2023-08-18 07:30:29 ET
Summary
- Tapestry announced fourth-quarter results that missed expectations, as revenues of $1.62 billion missed by $30 million, and EPS of $0.95 missed by $0.01.
- The results were not the center of attention, with the Capri takeover sitting on top of investors' minds.
- Tapestry announced it's acquiring Capri Holdings, owner of Versace, Jimmy Choo, and Michael Kors, for $8.5 billion, paying a 59% premium over CPRI's pre-announcement market price.
- In a quick transformation of wealth, Tapestry shareholders lost pretty much what Capri shareholders gained, as investors are doubting the potential of the merged entity.
- I rate TPR stock as a Hold, as I find a lot of red flags regarding the acquisition, but estimate that the current valuation reflects very low expectations.
Tapestry (TPR), the owner of the Coach, Kate Spade New York, and Stuart Weitzman brands, announced fourth-quarter results that missed subdued expectations. However, I believe the company's results are the last thing on Tapestry's investors' minds.
It's been exactly a week since Tapestry announced it reached an agreement to acquire Capri Holdings (CPRI), the owner of Versace, Jimmy Choo, and Michael Kors, for $57 per share, a price that reflects a 59% premium over Capri's market price before the announcement.
At first glance, it seems like the acquirer, Tapestry, is trying to fix its own problems by acquiring another problematic asset. It doesn't usually turn out well, as according to most studies, 70%-90% of acquisitions fail. Before we jump to conclusions, let's dive into the prospects of the future six-armed group.
Background
In June, I wrote an article about Capri, claiming ' It's A Value Trap, But A Likely Takeover Candidate ', as I thought the company's fundamentals are showing no signs of improvement, but its low valuation was observably attractive for the right buyer. At the end of June, I initiated coverage on Tapestry as well, with a thesis that could be summarized as a weak buy, as I thought the upside is very low.
To my surprise, the takeover came early. Clearly, the companies decided to make my life easier so I'd only have to cover one combined entity from now on.
Jokes aside, there are a lot of question marks surrounding the acquisition, but one thing is quite clear. If you're a Capri shareholder, you should be quite happy. I rate the stock a Sell, in my post-announcement article ' Capri Holdings: The Takeover Is Finally Here '.
This article will be dedicated to analyzing the acquisition through the eyes of the Tapestry shareholder. Let's dive in.
Acquisition Terms
Tapestry will acquire all outstanding shares of Capri, for a total consideration of $57 per share, reflecting an enterprise value of $8.5 billion, consisting of $6.8 billion in equity value and $1.7 billion in net debt.
The acquirer has already secured an $8.0 billion bridge loan, which it plans to replace with a combination of senior notes and a term loan. The interest rates on those are yet to be disclosed. Following the acquisition, Tapestry's net debt should amount to approximately $9 billion.
The companies expect closing in calendar year 2024, subject to customary closing conditions including the approval of Capri's shareholders, and receipt of the required regulatory approval.
The agreement allows for termination in specific situations, including mutual agreement, government orders preventing the merger, failure to complete the merger by August 10, 2024 (with possible extensions for regulatory approvals), failure to obtain Capri Shareholder Approval, uncured breaches of representations or covenants, Capri's breach of non-solicit covenants, adverse changes in Capri's board recommendation, or entry into a better offer. If certain termination conditions are met, Capri will have to pay Tapestry a $240 million cash termination fee.
Regarding the management structure, we didn't receive official details, but the overall impression from the companies' joint statements and joint investor conference is that Capri's executives will remain in place.
Tapestry And Capri - The Merged Entity
Tapestry and Capri share a lot of things in common. Both companies started as mono brands, generated excitement over acquisitions, and then failed with their integration.
Capri started as Michael Kors, it then acquired Jimmy Choo and Versace in 2017 and 2018. Together, the acquired brands grew sales at a mid-single-digit CAGR and failed to achieve industry-average margins.
Tapestry started as Coach, it acquired Stuart Weitzman in 2015 and Kate Spade New York in 2018. Between 2018-2023, Stuart Weitzman sales only decreased and margins remained low, Kate Spade grew revenues at a miserable 3% CAGR and margins only improved slightly.
Furthermore, both companies operate in the high-end fashion category or as they like to call it "accessible luxury". Additionally, both companies are currently on a downtrend in terms of margins and growth.
And if you're not convinced yet, look at their stocks' performance over the past five years, up until the divergence following the announcement.
Together, their combined group will own six different brands, including Coach, Kate Spade, Stuart Weitzman, Versace, Jimmy Choo, and Michael Kors. We can divide this group into two categories. In luxury, we have Versace, and arguably Jimmy Choo. In high-end fashion, we have Michael Kors, Coach, Kate Spade, and Stuart Weitzman.
TPR-CPRI Investor Presentation
Between the six brands, the merged entity will own nearly 2,700 retail stores and a significant digital presence, as the combined direct-to-consumer sales accounts for approximately 79% of the group's sales.
Geographically, the Americas will remain the most notable region with 61% of the group's sales, Asia will come in second with 23% and the rest of the world will account for 16%.
A more significant change will occur in product categories, as accessories will account for 67%, and the Footwear business, thanks to Jimmy Choo and Versace, will become 15% of the group's sales. Apparel should account for 10%, and the rest is attributed to licensing and others.
TPR-CPRI Investor Presentation
The two companies provided lackluster growth during the past few years, with a pro-forma revenue CAGR of 3.0% between FY18-FY23. Individually, Tapestry grew at a 2.5% CAGR during the period, and Capri was slightly better at 3.5%.
For reference, luxury names LVMH (LVMHF) grew at a 14.0% CAGR, Richemont (CFRHF) grew at 12.6%, and even Kering (PPRUF) grew at a double-digit pace. On the contrary, high-end names like Ralph Lauren (RL) and PVH Corp (PVH) were pretty much flat during the period.
Created and calculated by the author based on data from the companies' financial reports; Capri's fiscal year is one quarter ahead of Tapestry.
Looking at operating profit, we see an even more disappointing picture. Operating profit barely grew during the past six years, as revenue growth was offset by a 270 bps margin contraction. Overall, both companies experienced fluctuations in profitability, but for Capri, it was dramatically worse, as operating profit in FY23 was actually lower than in FY18.
Created and calculated by the author based on data from the companies' financial reports; Capri's fiscal year is one quarter ahead of Tapestry.
What Is The Purpose Of The Deal?
According to Harvard Business Review , over 70% of acquisitions fail to generate value for the acquirer's shareholders. In the article, they claim the reason for the very high failure rate is:
Acquisitions fall short of expectations because executives incorrectly match candidates to the strategic purpose of the deal.
To analyze whether the acquisition succeeds or not, we need to first define the purpose of the deal for Tapestry. Let's see what management has to say.
The acquisition of Capri marks an incredible milestone in our evolution as a company and accelerates our strategic agenda.
First, this combination expands our global reach.
Second, together, we enhanced our global footprint in geographic diversification with our complementary positions in Asia and Europe.
Third, with this acquisition, we are broadening our product offering and capabilities through an increased penetration of lifestyle categories, where Capri brings expertise and there is further opportunity for growth across each of our brands.
Fourth, this combination further leverages Tapestry's consumer engagement platform and data analytics capabilities built on a modern technology infrastructure to drive deeper consumer connections.
--- Joanne Crevoiserat, Tapestry's CEO, Acquisition Conference Call [ edited by the author ]
You can judge for yourself what this list means. To me, it's a complex way of saying they acquired three brands, and they plan to do a better job with them, in terms of growth and profitability.
This kind of deal is quite common in the fashion industry, and while many of them succeed, taking LVMH's empire as an example, many of them fail as well, looking at examples like Adidas and Reebok. Another example of failure is pretty much under our nose, as both Capri and Tapestry can't really say they succeeded with their previous acquisitions.
Red Flags All Over
The market's opinion of the acquisition is quite clear, as Tapestry's market cap dropped nearly 17% following the announcement, shedding more than $1.6 billion in value. Interestingly, that's pretty much in line with the $2 billion rise in value for Capri, in what turns out to be almost a zero-sum game.
The acquisition price reflects an EV / LTM Adj. EBITDA multiple of 9x, which is slightly below the levels of valuations for higher-quality companies, including Richemont and Kering.
Aside from the price, there are multiple red flags surrounding the deal.
Capri's Management Staying In Place
I know Tapestry team has great respect for our reputation designing exceptional innovative luxury products. Versace, Jimmy Choo, and Michael Kors will continue to execute on their strategies under the current leadership of Donatella Versace and Emmanuel Ginsberg, Sandra Choi and Hannah Coleman, and Michael Kors and Cedric Wilmot.
--- John Idol, Capri's Chairman and CEO, Acquisition Conference Call
To my best understanding, John Idol, who led Capri for the past twenty years, is also going to assume some kind of leadership role in the merged entity.
If there's one thing that's clear about the formula for success in LVMH is that Bernard Arnault is aggressively changing the acquired entity's culture, placing his people in leadership roles, and usually transforming the entire marketing strategy.
Personally, I don't understand how the same leaders, who have been there for quite some time, will all of a sudden revive their underperforming brands.
The Timing Of The Deal
Capri has been trading at or below the transaction price for the majority of the past five years. During that period, Tapestry has been pretty much treading water as well. In my view, both companies are doing this from a point of weakness, more than they are from a point of strength.
Capri hasn't been able to transition to the DTC channel as quickly and as efficiently as expected. It led the company to generate unsteady profits, and the stock to decline materially. I assume its management and the Board understood that they won't be able to generate an upside that's remotely close to the deal premium for their shareholders, and understood declining it would be unreasonable.
And on Tapestry's side, the company's previous acquisitions, specifically, the Stuart Weitzman acquisition, haven't worked out. In Coach, growth that was already quite low has come to a halt, and the future didn't look bright either, as the consumer category it caters to has become sensitive to the macroeconomic pressure.
Brand Differences
Versace and Jimmy Choo aren't "accessible-luxury". To get a grasp of the differences, Coach actually operates an online outlet store which is pretty much the opposite of luxury.
In my opinion, luxury requires different marketing, different store designs, and a unique customer experience. Combining those brands together might actually dilute the value of the Versace and Jimmy Choo brands even further.
For reference, Kering, which only owns luxury brands, generated sales of over $22 billion in 2022, operating less than 1,700 stores, whereas Tapestry and Capri combined generated $12 billion in sales, operating nearly 2,700 stores.
The difference is immense, and it comes in the form of lower growth, and lower profitability.
The Use Of Misleading Non-GAAP Metrics
As I discussed in my previous Capri articles, I view the adjusted numbers the company provides as misleading, as I believe they don't reflect the true state of the company's operations. For example, Capri excluded costs regarding ERP implementation, recurring store improvements, and e-commerce development, all of which are in my view core operating expenses.
Tapestry, on the other hand, did not use adjusted metrics in their earnings releases. Look at their third-quarter release for example. You will not find the word adjusted anywhere in the press release. Now look at their definitive agreement announcement . All of a sudden, the company talks in adjusted terms.
The beauty of guiding for accretive EPS on an adjusted basis is that you can always adjust certain expenses and deliver on the promise.
On The Positive Side
Tapestry and Capri have both reached a point where they had no reliable outlook for a turnaround.
Together, the companies are guiding for approximately $200 million in cost synergies, which is quite reasonable, and can be generated just from cutting certain corporate costs. Additionally, Capri has been investing a lot in digitalization, something that Tapestry is already quite advanced at.
The combined entity will have more resources to compete with fashion giants for top marketing talent, as well as brand promoters. Furthermore, the companies will be able to join forces in terms of logistics, saving costs on raw materials and distribution.
And, after the acquisition, there's a chance that the somewhat complacent management teams will become more rejuvenated and hungry, as they feel less comfortable in their old familiar seats. Hopefully, this will result in growth acceleration for their collection of six stalwarts.
Looking at the underlying valuation of Tapestry, we get to a Pro-forma enterprise value of almost $17 billion, which reflects its current equity value (market cap) of $8 billion, and projected net debt position which amounts to $8.9 billion.
As we saw, the Pro-forma EBIT for FY23 was $2 billion, which means Tapestry currently trades at an 8.5x EV / EBIT multiple, which is quite low, and does not reflect high expectations. Thus, any surprise to the upside should result in a decent return for shareholders.
Conclusion
Tapestry's fourth-quarter results became quite redundant in light of the upcoming Capri acquisition. While there's still time before the deal closes, investors are seemingly more focused on the potential success of the merged entity, rather than the near-term struggles of the separate companies.
In my view, there are plenty of red flags surrounding the deal, including the price, the lack of aggressiveness regarding management transformation, the deal's timing, the differences between the six brands, and the use of Non-GAAP numbers to present the deal to shareholders.
However, I believe the current valuation reflects very low expectations and estimate there are clear opportunities to drive growth acceleration and cost-synergies.
Therefore, I rate the stock a Hold.
For further details see:
Tapestry: Capri Acquisition Raises Multiple Red Flags (Rating Downgrade)