The price is right. The strategy makes sense. Now it’s up to the management team at Coach (COH) to execute.
Yesterday, May 8, Coach announced that it would buy Kate Spade (KATE) for $18.50 a share. That’s a 27.5% premium on the December 2016 price for the shares of the maker of handbags and accessories targeted at the millennial market. But Kate Spade shares traded at $24 just two months ago and the price of “only” 9.4 times cash flow is way below the average of 14 times for recent deals in the luxury sector. After the all-cash deal debt at Coach will be twice operating cash flow. (Coach is a member of my Dividend Portfolio. The shares are up 21.55% as of the close on May 9 since I added them to this portfolio on December 6, 2016.)
The move to buy Kate Spade is part of Coach’s effort to expand from a maker of leather goods stamped with its logo to a full-line luxury goods retailer with multiple brands. The objective is to end up with a structure like that of French luxury giant LVMH Moet Hennessy Louis Vuitton (LVMUY)–although Coach obviously as a long way to go to reach anything like that stature. But recent moves have pushed Coach in that direction–the introduction of the company’s 1941 luxury label, the acquisition of shoemaker Stuart Weitzman, and now the acquisition of Kate Spade. As part of that effort Coach has also added more stores overseas and cut back on its discount sales.
Those last two moves will also help push up sales and income at Kate Spade too. Coach’s extensive retail network in China and Japan will help Kate Spade expand in those markets and Coach’s experience in trimming back its own use of discounts will be useful discipline at Kate Spade where discounting has run amuck in recent years.
On the other hand, the acquisition of Kate Spade gives Coach a big opening in the millennial market–about 60% of Kate Spade’s sales are to that demographic.
Now, of course, Coach simply has to keep those customers happy–the Kate Spade line of colorful, fun, and whimsical bags is at the opposite end of the fashion spectrum from Coach’s core offerings. Coach has said that Kate Spade, founded by designer Kate Spade in 1993, will keep its own design, marketing, and sales teams.