This week's Economist ominously warns of "The Trouble with Private Equity" at a time when many in the fashion world are wondering how the infusion of private capital will impact their industry. In the last month alone, La Perla, Samsonite and Valentino have all been snapped up by private equity funds. Just today, The Sunday Times broke the news that Prada has also been in talks with private investors. (Not surprisingly, Prada has denied these reports, but it is not hard to see why this would be a natural option for Patrizio Bertelli, especially given several failed attempts at taking Prada public.)
The recent investment exuberance around fashion brands is a dramatic departure from the stance that many professional investors took even just a few years ago. Back then, they said there was too much "fashion" risk and that without predictable and stable revenue streams, their highly-leveraged (heavy on debt, light on equity) investment strategies were untenable. Now, with more and more money fighting for fewer investment opportunities, it seems much of this wisdom has been thrown out the window.
That said, the future of private equity in fashion is largely unproven. The process- and growth-focused strategies favoured by private equity may not always work for fashion brands. These strategies can conflict with the notions of careful growth, exclusivity and creative freedom that are part of a luxury fashion brand's success. Certainly, there have been some remarkable investment success stories, like the meteoric rises of Jimmy Choo and Gucci. However, there are also stories of failed investments, including the $500m debacle at Asprey and TPG's ongoing struggle with Bally.
Valentino has now exchanged hands 3 times in as many years, most recently when Permira took a controlling stake in the business after winning a behind-the-scenes battle with The Carlyle Group. This serves as a relevant current day example of why some of these investments may not work out in the long run.
1. Limited fashion and luxury experience: As far as I can tell from Permira's website, they have absolutely no experience in the high-fashion and luxury sector. Most of their consumer sector investments are in companies focusing on things like frozen food, ceramic tiles and opthalmic lenses. There are investments in New Look, the UK high street retailer and Cortefiel of Spain, but these a far cry from the haute-couture frocks and fashion dreams that Mr. Valentino put on show in Rome over the weekend. This apparent lack of experience seems to contradict the management strategy that Permira itself has touted on its website:
"Permira has a reputation for establishing close relationships between the Permira Funds as investors and the management teams of the companies in which the Permira Funds invest. Underlying these relationships is a deep understanding of the business fundamentals and competitive dynamics of vertical industries. This understanding has been built up over many years of investing in companies in these industries."
2. Short-term investment horizon and high acquisition prices can lead to misaligned incentives - Second, private equity funds like Permira usually expect to exit their investments within 3-5 years. Having paid a 20%+ premium over Valentino's share price, Permira will need to be able to return several times what they paid back to its own investors within this period. This means that they may make decisions that are optimal for value creation in the short term (rapid top-line growth, aggressive store rollout, rapidly increasing licensing revenue, etc) but which can erode brand value over the long term (over-distribution, proliferation of diffusion lines, over-licensing, etc.) The brand is the most valuable long-term asset of a luxury fashion brand and should be carefully managed and protected.
3. Limited engagement with Mr. Valentino on succession planning - A key reason for the success of the Gucci investment were the open relations between Tom Ford, Domenico de Sole and Investcorp. It's therefore surprising that, according to reports, Valentino and his business partner Giancarlo Giametti were not even consulted by Permira during their discussions to buy Valentino. Sure, neither of these two gentlemen have any remaining financial interest in the business, but as co-founders they are at the heart of the Valentino brand and Valentino is still the house's Creative Director. There would have been much to be gained by bringing these two key figures on side and agreeing a strategy and succession plan with them. When the 75 year-old Valentino retires (as many speculate he will do very soon), he should play a key role in identifying, attracting and apprenticing his successor in all that is Valentino.
And yet, the acquisition spree of fashion brands is far from over, with several of the highest-profile funds (including The Carlyle Group, which lost out to Permira in the fight for Valentino) said to be actively looking in the space and the details behind Prada's reported discussions (or lack of discussions) still to be revealed. While private equity could actually be a very good at dealing with some of the industry's inefficiencies (the excesses of some designers like Valentino do, after all, need to be reined in), it will also need to be delivered with deep industry expertise, a sensible investment horizon, and respect for the creative aspects of the business in order for it to have any chance of succeeding.
Photos courtesy of the New York Times/Jason Schmidt/Alissandro di Meo