Coach’s Growing Millennial Focus Makes Kate Spade the Better M&A Play

Talks between Coach Inc. and Kate Spade & Co. may have cooled in recent weeks, but don’t rule out an acquisition by Coach just yet.

Coach on Tuesday posted third-quarter results in which profits were better-than-expected, even though net sales were below Wall Street’s consensus estimates. The accessories firm certainly delivered on profits — it beat Wall Street’s diluted EPS estimates by 2 cents and posted the fourth consecutive quarter of comparable-store sales gains. The results sent Coach shares up 11.4 percent to $43.15 in Big Board trading.

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Coach’s chief executive officer Victor Luis — while not giving away too many specifics — has always been fairly straightforward about the company’s general mergers and acquisitions strategy, but his comments this time around actually provided the most detailed insight into the group’s thinking on the mergers and acquisitions front.

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During the conference call to Wall Street analysts, Luis said: “We’re looking for great brands. Brands that have the potential for growth. Brand health and consumer perception for us is absolutely critical. We aren’t looking for brands that have in essence lost their way or need to be completely repaired or repositioned in the minds of consumers.”

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He added “healthy brands that have a unique positioning” and allow the company to leverage its expertise — sourcing, leather-goods positioning — to “diversify, whether that be our consumer target or specific consumer attitude or segments of the markets or perhaps a geography channel or category are what interests [us] most and what we’re most focused on.”

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In a telephone interview after the earnings call, Luis said the company’s acquisitions strategy is “not focused on any specific geography at all.”

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One of the hiccups in a Kate Spade and Coach hook-up has been Kate Spade’s stock price. It was trading in the $18-a-share range when it was first disclosed that Coach might be angling to buy its competitor, and Wall Street and investment bankers thought $24- or $25-a-share would be the uppermost price per share range that Coach might be willing to pay. Financial sources told WWD that a per-share-price range of $20 to $21 is the more reasonable premium for Kate Spade, given the retail backdrop. But the stock price eventually got ahead of itself — it went as high as $24.24 on March 1 — as investors were anticipating a price premium for Kate Spade. Then reality got in the way. Kate Spade released first-quarter earnings that were somewhat lackluster, and its shares have settled back down to the $17-a-share trading range.

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As the parties appear to be taking a breather from the negotiating table, Kate Spade’s broadening of its pool of potential buyers to include private equity firms allows it to test the waters, even though strategic buyers typically pay more than financial sponsors. That also applies a bit of pressure on Coach to step up to the plate and get a deal done.

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According to Ariel Ohana of Ohana & Co., “With the hire of Josh Schulman [as president and ceo of the Coach brand], Coach made it clear that they are trying to build a multibrand luxury conglomerate, and there aren’t so many sizable options available.”

In the past week, there’s been chatter about Coach possibly eyeballing Jimmy Choo as an acquisition target. The Bally brand is also now available after JAB Holding put both subsidiaries up for sale last week.

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So the dilemma for Coach is whether it wants American luxury, better known as lifestyle brands such as Kate Spade, or European luxury and its unique heritage, often viewed as representative of the world’s true luxury brands. And after reviewing the pros and cons of each, it might not be much of a dilemma for Coach after all.

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In the telephone interview, Luis said he was “incredibly proud of what is happening with the transformation of the Coach brand and [the ability of] bringing the Coach brand into the fashion conversation. In two years, we’ve become a credible player in the fashion space.”

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While buying a Jimmy Choo or Bally would bring immediate luxury credentials to Coach, both brands are accompanied with risk. One investment banker thought the Bally brand resonated more with men than women, while Coach’s core base is the women’s market.

 

Another investment banker in the luxury space called Bally a “tired brand.” Moreover, Luis said in Tuesday’s conference call, he wasn’t interested in brands that need to be repaired or repositioned. That also rules out what has been speculation over the past six months that Coach might be interested in acquiring its other American competitor, Michael Kors Holdings, which is in the midst of trying to turn around its North American fortunes.

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As for Choo, a stumbling block is how one grows the brand, which is on the block for the fourth time. A banker suggested the possibility of a sub-label targeting a lower-tier price point, while acknowledging that brings risk to the higher-end line. In the telephone interview, Luis spoke about growing the group’s Stuart Weitzman brand, which could serve as a barometer for the limitations in expanding Jimmy Choo.

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Luis said the next category for expansion for Weitzman would be in handbags and small leather goods. That should be ready in May 2018, and will be spearheaded by the footwear brand’s new creative director Giovanni Morelli, who joins the company this week. As for other category extensions, Luis noted fragrances and soft accessories. He didn’t rule out the possibility — at some point way down the road — of turning Weitzman into a lifestyle brand, but said right now Coach’s interests was in focusing on “leather goods and accessories, footwear and outerwear.”

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Luis added, “That doesn’t mean we as a company do not believe in apparel at all, we just do not see apparel as a core growth category for us in the short- or medium-term.”

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He reiterated the company’s preference for any acquisition to be able to leverage the group’s supply chain, as well as its in-house talent “around the world.”

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Kate Spade in many ways still fits the bill. The company can benefit from both Coach’s supply chain know-how and its team of executives overseas to bring the brand to more international markets. Further, financial sources said the company has been making queries on what pricing it could get for larger volume orders for raw materials, such as leather. And the brand, which is favored by Millennials, is within the target group of consumers Coach is targeting with its higher-end 1941 Collection.

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During the call, Luis said the Weitzman brand has been “gaining traction with the Millennial consumer.” He also spoke about the partnership the Coach label has with brand ambassador Selena Gomez, who wore Coach to the Met Gala on Monday night in Manhattan. The custom handbag she collaborated on with designer Stuart Vevers will be in the brand’s stores and select department store doors globally in the fall. And the first global handbag advertising campaign with Gomez will begin running in July through the fall and winter and will be followed by a second campaign in spring 2018.

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So far, Coach has pulled out of over 250 doors in the department store channel, and the brand expects to have in the range of 700 luxury doors by the end of the year. The company said the penetration of the above $400 price bracket — driven by the Rogue and Swagger silhouettes — increased to over 55 percent of handbag sales in North America, up from 40 percent a year ago. For Collection, 1941 handbags represent 40 percent of handbag sales in its top-tier retail stores.

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Jane Hali of Jane Hali & Associates said, “Coach continues to be heading in the right direction with their strategy. Their continued approach to target Millennials and use of celebrity influencers such as Selena Gomez is key for global Millennial awareness.”

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Wells Fargo’s Ike Boruchow said Coach has a solid outlook for the fourth quarter, noting, “business appears to be gaining momentum.” Jefferies’ Randal J. Konik said gross margin expansion — up 190 basis points year-over-year to 70.9 percent following last quarter’s 110 basis point increase — highlights the brand’s revival.

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