In this issue:
- De-Globalizing Luxury
- Rumor Becomes Fact
- Net Present Value
- Chilling Effects as a Policy Tool
When you think about successful multinational companies, what usually comes to mind are the large US-based tech companies, which have amassed an enviable track record of long-term and increasingly global growth. There are some other categories that can create big multinationals—energy companies end up operating everywhere, because whatever they own right now is generally a depleting asset; pharma companies, which can amortize R&D over a larger customer base; financial conglomerates, which get regulatory returns to scale. Among European multinationals, an interestingly overrepresented category is the luxury goods business. In the Euro Stoxx 50 index, four of the top 25 components by market cap are in the luxury goods business; for the US, the top fifty companies by market cap don't include any luxury goods businesses.1
LVMH, off and on the most valuable company in Europe, is a canonical example. LVMH was built from acquisitions (it started as a construction company, and under the leadership of Bernard Arnault pivoted into real estate, and then started snapping up fashion brands). It's diversified across different products, including wine and spirits (Moët and Hennessy are the M and the H), fashion (Louis Vuitton is the LV), perfume and cosmetics, watches and jewelry, and a few other categories.
The luxury business is mostly a bet on the 1%, but that's true in three senses:
- The most obvious is that the market will grow if the number of wealthy people in the world goes up, and if they get richer on average.
- It's also a bet that the global 1% will continue to compete for status in the same ways. This seems like a safe bet, given the very long history of luxury goods—some of the oldest human artifacts are frivolous things that not everyone can afford, so if the luxury goods industry predates human history, it's probably not getting disrupted any time soon.
- More subtly, the luxury business is a bet on the concept of the 1%, that there's a global cohort of people who compete on status amongst each other, not separate status ladders in different places.
Luxury goods companies are mostly in the business of creating a market in social status. The products generally are better than cheaper alternatives, but not that much better, while the cachet is impossible to directly substitute for. The risk that this could change is especially acute because status games have network effects: something is high-status if lots of people know about it, want it, and can't necessarily have it; if people start wanting other things, even other kinds of luxury goods, the existing crop of multinationals will run into problems.
That's especially salient because of luxury companies' increasing dependence on China. LVMH trades at 29x next year's earnings, so it's priced for some amount of growth. And it has been growing: over the last five years, sales compounded at 4.6% annualized, a healthy growth rate for a large company. But that can be broken down into two categories:
Revenue in Asia ex-Japan has been growing at 9.8%, the fastest-growing region by far (the next-fastest is Japan, at 4.9%, and the company's average growth excluding Asia-ex-Japan is 2.4%). Put another way, 64% of the company's revenue growth in the last five years has come from Asia ex-Japan. And that actually understates China's impact: China is an enormous luxury market, but China's outbound travel market has also been growing quickly, and buying expensive goods outside China is part of the travel experience. Some of this is because of price differences—import taxes and regional price differences raise the cost of domestic luxury consumption for Chinese consumers. (In some cases, it's an arbitrage; bring a nice $12,000 purse back home from vacation and you can flip it for a profit that recoups some of your costs.) Overall, shopping from outbound travelers may account for half of China's pre-Covid luxury spending
The bet for luxury companies is that global travel will normalize over time, and that China's growth will resume, leading to revenue acceleration both inside and outside of China. But that's still dependent on a stable global market for social status. Status markets are prone to sudden collapses; the status ladder only stays balanced because so many people are climbing it, and if enough of them jump off all at once, it topples over. In China, there's an organization whose implicit mandate is to be the arbiter of social status: The Party. A political party and a handbag company don't sound like direct competitors, but stranger things have happened: Netflix has cited both video games and sleep as its biggest competitive threats. And a big motivation for the CCP's recent regulatory actions has been to weaken centers of power that aren't controlled by the party, or whose profits don't ultimately accrue to it.
There are some Chinese competitors in the luxury goods market. Inconveniently for the CCP, the #1 example is Kweichow Moutai, which makes a high-end liquor that was once a favorite of Mao Zedong and is now, inevitably, a default social lubricant for Party-related deals.2 It's expensive enough to count as either a generous gift or a bribe; much like Tide in the US, it's liquid enough to constitute a de facto second currency for illicit deals, albeit at a different scale. The company, though, turns out to be fractally corrupt: not only did they sell a product that implicitly encouraged dishonest dealings, but Moutai's former CEO was just given a life sentence for bribery.
The luxury-corruption connection makes it hard for the CCP to indigenize luxury goods consumption, but it gives them a good reason to. And as they start thinking about "Gray Rhino" risks rather than Black Swans—the ones that are obvious, but that nobody is doing anything about—the question of what's high-status may become more important. Crackdowns on consumer tech coupled with subsidies for hard tech are partly a choice about capital and partly a way to reallocate social status. And if the CCP decides that social status is a national concern, China as a luxury goods market switches from being a source of demand for multinationals to being a source of competition for them, from an entity with an effectively unlimited budget and plenty of competition-crippling rule changes at its disposal. And the net result of that is that the list of industries that can produce huge multinational success stories shrinks, making big tech even more important to the global economy.
Rumor Becomes Fact
A few months ago, at the peak of SPAC mania, Andrew Walker of Yet Another Value Blog pointed out that one SPAC merger, between Churchill Capital IV and Lucid, was prompted by an incorrect rumor that the deal was happening; management saw what the rumor did to their stock price, and decided to make it come true. Such things happen from time to time. For example, Amazon launched a product that mimics some of Peloton's virtual coaching, which has hurt Peloton's stock; a few months ago an Amazon seller started offering a Peloton-like bike called "Prime Bike," whose branding made it look like an official Amazon launch, which Amazon had to disavow.
Peloton price reactions are informative because one of the perennial debates about the company is just how durable their customers are. Peloton's monthly churn is 0.86%, which is quite low for a pricey consumer offering, especially one that looks like a fad. And Amazon is interested in low-churn models because their bundle includes some subscription projects, and ongoing transactions that provide additional incremental profits. For any consumer product category with notably low churn, if Amazon can be convinced that creating an in-house version will reduce churn for Prime subscribers, and increase their engagement, then the product's economics are better for Amazon than they are for anyone else.
(Disclosure: I am long Amazon.)
On Tuesday, Cloudflare announced a competitor to Amazon's S3 storage product, with a pricing model that dramatically lowers egress fees. (A few months ago, Cloudflare had pointed out that egress fees were far higher than Amazon's underlying costs, and represented a form of lock-in.) Depending on the exact use case, the economics can be quite promising. It's a very interesting conflict, because it's a fight between two kinds of infrastructure and two kinds of business model: Amazon can offer very cheap storage because it's operating at such massive scale, and because it knows that cheap storage rounds down to free in the customer's calculations, which means Amazon can expect revenue to rise over time. Cloudflare's infrastructure operates at a different layer, and seems to give them a competitive advantage in moving data relative to storing it. The other conflict is that Amazon is a mature enough business, with a wide enough range of products, that it can price some things aggressively in order to maximize the consumer surplus. But, in this case, they don't have enough of a lock on the market that they can price out a competitor for storage costs, which means that they can't overcharge for pulling data out.
An interesting open question here is what the economics look like for Cloudflare. Is Cloudflare pricing at close to cost and expecting to make it up on volume? Or, even more interestingly, are they pricing this to lose money upfront but bring developers into their ecosystem? The most intriguing possibility for investors is that Cloudflare will eventually use the same sort of aggressive pricing for some cloud storage services as Amazon, and will do so at a time when there isn't a competitor who can operate at big enough scale to undercut them on the core product.
Net Present Value
The Diff wrote up Fanatics Inc. a few weeks ago, noting that the company has been the high bidder for several sports licensing rights. They've now raised $350m at a $10.4bn valuation for just their trading card arm ($, WSJ). It illustrates some interesting returns to scale:
People familiar with Fanatics Trading Cards say the new venture will angle to become the one-stop shop for all things in the trading card industry—including primary sales, secondary-marketplace deals, grading of cards and even storage.
When there are several companies with the rights to different sports team brands, it's hard for them to coordinate to create a secondary market. They may have differing levels of interest, or economics that are more weighted to primary versus secondary sales. But when one company is responsible for the entire market, it can consolidate secondary market sales, too; one risk in the baseball card market is counterfeit cards, especially cards that have been slightly modified to appear closer to mint condition. If the manufacturer is also in the business of vetting cards, it's an easy company to default to, and if those ancillary services can be directly bundled with an exchange—probably an exchange that also gives high-volume buyers and sellers exclusive access to newly-issued cards—then the take rate on transactions can go even higher.
Chilling Effects as a Policy Tool
Politico takes a look at the FTC under Lina Khan. There's some back-and-forth within the article on management styles and other concerns, but one of the interesting anecdotes is that the CEO of Illumina (previously on The Diff here) tried to get a meeting with the FTC on an acquisition, and couldn't. One way to look at the acquisition process is that there's a continuous cost in terms of service providers and management distraction, which may or may not actually lead to a deal. If deal uncertainty goes up, the return on those upfront costs goes down, so the FTC can slow down dealmaking merely by being less available to potential dealmakers. That is a strategy that makes sense for them, given that the FTC has lots of deals to review, and given that many of them will be pursued because their effect on competition is significant but not obvious upfront.
You can make the argument that both Tesla and Nike count, but in Tesla's case the price point doesn't quite fit, and while Nike does sell some very expensive shoes, I suspect the real ROI from those is that they generate lots of hype to the benefit of more moderately-priced footwear.
Moutai has a surprisingly low profile in the West for a company that was, earlier this year, worth some $500bn. I read a business book recently by a respected journalist who at one point alluded to a Chinese investor closing deals over "Mai Tais," which was probably not the beverage in question.