“Qui n’avance pas, recule” – French Proverb
We live in changing times. Disruption is the word on every CEO's lips and new technologies rain thick, upending long established names and business models. Where companies could once rest with the domination of their niche, they now must constantly innovate to maintain their leadership. To better understand the challenges and changes facing the French companies in our investable universe, Ben Peters and I recently visited Paris. Often referred to as the "City of Light" (La Ville Lumière) for its leading role in the Age of Enlightenment, Paris and her inhabitants are no strangers to change and, as we found, neither are the companies that call the city home. Here I will discuss how each company is evolving and adapting to industry changes.
Sanofi - 3.8% of Evenlode Global Income
Sanofi have revamped their research strategy with three major changes in approach. Firstly, the primary area of research has switched from small molecules to biologics. These are more complex and harder to manufacture than many of the simple molecule treatments, which have already been largely explored as therapies. Secondly, the new treatments are multi-targeting (can treat multiple conditions) rather than targeting individual illnesses, creating more market opportunities and reducing development uncertainty. Finally, Sanofi are increasingly seeking to move away from licensing drugs for sale and towards proprietary drug ownership of the underlying technology. A great example of this shift is the newly developed immunology drug, dupixient. Sanofi were able to bring the product to market faster by targeting an unmet need (atopic dermatitis) and receiving a priority review. Early acceptance has helped build the safety profile of the biologic, speeding the time to market in the more attractive asthma indication (with others to follow).
The same strategy is being applied across the rest of the pharmaceuticals business. John Reed, the newly appointed Head of R&D, comes from successful developments at Roche at a time when Sanofi are testing their own adaptable oncology drug. Cemiplimab, a monoclonal antibody therapy, has been granted Breakthrough Therapy Designation by the FDA and is undergoing a Priority Review for skin cancer (CSCC) in October. Sanofi believe the treatment mechanism (PD-1 inhibition) can be used in many other oncology indications, but development and testing will focus on large markets for lung cancer (NSCLC) and cervical cancer in the near term. Alongside these developments, Sanofi is countering pricing pressure for established products (non-patent protected) by selling into emerging markets, where volume growth has been excellent. Distribution and sales strategies are localized to the country and/or region, leveraging Sanofi’s experience as a key differentiator for growth in these markets.
Euronext - 3.4% of Evenlode Global Income
The European exchange operator is looking to diversify revenues away from the transactional fees earned on the trading of equities. To do this, Euronext are focusing on two initiatives; innovation and new markets. The company has developed a new software platform for trading, Optiq. The platform is over ten times faster than their previous platform and is the fastest platform globally. This is important not only in attracting volumes from high frequency traders, but because Euronext licence the technology for use on other exchanges, such as the Luxembourg Stock Exchange. This helps drive recurring cash flows that will cushion the business in a cyclical downturn. The platform will be extended to the derivatives business in the coming year and will be utilised for all asset classes Euronext cover. Giorgio Modica (CFO) did however stress that we shouldn't underestimate the difficulty in moving platforms and that such a large investment in the software platform would be a rarity.
Euronext are also seeking to create public exchanges for other asset classes, most notably fixed income and exchange traded funds (ETFs). In fixed income there is an unmet need. 34,000 LSE bonds do not actively trade due to lack of liquidity. Euronext's acquisition of the Dublin Stock Exchange has given the company significant exposure to corporate debt trading and the company continues to build a pool of liquidity providers and trading members. Perhaps a greater opportunity lies in ETFs. Europe has a third of the penetration of ETFs as the US, and 70% are traded over the counter (i.e. not on an exchange!). These give Euronext attractive avenues for investment, growth and diversification over the long term.
Publicis - 1.5% of Evenlode Global Income
The disruption in the global advertising sector has been discussed at length, with the rise of digital advertising channels (Facebook and Google) and ongoing pressure on consumer goods companies to improve margins. However, Publicis were ahead of the industry in adapting to these changes, simplifying their internal structure by moving from thousands of individually offered agency brands to a centralised solutions-based approach. The company also shifted to provide a digital platform (through the acquisition of Sapient) and serves as a strategic consultant to customers, helping them get efficiencies from their spend. As an example, Publicis cited the dramatic savings made by Expedia, who switched from an expensive (£100m) TV campaign to a more effective (3x customers reached) and digital campaign at half the cost, after advice from Publicis.
Publicis also explained the importance of remaining data agnostic, offering the services to analyse data but not selling the data itself. This is particularly important to customers who (unsurprisingly) want to control their own data and use external data from the best source (rather than that selected or sold by the advertiser). Publicis' independence enables the building of trust with customers, something the sector must seek to do following the historical lack of transparency over media buying costs. The company operates with low debt and high free cash flows, enabling it to invest through the downcycle and take share as others adapt more slowly.
Essilor is the world leader in the production of lenses and in developing the technology behind them. While we do not currently hold Essilor in the Evenlode Global Income portfolio, we do hold Luxottica (2.5% of Evenlode Global Income), the company that is expected to merge with Essilor in the coming months. We discussed the cultural integration of the two companies and their greatly differing operational models. Essilor operate ever closer with opticians, partnering to provide training and marketing services around the technical excellence of their product. This contrasts with Luxottica, the maker of Oakley and Ray-Ban sunglasses, who control the vertical business processes from material procurement and manufacturing, to marketing and selling to the customer (often in their own stores). An experienced management team has been tasked with finding the synergies between these business models and driving savings. The equity ownership culture of Essilor (54% of employees hold shares) needs to be "sold" to Luxottica but is highly encouraging from a governance standpoint. The merger offers great opportunities, most evidently in China where online sales are growing rapidly and consumer lens choice is less differentiated by technology and more by brand. In China it is estimated that between 800 and 900 million people have myopia (short-sightedness), a huge opportunity for future growth.
We were also given a detailed breakdown of the technological advantage built by Essilor in the lens market. The company is almost unrivaled within more complex lenses features, including UV absorption (rather than reflection) and quality of variable focus (progressive lenses). Once opticians are trained, explaining the health implications of the technology justifies additional patient spend and wins loyal customers. Research continues to further improve the product range, including shared projects with many of the world's leading academic institutions. This provides us with confidence that Essilor can continue to develop their technology and earn a premium to the market.
So, what did we learn from the trip as a whole? We already knew that these companies had excellent competitive positions, economic moats and an ability to generate free cash flow. However, it was refreshing to observe the cultural embrace of new technologies and a view of change as a positive influence. At each business, the management team appears to understand that the strong position they currently occupy will only be retained through careful planning and execution to take advantage of the changes they will undoubtedly face.
Sanofi have revamped their consumer healthcare portfolio, radically changed their drug discovery platforms and are building a position in emerging markets. Euronext have expanded their market coverage through M&A, implemented a new technology platform for trading and are entering new asset classes. Publicis have overhauled the internal structure of the organisation, shifted the business model to digital & data and realigned with the evolving needs of the FMCG customer base. Essilor have committed to a mega merger with Luxottica, further differentiated their products technically and invested in the relationship with the network of opticians that market and sell their products.
The opening French proverb remains true; “those who do not move forward, recede”. Judging by our meetings in Paris, the French companies in the Evenlode Global portfolio certainly agree.
1st October 2018