAs a first step towards finalization of the combination with Luxottica, Essilor has become a holding company on November 1, 2017,following a partial transfer of substantially all of its current operating activities and assets into an existing wholly owned company thatwas renamed renamed Essilor International. At the closing of the transaction, Delfin will then contribute its 62% stake in Luxottica toEssilor (which will then be renamed EssilorLuxottica). We understand that Essilor's current capital markets debt instruments (existingEurobonds and Private Placements) will remain at the level of EssilorLuxottica. There will be no upstream guarantees from EssilorInternational to EssilorLuxottica and we understand that Essilor International will have no debt except a limited quantum at localaffiliates level as the case may be under local legislation requirements. Luxottica's current debt instruments are expected to remain atthe level of Luxottica.
We therefore believe that there will be a degree of structural subordination of debt at EssilorLuxottica versus the existing debtheld at Luxottica. However, EssilorLuxottica's creditors will continue to benefit from full access to Essilor's cash flows as well as aclaim over Luxottica shares; they will only be subordinated to Luxottica's creditors in respect of Luxottica's cash flows. The currentrating and outlook assume no increase in structural subordination. We expect that subordination will reduce over time as thecompany has publicly stated that it will aim to concentrate treasury management at the level of EssilorLuxottica and to ensure apari passu treatment of all creditors. Future debt issuance for the combined group is therefore expected to take place at the level ofEssilorLuxottica, while existing debt at Luxottica will gradually amortise as it largely matures in 2018 and 2019.
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ProfileEssilor is a publicly listed company headquartered in France. It is the world's leading ophthalmic optics group. Essilor designs,manufactures and markets a wide range of lenses to improve and protect eyesight. It also develops and markets equipment,instruments and services for eyecare professionals. Essilor reported consolidated revenue of €7.1 billion and EBITDA of €1.7 billion in2016.
Headquartered in Italy, Luxottica has leading positions in the sunglasses and eyewear retail market. The company's portfolio includesRayBan and Oakley eyewear brands and the Sunglasses Hut and Lenscrafters retail outlets, but also product licensing agreements underbrands such as Prada, Chanel, Burberry and Ralph Lauren. Luxottica reported consolidated revenue of €9.1 billion and EBITDA of €1.9billion in 2016.
Rating Methodology and Scorecard FactorsIn assessing the credit quality of Essilor, we apply the Global Consumer Durables rating methodology. Essilor's A2 rating is positionedone notch above the grid-indicated rating of A3, reflecting the company's solid track record of regular growth and stable operatingmargins, even during cyclical downturns, contrary to many players rated under this methodology.
Exhibit 9
Rating Factors: Essilor International (CG d'Optique) S.A.
a) Total Sales (USD Billion) $8.1 Baa $8.7 - $9.2 Baa
Factor 2 : Business Profile (25%)
a) Competitive Position A A A A
b) Brand Strength Baa Baa Baa Baa
Factor 3 : Profitability (5%)
a) EBIT Margin 17.0% A 16.5% - 17.5% A
Factor 4 : Leverage and Coverage (35%)
a) Debt / EBITDA 2.3x Baa 2x - 2.2x Baa
b) RCF / Net Debt 25.5% Baa 30% - 35% Baa
c) EBIT / Interest Expense 14.8x Aa 15x - 17x Aa
Factor 5 : Financial Policy (15%)
a) Financial Policy A A A A
Rating:
a) Indicated Rating from Grid A3 A3
b) Actual Rating Assigned A2 A2
Current
LTM 06/30/2017
Moody's 12-18 Month
Forward View
All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations.This represents Moody's forward view; not the view of the issuerReflects Essilor on a stand-alone basis, prior to the combination with LuxotticaSource: Moody's Financial Metrics™
Ratings
Exhibit 10Category Moody's RatingESSILOR INTERNATIONAL (CG D'OPTIQUE) S.A.
Outlook PositiveIssuer Rating A2Senior Unsecured A2Commercial Paper P-1Other Short Term -Dom Curr (P)P-1
ESSILOR INTERNATIONAL SAS
Bkd Commercial Paper P-1Source: Moody's Investors Service
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Appendices
Exhibit 11
Moody's-Adjusted Debt BreakdownEssilor International (CG d'Optique) S.A.
Source: Moody's Financial Metrics
Exhibit 12
Moody's-Adjusted EBITDA BreakdownEssilor International (CG d'Optique) S.A.
Source: Moody's Financial Metrics
9 27 November 2017 Essilor International (CG d'Optique) S.A.: Update to Discussion of Key Credit Factors
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REPORT NUMBER 1099516
10 27 November 2017 Essilor International (CG d'Optique) S.A.: Update to Discussion of Key Credit Factors
