BBRYF - Tapestry And Capri: A Deep Dive Into M&A Odyssey And A Lost Decade

2023-08-23 14:18:07 ET

Summary

• Tapestry's strategy of improving its tarnished Coach brand was appealing a decade ago.
• However, 10 years later, Louis Vuitton and LULU were the frontrunners in the luxury brand arena, while Tapestry, Ralph Lauren, Capri, and Burberry struggled.
• Tapestry's accumulation of debt and acquisitions did not lead to significant profit growth, but the company has a resilient balance sheet and cash generation mechanism.

In the spirit of candid reflection, I cast my mind back to the last decade when I held a stake in Tapestry ( TPR ). The firm seemed to hover within a certain range, and upon deeper scrutiny, I could discern an undercurrent of potential. Tapestry was emerging from an era where aggressive discounting bolstered profits but, in the process, somewhat tarnished the brand's sheen. Despite the stock's price exhibiting certain frailties, I perceived a sound strategy being put into action. The inevitable choice lay ahead: a short-term dip in sales to ultimately fortify both the bottom line and the brand’s allure. As a result, throughout that decade, I found myself buying during softer periods and selling during peaks, often synchronized with earnings announcements.

I penned my first insights on this stock back in 2014, with my subsequent commentary coming in 2019. The investment journey with Tapestry turned out fruitful, largely owing to my philosophy of staggered buying and seizing opportunities to buy during dips and sell during peaks. My departure from this investment was influenced by the unfolding Covid pandemic. With the Chinese market being pivotal to Tapestry’s revenue stream, the impending lockdowns signaled a need for reevaluation. However, even before this global crisis, certain strategic moves by the company in 2019 had me slightly apprehensive. While I was optimistic about the prospects of a Kate Spade revival , I was yet to witness a full-fledged turnaround for Coach. And amidst this, Tapestry seemed eager to venture into new acquisitions.

With the passage of time granting us a clearer perspective, it seems fitting now to reflect deeper and discern where my judgments might have faltered.

Looking at the peers

When we embark on a bird's-eye view of the luxury brand arena, the landscape reveals some compelling insights. Delving into the decade-long performance of notable brands like Burberry ( BURBY ), Tapestry (TPR), Capri ( CPRI ), Lululemon Athletica ( LULU ), Ralph Lauren ( RL ), and Louis Vuitton ( LVMUY ), the story unfolds:

It's evident that Louis Vuitton and Lululemon stood out as the decade's frontrunners. Their ascendancy is all the more remarkable considering their significant size a decade prior. Conversely, brands like Tapestry, Ralph Lauren, Capri, and Burberry seemingly treaded water.

A more condensed lens of the last 5 years echoes similar sentiments.

Even year to date.

One can't help but surmise that barring Louis Vuitton and Lululemon, there seems to have been some missteps or missed opportunities with the rest.

A closer look at Tapestry

Allow me to begin by delving into the journey of Tapestry. A decade ago, the entity was recognized as Coach, with its luxury accessories Coach brand being its prime venture. This corporation then embarked on an ambitious spree of mergers and acquisitions, bringing Stuart Weitzman and Kate Spade into its fold. Along this path, it augmented its debt profile, notably reconfiguring its balance sheet to accommodate this increased debt burden.

Flashback to 2014, the firm had a nearly untarnished balance sheet with minimal debt. Fast forward, it now shoulders close to $3 billion in combined capital leases and long-term obligations. This ramp-up in leverage—from 1.5 to 3—corresponded with a substantial uptick in goodwill and intangibles.

But let's evaluate the fruits of these endeavors. Over a span of a decade, revenues have experienced a 38% surge. Yet, when we glance at the bottom line, a contrasting story emerges. Profits dwindled from $1.203 billion in 2014 to $1.172 billion by 2023. So, in essence, the firm's strategy to accumulate debt, channel funds into acquisitions for revenue growth, seemed to falter when it came to profit realization. One beacon of positivity has been their stock buyback initiatives, enhancing the EPS from $2.79 in 2014 to $3.88 in 2023.

Does this paint a gloomy picture for Tapestry? Not entirely. The company possesses a resilient balance sheet coupled with a commendable cash generation mechanism, offering a shield against potential headwinds. Yet, the firm stands on the precipice of another significant acquisition, especially when debt costs are soaring. Their target, Capri, mirrors a somewhat analogous trajectory.

Almost devoid of debt in 2014, Capri gradually stacked up liabilities over the years.

And not to forget the inflation in goodwill and intangibles.

Their leverage magnified from 1.2 to a staggering 4.1 over the decade. The outcome? A 66% boost in revenues, albeit with profits retracting from $660 million in 2014 to $619 million in 2023. These figures hardly evoke a sense of stellar performance.

Interestingly, both entities, despite their distinct challenges, seem to believe that another M&A might hold the remedy to their quandaries

Tapestry and Capri

From the recent analyst call , several key takeaways emerged. The merger promises to establish a formidable entity boasting revenues of $12 billion, marking its footprint in over 75 countries. The strategic vision revolves around capitalizing on a sprawling luxury market, believed to exceed $200 billion, offering a diverse customer palette and fortifying their stronghold particularly in Asian and European territories.

In the realm of expertise, Capri’s knowledge opens doors to innovative product exploration, while Tapestry’s prowess in technology and a consumer-focused approach promises to bolster Capri's direct engagement with their audience. Brands under the combined umbrella - namely Versace, Jimmy Choo, and Michael Kors - will retain their distinctive brand identities but will harness the cumulative resources at their disposal.

On the financial frontier, post-acquisition projections are optimistic. The conglomerate foresees revenue escalations, enhanced direct-to-consumer engagement, and unwavering operating margins driven by tangible cost curtailments and optimized operations. The merger pins hopes on unlocking $200 million in synergies within a three-year window, largely attributed to the elimination of redundant corporate expenditures and enhanced supply chain dexterity.

Conclusion

Drawing a parallel to the tech world, this strategic move evokes memories of Anssi Vanjoki's poignant observation in 2005, likening the BenQ and Siemens union to " Two turkeys not making an eagle. "

The primary synergistic value being the elimination of duplicative roles does raise eyebrows. Even the pro forma operating profit, albeit on paper, presents a lackluster picture. Envisaging independent profits of $1.2 billion for Tapestry and $0.8 billion for Capri, the combined financial muscle is projected at $1.9 billion – a sum that appears to be losing steam before the journey has even commenced. While I intend to monitor this development closely, the last decade’s modest achievements do infuse a degree of skepticism.

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