Coach (COH) has increasingly yearned to be a portfolio manager of accessories brands that it could grow, and just opened its pocketbook up very wide to further that mission.
The handbag and accessories maker said Monday it will acquire Kate Spade (KATE) for $2.4 billion. The deal represents a 27.5 percent premium to Kate Spade's closing price as December 27, 2016, which is when speculation of Coach's interest surfaced. Kate Spade shares closed Friday at $16.97. They surged more than 8 percent on Monday to $18.38, while Coach's stock gained 4.8 percent to $44.71.
Coach sees about $50 million in cost savings within three years of the deal closing, most of which will come from closing unproductive locations at department stores and consolidating operations. On a conference call with analysts, Coach executives said Kate Spade will continue to be an independent brand, but will likely leverage its best in class leather supply chain.
Kate Spade could use any help Coach's executives may have on offer.
After a successful 2016 that saw sales climb 13 percent to $1.38 billion and earnings jump 40 percent to 70 cents a share, Kate Spade struggled in the first quarter. Sales fell slightly in the quarter to $271 million, while earnings declined to 1 cent a share from 5 cents a year earlier.
For watchers of Coach under CEO Victor Luis, who assumed the leadership position in January 2014, the play for Kate Spade isn't a shocker. It was always a matter of when Coach's next deal would happen, not if. In January 2015, Coach spent $574 million to buy designer footwear maker Stuart Weitzman.
"We have been pretty consistent in discussing our interest in three spaces -- the handbag and accessory space, the footwear space, outerwear as well as other luxury retail categories because it is about the unique skill-set we can bring to any acquisition," Luis said in an interview with TheStreet in November about his views on potential acquisitions. Luis believes Coach is best in class in quickly scaling luxury brands globally as well as developing them by expanding into new categories.
TheStreet caught up with Luis on Monday to discuss his big deal. What follows is an edited and condensed version of the conversation.
Q: When did you identify that Kate Spade was attractive and that you wanted to make a deal happen?
Luis: I wouldn't point to any specific moment. I think that we have said in the past that our capital would be used for acquisitions, the first one being Stuart Weitzman in 2015. Obviously since then we have continued to follow brands in our space, with a focus on three categories that we think are very attractive long-term because they are the most branded categories in the fashion space. That would be handbags and accessories, footwear and outerwear. Of course Kate Spade has strength in handbags, but also has opportunities across a broad range of lifestyle categories that we find attractive.
Q: We have talked a fair amount in the past about your acquisition strategy, which you have told me is focused on buying great brands. What makes Kate Spade so great?
Luis: The most important characteristic of great brands are the ones that resonate the most emotionally. It's where consumers have a true relationship with the brand that goes above and beyond the product and gets into almost a fanatical emotional connection. Kate Spade has created a very unique positioning in the marketplace. They own the emotional attributes around fashion that are connected with fun, fashionable and femininity that resonates both in the U.S. but globally with consumers.
We were especially excited in our due diligence to find the strength which the Kate Spade brand has with millennial consumers. We know that this is an important market not just because of the size of the opportunity, but also because of the long-term opportunity to growth with them.
Q: Why do you think a millennial would choose a Kate Spade bag as opposed to one from Coach?
Luis: I think it's the positioning. In the case of Coach, we have a positioning that's much more based on heritage and a history as a house of leather. Under the leadership of Coach creative director Stuart Vevers, Coach is focused on a New York cool fashionable positioning. In the case of Kate Spade, it's much more about fun and whimsical and uniqueness of the Kate Spade girl. It really comes down to attitude.
Q: So you don't think this deal cannibalizes the Coach brand?
Luis: We of course have research that shows that the crossover in consumers is no more than about 10 percent. So that gives us a certain level of confidence. And Kate Spade has tremendous distribution opportunities not only domestically, but especially internationally.
Q: How does this deal help Coach navigate the challenges right now in retail?
Luis: It's an opportunity for growth. Any brand that tries to be everything to every consumer invariably loses its way. By definition of trying to be everything to everyone, they lose the uniqueness of their identity. Brands are attractive because they stand for something special. In the case of Stuart Weitzman, Kate Spade and Coach we feel we have three unique brand positions. We can leverage our supply chain and know how to build and develop brands globally. This is what excites me most.
Q: When you say you want to clean up Kate Spade's distribution, will you be closing a good number of under-performing doors at department stores like you have done at Coach?
Luis: We are talking very specifically not about traditional department store distribution, but instead about two unique channels that could hurt long-term brand health. One of those is online flash sales due to its very promotional nature. The other channel is urban discount centers that could drive negative brand perception, such as TJ Maxx (TJX - Get Report) and the like. We want to reduce these perceptions by reducing the level of sales in those two areas.
Q: Back in the day, companies such as Liz Claiborne and Jones Apparel Group built up these big portfolio of brands only to decide that wasn't the right model. They then sold brands. Why is now a good time to be going back to the type of model?
Luis: For us, the key is that we first and foremost re a direct to consumer company. We have some wholesale distribution here and abroad. At the end of the day, this deal is not just about scale and being a conglomerate -- it's about great brands. Each of these brands needs to drive their own relevance and positioning.