Nonsensical Bear Thesis at The Watches of Switzerland Group $WOSG

7x fwd FCF, 25%ROIC, Huge Reinvestment Runway, Proven and incentivized Best in Class Capital Allocator

Executive Summary:

WOSG is a luxury watch retailer operating in the UK and the US, 46% of the market in the UK, 10% in the US. Watches of Switzerland along with its brands Mayors, Mappin & Webb, and Goldsmiths, are authorized dealers for luxury watch brands like Rolex, Patek, Cartier.  WOSG derives 55% of its Rev from Rolex and 75% from its top 8 watch brands. Jewelry is 6-8%, and the rest is servicing and other smaller watch brands. 

Why the opportunity exists:

1. Market thinks Rolex might go DTC because they acquired another large watch  retailer(Bucherer). Rolex is estimated at ~60% of rev. Even if they are not going DTC, they will be favoring Bucherer in allocations. 

2. UK Luxury slowdown, short term selling from guidance cut, market thinks more cuts could come and trust management guidance less.

3. Kicked out of Stoxx Europe 600 Index

Why I think Its a long:

1. Rolex is extremely unlikely to go DTC because

   1. They have little incentive to do so

   2. They are expanding capacity and will struggle to sell them if they are doing a transition to DTC at the same time

2. If you get comfortable with disintermediation risk, Rolex licenses are essentially a license to print money with a huge moat, which makes WOSG a business with a huge license moat, long reinvestment runway at high ROIC, top tier management with huge insider ownership and solid capital allocation track record, in a resilient industry, with a cheap valuation. 

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When a stock has a terminal or existential story that seems to make sense, people assign a probability to that story with superficial knowledge and pass on it quickly while quoting the Warren Buffett Russian roulette quote. In reality, a lot of times the story doesn't really make sense or has a near 0% chance of happening as you gain more understanding and assess the situation, creating a very asymmetric opportunity.

When SVB collapsed, there was a lot of fear and pretty much no one was brave enough to look for value in the regional banks that got thrown out the bathwater along with SVB. Yes, financials are a complicated and highly levered business, but in reality, this banking crisis is nothing like the subprime crisis of 2008; It is a simple liquidity crisis, a bank run triggered by a misconception about the asset book of banks. At 0.15 B/V(my avg was like 13$), the market was basically saying $WAL was getting seized this week. But if you just took a look at the BS, you would have noticed $WAL had 60 billion in deposits with 30 billion of them being insured, while having 29 billion in liquidity.  The bank can effectively cover a 100% bank run on their uninsured deposits.  The bank was probably not going to get seized unless the liquidity somehow evaporated into thin air. I believe we have a similar situation here with $WOSG.

Rolex as a brand:

To properly explain my view, I need to first give a background on Rolex.  Rolex is a company under the Hans Wilsdorf foundation, a non profit that was created after Rolex’s founder Hans Wilsdorf passed away.  This allows Rolex to take a very long term view in making decisions, solely focused on preserving brand equity and integrity while not being beholden to shareholders to grind out the last basis points of margin.

• Rolex had a handshake deal for 70 years with Aegeler to be the exclusive movements producer for Rolex until 2004 when Rolex acquired the company.

• Breitling CEO after the Bucherer acquisition: “Rolex is a great company. They have the best behavior in the industry; they respect all the other brands, and I'm very happy about this acquisition. And as far as I understand, nothing will change for us and for Bucherer in this relationship.”

• “Rolex, most people that follow us know that we do get a number at the start of the year, in terms of units, for Rolex UK, in the US, we've had those meetings, they take place in January, and those numbers never missed, in our experience.” - WOSG CEO Brian Duffy

• Rolex only works with “internally flawless” stones, but still has a machine to sort through the stones to check for bad/fake stones.  They only get bad stones once every 10 million stones.

• Rolex has sponsored golf, sailing, motorsports, tennis, equestrian since the 1960s and have not expanded into other sports since.

Rolex makes around 1.3million watches per year, and is going to expand capacity by 60% before 2030.

Why Rolex is very unlikely to go DTC

Rolex has said that acquiring Bucherer is not a strategic decision into retail and there will not be any distributions or allocation changes.  Mr. Bucherer has no heir and as the last living person to have worked with Hans Wilsdorf, Rolex seems to be the best place to carry on his legacy and maintain its Swiss heritage. 

However, the market clearly did not believe this, neither did I.  But further analyze the incentives and you can hopefully see that there is little to no risk of Rolex going DTC. 

Let's start from looking at incentives. The three reasons to go DTC are usually brand presentation/service, customer data, and margin.  Rolex only has the margin incentive, and that incentive is as weak as it can get while still involving various execution risks.

• The Dynamics between Rolex and its retailers are very unbalanced.  To continue to hold a Rolex license, retailers need to cave into Rolex’s every demand, including how it's presented in the store and being pushed to continue to improve the store.  Rolex could actually impose store investments onto retailers, and retailers who do not comply will be dropped. Because of this, brand presentation can largely be controlled and any customer data could already be demanded from the partners. 

• Rolex has the ability to take back margin from retailers as part of a price raise.

• WOSG has best in class customer service (highest google review and NPS score vs comps)  and also opened a lot of mono brand shops (Rolex only) for Rolex, while having Rolex front and center in their multi brand locations. 

• If it can already slowly take back margin (price raises give operating leverage to the retailers = margin expansion that Rolex could take back) and control brand presentation through its massive leverage over the retailers, why would a non profit board of a few old men, sitting around in a room with a picture of the late Hans Wilsdorf on the wall, decide to take the massive execution risk of transitioning to DTC in order to eke out a few points of extra margin? There is simply no incentive in doing so.  Being low capital intensity is also better for the non profit activities that the foundation is interested in doing.

None of the other brands have this kind of leverage because stores with Rolex licenses usually have Rolex making up a large part of their sales.  In return, Rolex reassures the retailers by committing to not compete with them in retail. Rolex’s commitment to work exclusively through retail partners historically has led to far more investment from its authorized dealers than any individual watch brand — even Rolex — could make on its own.¹  

As Rolex is ramping capacity, it needs the existing distribution points that retail partners currently provide.  Bucherer alone currently represents 5% of Rolex’s revenue.  Even if Rolex were to go DTC, acquiring WOSG would be way easier than building out the distribution points themselves, as they would be acquiring 40% of the market in the UK with the best locations. This provides a floor to a certain extent for WOSG’s valuation.

A plausible explanation for the Bucherer acquisition was that Rolex didn't want competitors(LVMH/ Richemont) or PE funds to acquire it, and they are big enough now to spend money to maintain the status quo and prevent disruptions.  The acquisition price was allegedly fairly expensive²³, which suggests that a bidding war might have taken place.

Another concern investors have is Rolex favoring Bucherer in terms of allocation.  This was a more plausible argument at first glance than disintermediation, but it still does not make sense. The primary goal of Rolex is to maintain its long term brand equity. Why would Rolex risk its brand integrity and image among the Swiss watch circle and watch distributors to increase revenue by maybe half a percent? As Bucherer makes up 5% of Rolex’s revenue, it does not move the needle and simply makes no sense. I find it unlikely that Rolex would starve the operator of the largest Rolex store in Europe of allocations. 

The Consolidation & The Business

In 2008, Rolex had like 2,000 points of distribution in the US. Today there are less than 300. Almost all brands besides Rolex are moving towards some form of DTC and making their most sought after models “monobrand only”. However, WOSG stands to be a beneficiary of this trend. As Rolex and other watch brands consolidate agencies and deepen their relationships with their preferred retailers, the added demand and supply allocation would provide a tailwind for WOSG.

WOSG’s focus now is primarily on mono brand boutiques that seem to⁴ have good economics, as ROIC and margin was not diluted from them. The agencies from brands act as a moat (ironically), and the recent consolidation further strengthened the moat.  The less agencies brands are willing to maintain, the more allocation existing agencies have, and the harder it is for new players to acquire an agency. When WOSG reinvest into existing stores by expansion or relocation, it also takes allocation share away from other retailers⁵. Smaller retailers simply can not keep up with WOSG the FCF printer plowing everything back into high ROIC store reinvestments. As agency counts are shrinking, it is almost impossible for new players to acquire an agency license from the watch brands.  Long time dealers like WOSG have a century long relationship with Rolex and multi decade ones with other watch brands, demonstrating reliability over the years while building a track record of continuous reinvestment into brand presentation. Just to illustrate how good WOSG’s reputation is in the industry, AP, who has gone almost 100% DTC, has entered into a JV with WOSG to operate one of their AP houses. WOSG is currently the only AP house operator in the UK⁶. As long as WOSG continues to provide best in class customer service and continued investment into its showrooms to elevate brand presentation, it should maintain its relevance to the watchmakers. 

Wosg is a retailer with all the positive traits of luxury. It rarely ever runs discounts. The inventory has basically no shrinkage. It benefits from Rolex’s pricing power as any price raises by Rolex flow through to increase WOSG’s revenue. It has minimal marketing expense, able to surf on of the brand powers of Rolex and others. It has strong inventory turns with no warehouses, resulting in low capital intensity high FCF conversion. Expansionary Capex payback was 2-3 years historically. If you can come to the conclusion that the disintermediation risk is nonsensical, then there is no denying that WOSG is a high quality business.

The long range plan put out by WOSG plans to double sales and profits by 2028 with cashflows 100% reinvested. I'm not sure if they can meet the guide and do not have a strong opinion here. However, I'm pretty sure they will be able to reinvest 100% of the cashflows at historical returns on invested capital.  I'm not gonna try to forecast anything here but simply gonna highlight that you are buying a high quality business with massive barriers to entry on the cheap that can probably deploy 100% of the FCF at like a 25% ROIC. 

A big optionality you get from owning WOSG is the possibility of restored VAT free shopping in the UK. Tourist revenue made up 30% of their sales in 2019, now it is down to 5%. Restoring VAT free shopping is something that should be completely logical to do, as it will greatly benefit UK businesses. Increased allocation supply from the Rolex capacity increase, if they do not DTC, is also a tailwind for WOSG.

Resilience of the industry

The business is usually fairly predictable as a large portion of it is supply based with long waitlists. In January, the company had to lower guidance which cratered the stock by 40%.  Rolex and other brands hold their allocation meetings in January, and they are pulling back a bit on the rare metal watches after the luxury watch bubble popped.  Wosg guessed wrong in their initial guidance. Bottom line is luxury watches are a resilient industry and if your time horizon is measured in years, short term volatility should not matter.  

Rolex revenue increased from USD $4.8billion in 2013 to USD $11.4billion in 2023, a 9% 10 year cagr.

Management, alignment, capital allocation 

CEO Brian Duffy does not have a college degree. He enrolled in the KPMG apprenticeship program then worked at Polaroid. He was hired by Playtex to be the UK region finance director at age 28, became EU region CFO at age 33, then EU region CEO at age 37. At Playtex, He launched the Wonderbra “Hello Boys” ad campaign and turned Wonderbra’s 10mm in revenue into 220mm in 2 years.  Disagreements with parent company Sara Lee caused Duffy to leave the company and enroll into Guildford College to study contemporary music⁷.

While Duffy was playing the Guitar, he was asked to join Ralph Lauren as European president.  He took over when the division was generating £400mm in sales, and in 8 years turned it into a  1.5bn operation while profits grew from 28mm to 300mm.  Duffy then joined WOSG as CEO and was given an opportunity to invest in the business by Apollo. Duffy now owns 3.2% of the business worth around £40mm, while CFO Anders Romberg owns 0.6% worth around £6mm. CFO Anders Romberg has worked with Duffy for nearly two decades since the Ralph Lauren days.

Duffy’s capital allocation track record is best in class. WOSG entered the US market in 2018, purchasing Mayors for $107.7mm from Birks for sub 10x earnings⁸. Through a series of cheap acquisitions and reinvestments, the US is now half their revenue. More recently, It acquired the perpetual distribution rights  in North America of luxury jewelry brand Roberto Coin at 6x pe.  This is a brand that is growing revenue at 13% a year.  They never overpay for acquisitions and have a clear internal hurdle rate.

Notably, Duffy continued paying all employees during Covid while senior management opted to take a 25% pay cut and defer the rest. Duffy has also maintained the same base salary since 2014.

Valuation

From the FY25 guidance, WOSG will do 1700mm pounds in revenue. Assuming no change in EBITDA margin and taking mgmt’s FCF conversion guide, WOSG can probably do around 140mn in FCF.  This gives us around ~7x 2025 MC/FCF. On a pe basis, taking management’s guide WOSG probably does 98mn in earnings. This gives us a 10x pe.

Comps like The Hour Glass or Oriental Watch are not really suitable for multiple comparisons in my opinion. WOSG is still in expansion mode while The Hour Glass is a mature, illiquid, family controlled, SGX listed business.  

Risks to watch

• If Bucherer’s Rolex Boutique store growth in the US starts to materially outpace WOSG

  • Rolex could, theoretically, use the extra supply from its increasing capacity to power boost a Bucherer/Tourneau “DTC” expansion in the US. This would result in lower returns for WOSG and less reinvestment opportunities. This however would not move the needle for Rolex financially and I don't see why they wouldn't allow WOSG to expand unless WOSG stops performing up to Rolex’s standard and they need to protect brand image. 

• Swiss Watch market starts deteriorating again

  • However Swiss watch exports to the UK declined only 1% y/y from January to May this year

    

• Customer service starts to deteriorate

  • Only two things allow retailers retain relevance to brands: capex, customer service/brand presentation

• Wosg starts to lose Rolex multi brand or mono brand agencies

  • Indiscriminate consolidation by Rolex does not benefit WOSG

• Wosg stops getting any new Rolex agencies

  • Rolex has shown to still want to maintain small family owned agencies on a local level, to deter the big ADs from having too much power against Rolex⁹.

Disclaimer: I am long with a massive position at a £342 average cost. I was a bit lazy in making my thesis coherent enough to publish and the price has ran up about 20%. It's still cheap, Macro concerns have been de-risked a bit after the last result. My avg is probably less than yours. Do your own Due Diligence. This is not financial advice. I am not a financial advisor. Consult a financial advisor before investing. 

1. https://usa.watchpro.com/exclusive-bucherer-uk-chairman-predicts-end-to-monobrand-boutique-building/

2. https://www.swissinfo.ch/eng/business/rolex-breaks-taboo-with-takeover-of-bucherer/48833586#:~:text=The%20takeover%20price%20was%20not,to%20at%20 least%20CHF5%20 billion

3. EBIT margins for Bucherer UK was 6.1% from 2021-2022 (source: companies house), lower than WOSG. Bucherer also has less stores than WOSG.

4. Recent payback timing not disclosed by management for whatever reason. Payback was 3 years in 2019. Management says mono brand economics comparable to Multi brand.

5.  https://www.watchpro.com/wempe-closes-bond-street-store-after-losing-rolex/

6. Big 6000sqft shop. Material Good run one AP House in the US. All other AP houses in the world are directly run by AP as far as I know.

7. https://www.youtube.com/watch?v=sc1LqbOD2TM

8. Inventories were 62mn. Mayors was growing topline at LDD from 2016-2018, even more on the bottom line. It had very low margins compared to WOSG however and lost money before, hence the 30mn of accumulated losses. Source: prospectus

9. https://usa.watchpro.com/corders-column-rolex-acquisition-of-bucherer-may-be-designed-to-limit-the-power-of-major-multiples/