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Case Analysis Luxury Wars LVMH vs. Hermes

18-August-2014 Case Questions1. Herms International was a family-owned business for many years. Why did it then list its shares on a public market? What risks and rewards come from a public listing?

It may happen that at some stage in their life some family-owned businesses decide to go public and list their shares on the public market; this decision may be taken in order to be able to keep financial resources secure for the business expansion or to give shareholders a possible way of selling their shares just in case the prefer to cash them.This was the case of Herms. In fact as a result of the pressure by some members to cash out the company in the early 1990s, the company then decided to list 25% of its voting shares on the public market. This listing represented an outlet for family members who wanted to sell their shares at a market price and leave the company.We could suppose that this listing was agreed by the other members of the family because they either didnt see it as a potential threat to their control or simply because they didnt have the money or the desire to acquire the shares of the other members who wanted to leave. There are many benefits and risks that being a public company may offer.Greater company valuation: if a company decides to go public its market value will be always significantly higher than its private counterpart; in fact statistics say that private companies are usually valued at only four to six times earnings while instead public companies are valued at multiples greater than twenty times earnings. Since also public companies have a higher value than private ones, its cheaper for them to raise capital because they have to sell less stock in order to raise the same amount of money as their private counterpart.Public companies have a greater ability to use their stock to grow through mergers and acquisitions which usually are cheaper and easier to realize when public. Another advantage is that stocks in a public company are more liquid than those of a private company. This greater liquidity makes not only easier for investors to buy or to sell stocks but it also provides them a portfolio diversity or an exit strategy. Greater liquidity is one of the main reasons public companies are valued more than private companies.Being public may also enhance the company credibility and prestige with its customers and staff.However there may be a series of reasons why a company may decide not to go public. In fact going public is an expensive process that may cost up to more than $1 million and it could be much more difficult if the management is not familiar with the registration process. In a process of this kind the company has to face several high expenses that may consist in legal and accounting fees, exchange fees, financial printing, travel and other costs related to the offering and thus if the offering isnt successful it will result in a loss for the firm.Another disadvantage of going public is the loss of privacy. Once public the company has to reveal some information that the firm would better not reveal. This information may include transaction with management, detailed financial statement or any kind of advantage given to family members. In addition to that the decision making process has to be more formal and also less flexible, thus we can clearly state that the loss of privacy represents the worst disadvantage for company.Going public may represents also a threat since the company has to face a loss of autonomy. In fact as the company goes public it has to deal with the arrival of new shareholders and even though the family remains the controlling shareholder, minority shareholders have still rights to enforce their ideas and thus making it difficult for the family to operate freely.Moreover public companies may have to deal with the possibility of a takeover and for this reason they should implement certain anti-takeover measures like a staggered board of directors.2. Bernard Arnault and LVMH acquired a large position in Hermes shares without anyone knowing. How did they do it and how did they avoid the French regulations requiring disclosure of such positions?The way LVMH could acquire those shares without Hermes knowledge was through purchasing shares using equity swaps. According to Chance (2004, p. 75) an equity swap is a financial transaction in which one party agrees to make a series of payments to another at regularly fixed dates. The opposite party, in turn, agrees to make a series of payments to the first party. Wu and Chen (2007, p. 894) say that those series of payments made by each party are as follows: One party promises to pay the return on an agreed stock market index on an agreed notional principal. While the other promises to pay an agreed fixed rate, a floating rate, or a return of another equity index on the same notional principal.Bernard and LVMH used the floating rate type, which means that the debt instrument does not have a fixed rate during the life of the settlement. The case study explains that the cash flows were linked to the performance of the stock and the floating rate like LIBOR (London Interbank Office Rate). Which is the most common interest rate used in dollar-based derivate transactions (Chance, 2004). This kind of cash-settlements equity swaps have the advantage of being customizable. Those fixed payments allowed LVMH to pay an average of 80 euros per share of Hermes (price per share in 2006) instead of 178 euros per share when the purchase went public in 2010. (Financial Times, 2010)Equity Swaps are attractive instruments in financial markets because using those ways; investors are not participating directly. Hence, the cost of transfer tax, withholding tax on dividends, capital gains tax and so on are lower. (Wang & Szu-Lang Liao, 2003)According to the case Bernard Arnault, Chairman and CEO of LVMH, would be the one that agreed to make a fixed cash-payment to another one, specifically to three separate French backs. Arnault started making his move with French banks in 2008. Because the method of payment was using cash; Arnault didnt owned those shares until the banks agree to make the settlement in shares and not anymore by cash back in 2010. Equity swaps are private transactions that doesnt required to be reported to any regulatory authority (Chance, 2004). Thats why the LVMH and Bernard Arnault could avoid the French regulations imposed by the AMF (Autorite Des Marches Financiers French stock market regulator). This is because LVMH never actually own the stocks until 2010 and the contract was settled in cash, not in sharesThis kind of transactions (equity swaps) are not created in a public forum (Chance, 2004). Therefore, the family couldnt see those signals and intention of LVMH. Besides that fact previously mentioned; LVMH make the cash-settlement equity swaps with three French banks using two indirectly controlled LVMH subsidiaries in Luxembourg and Hong Kong. (The Economist, 2013)Despite that, the shareholders of Hermes are not happy about the circumstances in which LVMH took control of 17.1 percent stake in share purchases and the former filed a suit against the later for slander, blackmail and unfair competition. Due to that, the AMF launched an investigation to determine if LVMH respect market rules (Diderich, 2012). In the end the AMF concluded that LMVH never breached regulations regarding ownership thresholds or engaged in insider trading or market manipulation by using equity swaps. (ETC, 2013)3. The Herms family defended themselves by forming a holding company of their family shares. How will this work and how long do you think it will last?

The reason why Hermes decided to change its structure was to prevent Bernard Arnaulds , LVMH, to incorporate the same firm, as did with Louis Vuitton (Eiteman, Stonehill and Moffett), 2013).The firm that was before publicly-listed was trasformed in a Socit en Commandite, usually called limited partnership.As limited partnership is meaned: a form of partnership similar to a general partnership, except that in addition to one or more general partners (GPs), there are one or more limited partners (LPs). It is a partnership in which only one partner is required to be a general partner. (O Sullivan and Sheffrin, 2001).The reason why the Hermes management and CEO decided to convert in this particular firm type the before publicly listed company was because they were worried about the potential climbing of LVMH driven by Arnauld, to the top, or control, of the family run company Hermes.The power was concentrated in the hands of few people and the family in turn managed this.Beside this was created also a partner company, called Herms Sarl that had to be managed only by Herms family members.Even if the declared goal of this company was to choose the top management of the other firm and to define firms strategy (Eiteman, Stonehill and Moffett, 2013), but upfront was obvious that the main objective of the creation of the company was to avoid Arnaulds company possible scramble in Herms shares in order to take the control of the firm.How is that possible?First only family members were allowed to enter in this holding companyThe only clause that could fear Herms family members was that at list one of the family members has to be alive or keeping its shares to maintain the head of the holding company.The panic spread out when a family member, Laurent Mommeja sold his shares in the market for a value of 1.8 billion of dollars (Eiteman, Stonehill and Moffett, 2013).In order to avoid further sales of shares Herms family decided to create a holding company for a value of 73% of ownership stakes in order to ensure the control of the company (Nytimes.com, 2014).The 73% was composed as reported by Reuters (2014) a 50.2 per cent of equity and another 12.6% of capital represented by a first right of refusal on shares.After this was uttered a press release in which the family declared the intent to continue a long-term unit and strategy of the company.Even if with this press release the company changed form of company and of shares the price of the last one remained stable.Nevertheless Arnauld on the twenty first of December announced that it had raised its total stake in Herms to 20.21%, and had filed all required documents with AMF once passing the 20% threshold.(Eiteman, Stonehill and Moffett, 2013).Another reason because the Herms family decided to form a holding company was because usually those firm typologies permit to avoid hostile takeover and shares of the company are not available for public purchase.Another barrier that was built with the creation of the holding company was that only family memebrs were allowed to manage directly the company and its shares.In fact according to Reuters (2014) Only one third of the holdings members will be able to sell their shares as of 2031.

Usually the holding company structure is quite tough, and thanks to its special structure the holding company created by Herms should last.Even after several declarations the stock price remained constant, confirming the stability of the new born company.Another problem of LVMH attempted takeover was that usually in France when you acquire part of another company you have to declare the amount of shares owned to the AMF (Autorit des marchs financiers) according to General Principles of Financial Communication L. 233-9 once you overcame 5,10,15% of shareholding power. (Lautorite.qc.ca, 2014)In the 2013 the Amf according to Lexology.com (2014) was fined by Autorit des marchs financiers by 8 million euro for failing to inform the market that it was preparing to raise its stake in Herms, and for breaches of disclosure requirements when publishing its consolidated financial statements for 2008 and 2009.Even for this reason, since Arnauld is been processing after the acquisition of such amount of shares is possible that is going to stop the attempting of takeover to Herms.First family has right to refusals on sale of shares, and that will stop LVMH takeover to acquire one third of Herms shares.According to french law in fact once LVMH reached one-third share ownership it would have to make a public tender for all remaining shares (Eiteman, Stonehill and Moffett,2013).At the moment also Herms is consolidating its position within the french market reaching a market value of 28$ billion (Reuters, 2014).LVMH according to Roberts (2012) is valuated 25.9$ billion.This analysis is going to reinforce again the thesis that at the moment would not be possible to for LVMH to increase in the position in Herms company both from an economical and legal point of view.

BIBLIOGRAPHYDiderich, J. (2012), "Paris Prosecutor Examines Hermes Complaint",WWD,vol. 204, no. 79, pp. 2.Eiteman, D., Stonehill, A. and Moffett, M. (2013). Multinational business finance. 13th ed."Hermes: LVMH Ends AMF Proceedings", 2013,Entertainment Close - UpHidden predators; LVMH and Hermes2013, The Economist Intelligence Unit, London.Lautorite.qc.ca, (2014). Auto rite des marches financiers | AMF. [online] Available at: http://www.lautorite.qc.ca/en/index.html [Accessed 14 Aug. 2014].Lewis-kappes.com, (2014). The Advantages and Disadvantages of Going Public. [online] Available at: http://www.lewis-kappes.com/CM/FSDP/PracticeCenter/Securities/Securities--Business-Focus.asp?focus=topic&id=3 [Accessed 14 Aug. 2014].Lexology.com, (2014). French AMFs 8m fine for LVMHs disclosure failures that concealed stake building in Herms | Lexology. [online] Available at: http://www.lexology.com/library/detail.aspx?g=9cc619d2-a523-44fd-af0b-09d4af17c518 [Accessed 14 Aug. 2014]."LVMH/Hermes", 2010,FinancialTime.com. Nytimes.com, (2014). Log In - The New York Times. [Online] Available at: http://www.nytimes.com/2011/09/16/business/global/hermes-scores-victory-in-battle-with-lvmh.html?_r=1& [Accessed 14 Aug. 2014].O'Sullivan, A. and Sheffrin, S. (2001). Economics. 1st ed. Upper Saddle River, N.J.: Prentice-Hall.Pages.stern.nyu.edu, (2014). From Private to Publicly Traded Firm: The Initial Public Offering. [online] Available at: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/invfables/ipo.htm [Accessed 14 Aug. 2014].Ramaswamy, M. and Ramaswamy, M. (2011). LVMH, Herms, and the Danger of Going 'A Little Bit Public'. [online] Harvard Business Review. Available at: http://blogs.hbr.org/2011/03/lvmh-and-hermes-the-danger-of/ [Accessed 14 Aug. 2014].Reuters, (2014). Hermes confident holding company will fend off LVMH. [Online] Available at: http://www.reuters.com/article/2010/12/06/hermes-lvmh-idUSLDE6B51GU20101206 [Accessed 14 Aug. 2014].Reuters, (2014). Hermes family creates majority holding company. [online] Available at: http://www.reuters.com/article/2010/12/05/us-lvmh-hermes-idUSTRE6B42DJ20101205 [Accessed 14 Aug. 2014].Roberts, A. (2012). Louis Vuitton Tops Hermes as Worlds Most Valuable Luxury Brand. [online] Bloomberg. Available at: http://www.bloomberg.com/news/2012-05-21/louis-vuitton-tops-hermes-as-world-s-most-valuable-luxury-brand.html [Accessed 14 Aug. 2014].

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Chance, D. (2004). Equity swaps and equity investing. The Journal of Alternative Investments, 7(1), pp.7597.

Wang, M. and Liao, S. (2003). Pricing models of equity swaps. Journal of Futures Markets, 23(8), pp.751772.

WWD, (2012). Paris Prosecutor Examines Herms Complaint. [online] Available at: http://www.wwd.com/business-news/legal/paris-prosecutor-examines-herms-complaint-6406154 [Accessed 15 Aug. 2014].