This looks like a total calamity!

Small-cap miner Gemfields is to buy the loss-making luxury goods maker Fabergé. But the takeover makes no sense, says Tom Bulford. Here, he explains why.

I have a question for you: what value would you place on a business that has just reported semi-annual revenue of $2.6m, a net loss of $7.3m and has net tangible assets of less than zero?

Not much, I hope.

Why would you want to stump up for these losses? What chance is there that the business could possibly grow its revenue to a level that turned those losses into profits?

Well, City advisers have turned their highly trained professional minds to this conundrum and decided that, all things considered, this business is actually worth $142m.

Did you read that correctly? Is it a misprint? Did I mean $1.42m or $14.2m? No! This tiddly, loss-making business has really been valued at $142m. I reckon that makes the proposed deal in which Gemfields (GEM) is to acquire this business – which  goes by the name of Fabergé – an absolute stinker.

An ambitious plan to infiltrate the luxury market

This is not the news I want to hear and it gives me no pleasure. I am a shareholder in Gemfields. I like its chief executive, Ian Harebottle, a lot. He is a real enthusiast for the gemstones business and he has done a great job of running Gemfields’ Kagem mine in Zambia and marketing its emeralds. But judging by his carefully choreographed comments, I doubt that he is very happy about this deal. Because, for reasons that will become clear, I doubt he has had much say in its terms.

So let’s get down to the nitty-gritty. You will have heard of Fabergé. It was created by Gustav Fabergé in 1842 in St Petersburg and made the fabulous jewelled eggs commissioned by the Imperial Russian family from 1885 through to 1916. Since then it has not been plain sailing.

The Bolshevik revolution saw a violent end to production, and in 1951 the Fabergé family were forced to cede their rights to use the family name to an American corporation in return for just $25,000. After various further changes of ownership the family was reunited with the brand and the business ended up in the control of the South African conglomerate Pallinghurst Resources – remember this name.

In 2009 Fabergé was re-launched as a luxury goods brand and now has five retail outlets in Geneva, Hong Kong, New York and London, where you can find them in Mayfair and in Harrods. It has ambitious plans. It wants to open 20 stores over the next ten years and have a total of 71 by 2033. It reckons that each store is capable of selling $6.5m of luxury goods at a high margin which, if achieved, would make it a quite large and certainly profitable concern.

 

Fabergé’s only value is its name

But that is all supposition. What we have today is a small, loss-making business whose main attraction is the Fabergé name. In marketing-speak this name has ‘resonance’, it is clearly worth something and Gemfields cannot expect to acquire this for a song.

But this is where it gets really murky. You see, in its latest balance sheet, at the end of September, Fabergé recorded intangible assets of $36.2m. I do not see how Fabergé can have any significant intangible assets beyond its famous name. This was valued by

Fabergé’s directors at $36.2m just two months ago – and yet, (given that the tangible assets are a negative number) Gemfields is now proposing to pay over $142m for these same intangibles.

If you are wondering how this could possibly happen, then wait for the punchline. But first let me tell you about the other supposed attractions of the deal. Gemfields will acquire a ready-made retail outlet through which to promote its emeralds and the rubies that it hopes to mine in Mozambique. Fair enough – but Fabergé gets a supply of stones for its jewellery, so the advantages are not all in one direction.

A ridiculous price tag

Gemfields claims that building a luxury goods brand of its own would cost much more. That is a debatable point which should have been captured in Fabergé’s intangible value and fails to explain why Gemfields is paying almost four times their balance sheet value.

Lastly, Gemfields claims that the combined group will be bestowed with the high rating given to luxury goods companies, but this makes no sense. Gemfields will be half miner and half luxury goods retailer, and to suggest that this will be rated as if it were a pure luxury goods concern implies that investors are stupid.

As a Gemfields shareholder I would vote against the deal on the proposed terms. While the principle of the merger is OK, the price tag for Fabergé is just ridiculous. But here is the punch line. Fabergé is controlled by Pallinghurst Corporation – and so is Gemfields! Pallinghurst can do what it wants, regardless of the interest of minority shareholders – and it just has!

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