Multinational Financial Management

IBU5MFN

Leonel Oscar Gonzalez Soriano
17551537
Luca Cantadori
18162401
Riccardo Stiglich
18162418




Case Analysis
Luxury Wars LVMH vs. Hermes

18-August-2014


Case Questions
1. 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
shares
This 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 company
The 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.


























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