Swatch Group
Luxury watches at a bargain price $UHR.SW $SWGAY
Swatch Group is the second largest watch company in the world. Not just the plastic variety, they make many of the prestige brands in the glossy full-page ads from Omega, to Tissot, to Blancpain - the oldest watch brand still in operation, dating back to 1735 - thanks to a fascinating history.
The roots of the modern day Swatch Group can be found in crisis. First, religious reformer John Calvin, who preached austerity and piousness, convinced the city of Geneva to ban the wearing of jewelry, stifling the nascent local cottage industry of watchmaking. Fortunately the ban didn’t last long.
Skipping forward a few centuries (Substack has a word limit after all), the Great Depression again nearly destroyed the industry. In response the Swiss government, in combination with the local banks, engineered the merger of disparate parts of the watch industry into Allgemeine Gesellschanft der Schweizerishen Uhrenindustrie (ASUAG) in 1931.
At a similar time, the families owning the Tissot and Omega watch brands merged their operations to form Société Suisse pour l'industrie horlogère (SSIH). In the ensuing decades SSIH absorbed a number of other Swiss watch brands, outselling Rolex by volume.
The Second World War proved a boon for the neutral Swiss as other major nations turned their mechanical expertise away from watchmaking in favour of military devices. Hence Switzerland became the overwhelming market leader in watchmaking globally.
Then in the late 70s, low-cost quartz watches from Japan flooded the world, once again almost bankrupting the Swiss watchmaking industry, with the number of manufacturers dropping from 1,600 to 600 and employment in the industry falling 70%.
The two largest firms SSIH and ASUAG were both teetering on the brink of collapse, and their creditor banks considered stripping them for parts to recoup their loans. Japanese firms were ready buyers, with an offer of 400m Swiss Francs (CHF) offer for Omega on the table. The banks brought in Nicolas G Hayek, a prominent consultant, to evaluate the industry and report back on what to do. However, Hayek went rogue.
He led a group of investors in engineering a merger between ASUAG and SSIH and taking a majority stake. Then he took a radical step of doubling prices and emphasizing ‘Swiss’ and ‘Swiss made’ in their marketing. This premiumization strategy might seem obvious today but at the time it flew in the face of the history of technological progress. In quartz watches you had this revolutionary cost reducing innovation and Hayek’s strategy was to sell people the old technology at much higher price. Anyway, it worked!
At the same time, he introduced the low-cost plastic quartz Swatch in an array of bright colors. This again was highly counterintuitive as Swiss manufacturers had long considered themselves too expensive to compete with the Japanese at the low-end of the market. However, Swatch proved wildly successful, becoming the best-selling watch in history (until the arrival of the Apple Watch) totaling over 150 million units in its first decade and providing critical cashflows to support the broader business.
Even more amazing, the Swatch brand was produced entirely in Switzerland by designing manufacturing processes that minimized the use of labor. Today the Swiss watchmaking industry is the country’s third largest exporter, comprising 1.5% of GDP.
Though Hayek passed away in 2010, his children continue to control the company today with 44% of the voting interest. Son Nick Jr has been CEO since 2003 and daughter Nayla is Chairlady. Nayla’s son Marc is CEO of Breguet and joined the board in 2024.
The Brands
I am personally no watch connoisseur. So for my own as much as anyone else’s benefit let’s delve into the brands. Omega is the third best selling watch brand in the world with nearly $3bn of revenues behind clear leader Rolex ($11bn) and Cartier ($3.5bn) per LuxeConsult.
Swatch has two other $1bn brands – Longines and Tissot.
They also have a tail of lower sales but often higher price point brands. Their most premium brand is Breguet which has watches that fetch over $200k (one sold at auction for $7m!).
As an aside there is another Breguet estimated to be worth over $30m which was commissioned by Marie-Antoinette, but sadly she met her end by guillotine before the watch was finished. In fact the watch took Monsieur Breguet over 30 years to make, thanks to its complexity with 823 separate parts.
I will avoid going deep down a rabbit hole but suffice to say that the manufacture of watches is very technically complex. As a result over time, many brands preferred to outsource this part and concentrate on the branding and marketing side. After the 1970s near collapse and consolidation of the Swiss watchmaking industry, Swatch became an effective monopoly in the manufacture of ebauches (the French word for sketch used to mean the partially assembled movement component of a watch).
In the early 2000s Swatch tried to stop supplying ebauches to third parties. This triggered a lengthy back and forth with the Swiss Competition Commission who feared for the future of the broader industry. It took until 2020 for the government to allow Swatch to use its discretion in deciding whether to supply its competitors. I believe the company does continue to supply 3rd party brands for now, though it is a single digit percentage of Swatch’s sales so not that material to profitability.
The company is highly vertically integrated, even designing its own semiconductors and producing batteries. Some of these have interesting 3rd party applications such as in medical devices and its real-time clocks are used in battery management systems for electric cars, albeit these revenue streams are small.
Winding the Clock Back & Looking Forward
Firstly you can see that 2024 was a historic low in profitability. In fact you have to go back to 1999 to find a year when the firm had lower operating profit – a millenium ago!
You can also see that Swatch has struggled to grow over the past decade. The luxury watch industry has for some time been primarily a Chinese and Asian business. The slowdown of the Chinese economy, with declining household assets due to a property bust, and a shift away from conspicuous consumption (Omega watches were allegedly an important currency of corruption in China before President Xi’s crackdown) have been big headwinds for Swatch as you can see below Chinese sales dropped 23% in the past year. The $2bn sales they did in China, the lowest figure since 2009.
The other notable point from the historic record is the insanely high level of inventory they carry which works out to almost 7 years worth’ of sales. Far be it from me to question the strategy of the Hayeks but this does have the accounting effect of reducing returns on capital. All this inventory is already paid for in cash terms, indeed the buildup of inventory has cost the company $1.7bn over the past 3 years, so if and when they run down inventory levels this reversal would be a big boost to cashflow.
By contrast Richemont - the owner of Cartier among other luxury brands and also run by a long term oriented family - carries a little over a year of inventory.
Asset Value
Swatch’s inventory sits on the balance sheet with a value of CHF7.6bn ($9.1bn). So their holdings of watches are alone worth more than the company’s market cap!
Ok not all of it is completed watches. Semi-finished is presumably ebauches. Raw materials will be gold, silver and steel, much of which will have been bought at lower prices than today’s spot values. However more significantly, this is a business that earns a gross margin north of 80%. So while the finished goods are valued at cost, their true market value is closer to 80% higher, which – multiplying the CHF3.9bn - is a mark-up of over CHF3bn ($3.6bn).
The company does make adjustments to inventory for obsolescence, but these are very small – the whole point is that the product is timeless!
Another notable aspect from observing the balance sheet is that the company records almost no intangible assets: zero goodwill, and CH170m of other intangibles (which is mostly software and research & development related).
This is partly because the group hasn’t been very acquisitive and also due to a quirk of Swiss accounting that enables companies to opt to deduct goodwill from equity when it is created.
So when they acquired jewelry brand Harry Winston – the only major acquisition in Swatch’s recent history – this caused an accounting writeoff of over $500m of shareholders’ equity. I don’t think I’ve ever seen a company do this before, and it indicates extreme conservatism.
Who knows what the marketing expense would be to replicate the company’s unique intellectual property. This is a company with some iconic brands, the watch James Bond wears!
One very crude way to guess at the value of this asset is to sum the past 5 years of marketing investment which adds up to over CHF5bn ($6bn). Allegedly LVMH has offered over CHF3bn for the Breguet brand alone, so this could be a severe under-estimation.
I could do a similar exercise for research and development (R&D) which was CHF275m in 2024. When Cartier decided to get serious about watchmaking in the early 2000s and transformed themselves from a jeweler that sells watches into making their own movements it took them roughly 5 years to bring production in-house. So let’s conservatively say all of Swatch’s manufacturing know-how is worth (275m x 5) = CHF1,375m ($1.6bn).
So very conservatively one could value Swatch at an asset value of $25.5bn, which compares to a market capitalization of $9bn.
In effect the company could wind up its operations, never manufacture another watch, pay off its liabilities and still have multiples of the market cap left over.
Risks
The Apple Watch has done multiples of the unit sales of the Swiss watch industry combined annually since its launch a decade ago. Though they don’t disclose sales by brand this has no doubt been a challenge to the entry level Swatch brand. However, I don’t really see Apple watches and other digital devices as a threat to the higher end brands – their customers are buying for decoration, for prestige, status and differentiation. Indeed per Steven Wood (below) the entry level watch market has shrunk by over 20% over the past 20 years. The high end of the market by contrast has grown 3.5x. So I think the Apple Watch effect has already played out, while Swatch Group has the brands to excel in the high end.
The business is clearly cyclical, perhaps more so today due to this increasing reliance on expensive brands which are more of an extravagance than a plastic Swatch. Sales fell 9% in 2009, and 32% in 2020. I would regard the former as more indicative than the latter as 2020 saw the complete collapse of airport shopping which is likely a one-off.
This cyclicality is arguably exacerbated by the company’s approach in refusing to lay people off in cyclical downturns. In the 2024 annual report they wrote:
“The Group is sticking to its strategy of maintaining production capacities and avoiding redundancies. This will lead to a rapid improvement in the result for the segment in 2025, if sales improve.”
One cannot argue with the long track record of the family in stewarding the company. Often a cyclical industry requires a very long term perspective in order to make difficult decisions at cyclical troughs. This is particularly true in cultivating brands where the easiest thing to do is to cut prices and boost sales in the short term but damage the brand in the long run. However their brands have lost ground to competitors in recent years with Omega slipping behind Cartier, Longines falling from 4th to 7th and Tissot dropping from 6t to 11th in the list of best selling watch brands.
The Hayeks aren’t great fans of being a publicly listed company, often using earnings calls to criticize the short-termism of Wall Street and their annual reports make entertaining reading. In return they have faced criticism for not providing enough information to shareholders. Hayek Jr recently retorted that Swatch is in the business of selling “watches, not shares”.
The latest salvo is from an American activist (constructivist in his terms) investor called Steven Wood who owns a 0.5% stake and is calling for his own nomination to the board. Wood appears quite long term and is not pushing for redundancies for example. I’ll put a link to an interview with him at the end of this article, which offers some interesting insights.1
In my experience Switzerland has a rather patchy record in promoting the interests of minority shareholders (look up the Sika-Saint Gobain takeover) so I would not bet on his victory. Regardless, the family will continue to control the board and the company.
In terms of ‘China’ risk I would say that sales can always continue to fall but today China sales are only a quarter of the business vs nearly 40% a decade ago so the risk is substantially reduced and is certainly far better appreciated than it was a decade ago. By contrast the US business is much more material than it was a decade ago at 18% of sales vs 8%. This could continue to be a driver of growth or a headwind depending on your view of wealth effect created by booming US asset prices.
As Yogi Berra once quipped, “it’s tough to make predictions, especially about the future.”
What I do know:
o Industry profits are somewhere close to a cyclical low
o Swatch can generate over $3bn in cashflow just by running down inventory to 4 years
o The company pays a 3% dividend yield with plenty of scope to raise it and or buyback stock (net cash covers the dividend four times over).
This business is worth far more than $9bn. BUY.
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Disclaimer
This article is purely for informational and entertainment purposes and should not be construed as investment advice. Please consult a financial advisor before making any investment decisions.
Please also assume that I own and intend to trade any stocks discussed before and after dissemination of this report.
1 https://themarket.ch/interview/steven-wood-swatch-group-offers-incredible-potential-ld.13876
Definitely cheap, just wish they’d bring in new management
Other way around! Calvin didn’t stifle the luxury watch industry, he created it by forcing people to flex using object of utility.