The narrow-moat company's hookup is strategically sound, but better positioning Kate, extracting synergies, and expanding globally will take investment priority.
We think narrow-moat Coach
’s intent to purchase Kate Spade is strategically sound, allowing for management to use its talents in elevating brand distribution channels and achieving supply chain efficiencies to deliver returns for shareholders (with management expecting it to be accretive in fiscal year 2018 and plans for it to reach double-digit accretion in fiscal year 2019). Although we expect some top-line declines at the brand as we believe management will likely exit some lower tier distribution channels, we see this being offset by about $50 million in cost of goods sold and SG&A synergies, to be recognized by fiscal 2020. We estimate that the acquisition price of $2.4 billion implies a forward EV/EBITDA multiple of just under 9 times (and a 27.5% premium to the closing price of Kate shares on Dec. 27, 2016, the last day prior to media speculation of a transaction), which we view to be fair.
Bridget Weishaar is a senior equity analyst for Morningstar.
We are modeling this transaction to close early in fiscal 2018, with Kate adding $1.46 billion in revenue (24% of the combined firm’s total) and about $200 million in operating income (18% of consolidated operating income), driving our fair value estimate to $47.50 from $43.50. In our opinion, Coach management has successfully executed on a significant portion of the Coach brand repositioning, so we think that this acquisition comes at an ideal time and will not interfere with core brand performance (in alignment with our standard stewardship rating). That said, we think efforts to better position Kate, extract synergies, and expand globally will now take investment priority, and we do not foresee any additional large new brand acquisitions in the near term. Given Coach’s clean balance sheet, we see this all-cash transaction immediately driving debt to EBITDA north of 2 times but correcting to the 1 time range by year-end as the company repays the anticipated $800 million 6-month term loan with excess cash. We continue to view Coach as fairly valued.
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