2023-08-11 06:13:19 ET
Summary
- Investors lost interest in Capri Holdings' first-quarter results as those became redundant in light of the long-awaited takeover finally happening.
- Tapestry has agreed to acquire Capri for a price of $57 per share, reflecting a 59% premium over the pre-announcement market price.
- The deal is projected to materialize in calendar 2024, reflecting there's still time before investors receive the full price.
- Looking at Capri's results, the company continued to significantly underperform, with sales decreasing 9.6% and EPS declining an astounding 76.1%.
- No turnaround is happening any time soon, and there's always a chance the deal won't go through. I advise investors to exploit the opportunity and sell their CPRI shares.
Capri Holdings (CPRI), the owner of the Versace, Jimmy Choo, and Michael Kors brands, announced Q1-24 results that exceed subdued expectations, but the results aren't the focus of attention.
After the company delayed its announcement from Tuesday, there were only two options, either something really bad is happening, or, a takeover was soon to be announced.
Tapestry (TPR) saved the day, as it agreed to purchase 100% of Capri's shares at a price per share of $57, reflecting a 59% premium over the 30-day volume-weighted average price ending August 9, 2023. The deal is expected to close in calendar 2024.
Capri has been trading at a very obvious discount compared to its peers, a discount which I claimed is justified. As I wrote in my previous article, the best scenario for Capri shareholders would be a takeover, and here it is.
After the 55% surge following the announcement, I believe investors should sell their shares rather than wait for the story to develop.
I'll discuss the implications of the deal from Tapestry's point of view in a detailed article next week, following the company's earnings release.
Background
At the end of June, I wrote an article about Capri Holdings, claiming ' It's A Value Trap, But A Likely Takeover Candidate ', as I thought investors were overly focused on its low P/E and disregarded obvious red flags. On the other hand, I estimated its renowned brands will appeal to the right buyer, in an industry where takeovers are a common practice.
The owner of Versace and Jimmy Choo, supposable luxury brands, had near-zero revenue growth during one of the best growth periods for luxury. Its operating margins are inexplicably low, and it continues to rely on wholesalers to generate a significant portion of its sales.
The company is also an outlier in terms of reporting, with peculiar adjustments that I view as intentionally misleading.
Led by the same CEO for over twenty years, I saw no vision, no strategy, and no path for a turnaround in the foreseeable future. Thus, I rated the stock a sell despite the low valuation and advised holding it only as a hold-and-wait-for-an-acquisition play.
This Week's Rollercoaster Ride - Earnings Delay & Takeover Announcement By Tapestry
As investors were anxiously waiting for Capri's fiscal 2024 first-quarter results announcement on Tuesday, the company released an update the night before, saying it will delay its announcement to Thursday.
Typically, when a company delays its earnings report (not a common phenomenon), it means one of two things. Either there's something suspicious happening in its books and there are internal disputes about what exactly to include and say in the report, or, there's an important announcement to make which is yet to become publishable.
Well, now we know it's the latter, as Capri's first-quarter results became essentially redundant in light of the Tapestry takeover announcement.
Following an article by the Wall Street Journal, Capri's stock surged 30% in hopes of the news being true, despite the fact no details regarding price were provided.
To the delight of pre-market investors, the parties announced an agreement valuing Capri at $57 a share, reflecting a premium of approximately 59% over the pre-acquisition market price.
I find this price reasonable, as it reflects what I've discussed in my previous article. Capri is a distressed asset, and although it's not drowning in debt, it's clear that its management have done a lackluster job with its portfolio of brands.
For reference, Capri acquired Versace and Jimmy Choo for a combined enterprise value of $3.5 billion. In 2017, prior to those acquisitions, Capri was trading at a market cap of approximately $5.5 billion, getting us to a combined $9 billion. Six years later, it is being sold for $8.5 billion.
I believe Capri's investors should be more than happy with the 59% premium and sell the stock as it trades in the $50-$55 range, considering there's always a chance the deal will fall through.
In the release, the companies provided a target date of calendar 2024, which isn't too specific. Historically, those no-mans-land periods don't provide additional upside, and I don't think it's reasonable to expect the soon-to-be-acquired Capri will all of a sudden turn around its business. Therefore, I don't think there's a favorable risk-reward match in continuing to hold the stock at current prices.
Capri Holdings Is Still One Of The Cheapest Among Its Peers
There's one thing that's in consensus, Capri isn't close to being the highest quality in its industry. The only reason investors have considered investing in a company that's a clear underperformer is the price.
Prior to the announcement, Capri was at the very bottom among luxury peers in terms of valuation. Even if we use the transaction price of $57 per share, Capri would only become the second cheapest on the list, surpassing only its acquirer.
As we discussed in the previous article, Capri isn't really comparable to any of the names in the graph, with the exception of Tapestry, although even the latter is performing much better fundamentally.
Looking at a list of more comparable names including PVH Corp (PVH) and Ralph Lauren (RL), we see Capri traded at the very low end in terms of valuation, with a 5.8x forward P/E. However, in this case, if we use the transaction price, we'll arrive to a relatively high P/E ratio of 9.2x, very close to Tapestry.
Just like we said in the previous article, investors should ask themselves at this point - why was the company so observably cheap? Let's go over its financial results in the first quarter of fiscal 2024 and try to find out.
Capri Q1 2024 Financial Review
Revenues decreased 9.6% to $1.2 billion, as 6.4% growth in Jimmy Choo was offset by 5.8% and 13.8% declines in Versace and Michael Kors. Operating profit declined 65% to $80 million, and operating margin was 6.5%. Net income was $48 million, and EPS was $0.41, both decreasing over 70%.
Versace's operating profit decreased an astounding 94.2% and amounted to $3 million, reflecting a 1.2% margin, a 1770 bps decline. Jimmi Choo's operating profit decreased by 15.8% and amounted to $16 million, reflecting an 8.7% margin, a 270 bps decline. Lastly, Michael Kors' operating profit decreased by 41.4% and amounted to $130 million, reflecting a 16.5% margin, a 780 bps decline.
On the positive side, those unarguably bad numbers were actually better than expected, reflecting the low guidance and low expectations from the company.
Questionable Adjustments
Let's go through the company's adjustments briefly, and focus on why I believe they are misleading. First, the company excludes foreign currency impact from its adjusted EPS. Not too common, but I'm fine with that. Then, for some reason, management decides to exclude ERP implementation, which is a very regular G&A expense, that's much harder to swallow. Lastly, they add 'Capri Transformation' expenses.
In case you were wondering, those are:
The Capri transformation program represents a multi-year, multi-project initiative extending through Fiscal 2026 intended to improve the operating effectiveness and efficiency of our organization by creating best in class shared platforms across our brands and by expanding our digital capabilities. These initiatives cover multiple aspects of our operations including supply chain, marketing, omni-channel customer experience, e-commerce, data analytics and IT infrastructure. through Fiscal 2026, we expect expenditures up to $220 million related to these efforts.
Keep in mind, this isn't restructuring like you're seeing in Meta (META) or Alphabet (GOOG), which are non-recurring one-offs primarily due to extensive layoffs. This is literally continuing operating expenses which are essential in every company.
All in all, in my opinion, investors should look at the $0.41 GAAP EPS as reflective of the company's operations, and take the $0.1 F/X impact into consideration. Other than that, that's just nonsense, for lack of a better word.
Valuation & Decision Time
One of the first lessons they teach you regarding the evaluation of businesses is that the agreed price in a deal between a willing buyer and a willing seller (of the entire business, not a single stock), is most likely the best indication for the business' fair price.
According to the announced terms of the deal, said price is $57 per share. Adjusting for an acceptable control premium of 30%, we can infer that Tapestry's management values Capri's shares at $39.9.
With that in mind, there's really no reason to go into a lengthy valuation analysis. Rather, we should focus on the probability the deal will materialize at the agreed price, and how long will it take.
Investors who hold Capri shares should consider the following three scenarios:(1) The deal gets canceled; (2) A better deal comes along; (3) The deal is completed at the announced price.
In my view, the probability for the first scenario is low. According to the announcement, the deal should be completed in calendar 2024. Historically, regulators rarely intervene with acquisitions in the fashion industry, as evident by the enablement of behemoths like LVMH (LVMHF) and Kering (PPRUF). Moreover, the Wall Street Journal article mentions that the deal has been under discussion for months, insinuating that a lot of the due diligence process is already behind us.
Continuing on, I estimate the probability for the second scenario to be close to zero. The companies had a shared announcement. Capri has been trading at a cheap valuation for years, and the larger players in Kering and LVMH are not the kind that isn't aware of every potential opportunity.
Therefore, we are left with the third scenario, which I believe has the highest probability, as I believe there's a very high chance the deal gets completed in the first half of 2024.
As I discussed in the previous sections, I estimate that in case the deal fails the stock will very quickly fall back to its pre-announced price and probably even lower. At the time of writing, Capri is trading at $53.9 per share, 5.4% below the deal price. Unless you believe the second scenario has a much higher probability, I see no reason to hold the stock for that extra 5.4%, as the consequences of a potential cancellation would be harsh.
Conclusion
Capri shareholders have been through a rough ride. Long-term holders have seen the company peak in 2014, held through two large acquisitions in 2017 and 2018, only to see the company being acquired at a lower underlying value six years later.
Investors who bought at the February 2023 peak are still in the red, despite the 59% premium Tapestry agreed to pay.
I believe Capri investors should be happy with the deal, as the company's first-quarter results show that no turnaround was happening anytime soon.
Thus, I advise investors to sell at current prices, as there's always a risk of the deal falling through, which would presumably send the stock back to its pre-announced price and probably even lower. I don't see a reason to wait a year for an additional 5.4% and advise shareholders to exploit the current opportunity.
For further details see:
Capri Holdings: The Takeover Is Finally Here