Question

Coach is paying luxury prices to catch up with the Europeans.

The handbag maker is paying $2.4 billion for its rival Kate Spade, a figure not justified strictly by the numbers. But Coach’s owners like the $13 billion company’s move to a multibrand portfolio, which has worked for the industry leaders LVMH and Kering. Mature luxury brands can no longer expect to succeed on their own.

The deal on Monday represents a 27.5 percent premium on Kate Spade’s share price before talk about a possible deal emerged in December, or about $515 million. Coach is promising to cut only $50 million in costs, mainly from supply-chain savings rather than store closings, according to its chief executive, Victor Luis. Taxed and capitalized, these are worth about $320 million today, suggesting Coach is overpaying by about $200 million.

But while the deal math doesn’t quite add up, Coach’s investors lifted its share price about 6 percent, an indication that they trust an acquisition strategy like the one Gucci’s parent, Kering, and the French handbag-to-Champagne conglomerate LVMH have successfully pioneered. Despite a 1 percent contraction in the luxury sector globally in 2016, according to Bain, LVMH shares have soared 61 percent and Kering has doubled over the last year. Compare that with single-brand companies: Michael Kors is down 25 percent, Tod’s of Italy is up 8 percent and Burberry has gained 37 percent.

This suggests that holding a diverse portfolio of brands works well in a sector particularly sensitive to geopolitical, travel and currency shifts. But given that the market is also contracting thanks to slowing economic growth in China and President Xi Jinping’s crackdown on corruption, it also means that Kering and LVMH are expanding their slices of the profit pie.

Coach is far from becoming America’s answer to LVMH. Kate Spade sells midrange luxury handbags primarily to Americans, much as Coach does. Spade may help gain access to millennial shoppers, but the brand remains relatively unknown in Asia. The success of this transaction is also contingent on Coach’s applying the turnaround strategy it has employed on its core business.

Mr. Luis has promised that under Coach, Spade would pull back from discounting and sell fewer bags at department stores. That strategy bolstered Coach’s bottom line. It reported an estimates-beating 9 percent increase in profit in its last quarter. But performance in Asia remained relatively flat. Sales increased 2 percent in China, but decreased 1 percent in Japan, both on a constant-currency basis.

Copying the European cool people will take more than window dressing.

1. How should you analyze this acquisition?

What is the case about?

What is the benefit?

What is the potential loss or jeopardy?

What is the team's opinion about this acquisition?

Answer 1

This acquisition will have to be analyzed from a strategic and a financial point of view. Strategically the acquisition makes sense as Coach can gain from the multi-brand portfolio of Kate Spade and can bolster its position in the midrange luxury segment of handbags. But from a financial point of view the 27.5 percent premium does not make sense at all, given that costs cuttings will not be high and stores doing badly will not be closed.

The case is about the acquisition of Kate Spade by Coach. It talks about whether the deal will work or not in the future and shares the acquisition strategy that was adopted by Gucci and LVMH in the past. The case talks about the reasons why the acquisition does not make much sense given the market conditions in Asia and given the difficulty in implementing the turnaround strategy that has been proposed here.

The primary benefit will be that Coach will stand to gain from the multi brand portfolio of Kate Spade. This is because mature luxury brands are finding it increasingly difficult to compete and succeed on their own.

The potential jeopardy is that the turnaround strategy may fail to generate expected synergies and this may lead to the deal being a bad strategic decision. If expected synergies are not developed then the premium of 27.5 percent will make the deal financially unviable and this will impact the company’s valuations and its future sustainability as a going concern.

The team’s opinion about this acquisition is that Coach is acquiring Kate Spade without a proper strategy as to how it will make the acquisition work. There is a clear strategic gap and this may hurt the deal in future.