Safilo has decided to adjust its business model by boosting its retail business, which is due to represent at least 20 percent of sales in 2012 compared with 6 percent last year, thus reducing the relative importance of the wholesale segment. At the same time, Safilo wants to decrease its reliance on licensing by developing its house brands further. Total revenues are planned to rise as a result at a quicker annual rate of 7-8 percent until 2012, while margins should improve.
The group already started to move more forcefully into retailing a couple of years ago by expanding its network of sunglass stores in the USA, called Solstice, and by acquiring the Loop Vision chain in Spain. A few days ago it announced the purchase of Sunglass Island in Mexico and Just Spectacles in Australia (more on this in previous story).

The shift to increased retailing aligns Safilo’s strategy with that of its arch rival, Luxottica, but raises questions about how the financially stretched company will fund its expansion while maintaining its pledge of boosting its dividend policy.

The company has earmarked an overall annual investment budget of €60-70 million until the end of 2012. Safilo had net debt of €515 million at the end of 2007, or three times EBITDA, and it is now planned to grow to an estimated €530 million in five years’ time.

The world’s second largest eyewear company aims to increase the number of stores to 700-800 from 269 currently thanks to new openings and targeted acquisitions. It plans to spend €40-50 million a year on the development of its retail network, focusing especially on emerging markets like China, India, Russia and Latin America. In China, contrary to Luxottica, Safilo has not yet found a suitable takeover target so it plans to build is own retail network from scratch, with the first openings due in a couple of months.

In the coming days, the group is scheduled to unveil the brand of a new global retail chain for prescription glasses, but it’s not going to be Optifashion as previously speculated. The first store openings are envisaged in Spain, Australia and China. At the same time, Safilo plans to turn its American Solstice brand into a global retailer of sunglasses. In markets where the group already has a strong retailer of sunwear as a client, Safilo proposes to initially co-brand the chain before definitively imposing the Solstice name.

Safilo said it has already chosen the name of its new optical retail chain but is waiting to have its global brand registration completed before it is announced. Store fittings will be built by the Italian furniture group Citterio and shipped to the location. To optimize the management structure of the network, it plans to have 35-40 stores in any one territory.

For this year, the company has scheduled to open about 30 new Solstice stores in the USA and about five Loop Vision stores in Spain. The first store openings for the new optical retail chain owned by Safilo are also planned to occur in 2008.

In the wholesale sector, Safilo intends to boost the share of its house brands to make them represent about 30 percent of wholesale sales in 2012 compared with 20 percent in 2007, especially by developing new products and markets for its Carrera, Smith and Oxydo collections. These brands are expected to double their sales over the next five years by focusing on young males.

The development of house brands, which offer higher margins than licensed brands, is part of a move to boost the group’s EBITDA margin to 17-18 percent of sales from 14.7 percent in 2007.

Boosting house brands will also help the company to slightly reduce its structural weakness of depending on licensed brands, in particular Giorgio Armani, Gucci and Christian Dior which along with their satellite brands represent about 55 percent of Safilo’s revenues.

Safilo has already started negotiating the renewal of the critical Gucci license, which expires in 2010. The company is confident of keeping the licensing, indicating that the licensor has not engaged talks with any rivals. Because of the global reach of the Gucci brand the only valid other contenders for the license seem to be Luxottica or De Rigo.Citigroup estimates that the Gucci license will represent more than €250 million in sales in 2008.

In some stores, Safilo is experimenting with the exclusive sale of its own products to fathom the customers’ reaction. It believes it can provide 60 percent of the sunglasses and 40 percent of prescription frames of its stores without hurting their overall sell-out.

In agreement with its licensors, the company is also streamlining its wholesale accounts to obtain a more selective distribution for the top brands.

Regarding the newly acquired Banana Republic license, Safilo’s management indicated that it has slowed down the development of the collection and has postponed its sales targets, but stressed that the hiatus is not causing any contractual problems. Citigroup had projected $30 million in sales for the brand this year.

The Italian eyewear group is completing the construction of a new 30,000-square-meter production site in the Suzhou industrial district of Shanghai that will focus on manufacturing components for the group, such as hinges and the internal structure of frames. These elements are currently produced in Italy and labor costs represent about 70 percent of the total outlay. Safilo noted that labor costs in China are one-tenth of those in Italy, largely offsetting lower productivity levels.

The cumulative cost savings generated by the Chinese plant, which is set to become operational at the end of 2008, are expected to reach €40-50 million by the end of 2012, hence covering the cost of the construction of the site, but the transfer of production will add one to two weeks to manufacturing times.

Safilo said that it has discussed the transfer of production to China with its licensors, and they have agreed so far on 90 percent of the parts to be produced there. Claudio Gottardi, chief executive, said the company was negotiating what to do about the balance of 10 percent. The new site is scheduled to open by the end of the year but will only reach full capacity in 2012. The initial capital expenditures for the plant totalled €2-3 million last year. They will peak at €22-25 million this year and fall to €8-10 million in 2009.
From 2010, the company aims use the bulk of its cash flow for the development of its retail network. The company can also obtain funds for its development from the refinancing of a €195 million bond that bears a coupon of 9.625 percent and expires in May 2013. Safilo can decide to reimburse it from May 2008 and has started to negotiate with lenders to buy back the bond at a lower interest rate, but is in no hurry. It wants to obtain the best financing conditions, possibly driving for a reduction of about 2.0 percentage points.