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All that glitters

7 Aug 2020 By Edward Hadas, Lisa Jucca

Richemont likes to sell glittery things for more than they’re objectively worth. In a similar spirit, the luxury goods maker has proposed a “shareholders’ loyalty scheme” that gives current shareholders three-year warrants to compensate for a 50% dividend cut. It looks more like elegance than substance.

The pandemic has been hard on the owner of Cartier. Pre-tax profit is expected to be 59% lower in the year ending March 2021 than two years earlier, according to Refinitiv estimates. Although the Swiss-registered company’s balance sheet is strong, with 2.4 billion euros of net cash, chairman and controlling shareholder Johann Rupert decided to cut the dividend in half to 1 Swiss franc per share.

For most companies, that would be that. But Richemont will do something more, or so it claims. Current holders will receive warrants to buy shares in 2023, at around the market price when the instruments are issued later this year. With each share receiving warrants worth the equivalent of 2 Swiss francs, the company could end up increasing its share count by 3.5% – assuming that the share price in three years is above the current level of around 57 Swiss francs.

Charles Revson, a pioneer in selling basic goods at high margins, purportedly said, “We don’t sell lipsticks. We sell dreams”. Something similar is going on here. The warrants will have value, because investors are willing to pay for the possibility of buying shares at a discount three years from now. Using some plausible inputs into the option-price.com model, the warrants – which will be tradeable – might initially be worth as much as 6 Swiss francs each.

However, any value is far from something for nothing. It represents the potential gain of future buyers of newly issued shares at a price that will be lower than necessary at the time. In other words, it represents the potential loss of future Richemont shareholders.

The economics are ironic, since the potential dilution caused by issuing warrants creates a small incentive for current holders who are optimistic about Richemont’s prospects to sell their shares and instead buy warrants from less confident or legally restricted fellow equity owners. This luxury-class wheeze could therefore more accurately be called a disloyalty scheme.

(This column has been updated to correct the pre-tax profit forecast in the second paragraph.)

 

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