I Still Think Coach Is A Takeout Candidate
I wasn't at all excited about Coach's (NYSE:COH) foray into scooping up luxury designer footwear brand Stuart Weitzman. Our thesis on Coach centered on the strength of its balance sheet, and it seems like it will mostly use balancesheet cash to finance the $574 million transaction. Something might have gone terribly wrong in Coach's calendar fourthquarter to use its reserves so quickly. I don't like it, though we can't disagree with the view that shares are at bargainbasement prices. Let's examine the reasons why I think Coach may still be a nice takeout candidate.
1) The company's shares are dirt cheap. Shares of Coach have been punished recently as a result of poor performance from its North American women's handbag business. However, we value the company at nearly $50 per share, materially higher than its $35 per share price tag. During fiscal 2013, the company earned more than $3.60 per share on a diluted basis, putting its valuation at roughly 10 times achievable earnings should it turn around its North American business, and this valuation excludes its robust net cash position on the balance sheet. Coach's attractive price tag sets the table for an opportunistic play from a potential suitor, in our view.
2) Coach's balance sheet is still healthy. Unlike situations where a struggling firm may need a white knight to ensure survival, a suitor would not be bailing out Coach in any way. To the contrary, Coach is quite healthy. The firm had more than $860 million in cash and just $140 million in current and longterm debt on the balance sheet as of mid2014. Subtracting the $530 million initial outlay related to Stuart Weitzman, the firm still retains a net cash position. Its robust financial profile makes a deal celine handbags online much easier to consummate, as a suitor would not have a difficult time lining up debt financing. From a financial standpoint, Coach is an investmentgrade credit, which was recently reiterated by Moody's in the company's recent unsecured shelf registration.
3) Coach's free cash flow generation is solid. The company's cashflow generating profile is quite robust, and we think this is a key attribute to getting any deal done. Coach generated over $765 million in traditional free cash flow (cash from operations less capital expenditures) during fiscal 2014, and its free cash flow generation in fiscal 2013 and fiscal 2012 was even better. Under any combination, a potential suitor would not have to absorb its own premerger free cash flow to support Coach's operations. In fact, Coach's excess cash flow could be used to help support the strategy of the potential acquirer's portfolio. This would be a win for any suitor.
4) It is common for luxury companies to hold a large portfolio of brands. Richemont (OTCPK:CFRUY), for example, has a luxurygoods portfolio that includes such prestigious names as Cartier, Van Cleef Arpels, Piaget, Vacheron Constantin, and Montblanc, among others. LVMH Moet Hennessy has over 60 prestigious brands spanning segments such as wines spirits, fashion leather goods, perfumes cosmetics, watches jewelry, and selective retailing. Brand diversification is important to reduce the fashion risk that is typically inherent to a luxurygood maker's operations.
In 2011, LVMH bought Italian peer Bulgari and paid a 60% premium for the company, so it's not uncommon to see luxury goods maker's pay up for strong brands either, and Coach is certainly one of those. Though either a RichemontCoach or LVMHCoach combination may result in more of an extension of the combined entity's existing business lines, a deal may make particular sense for Coach, which remains heavily reliant on a struggling North American women's handbag and small leather goods operation. As increased diversification (lower volatility) would reduce the discount rate applied to a future expected free cash flow stream, Coach, under any acquisition scenario, celine would be worth considerably more to an acquirer than on a standalone basis.
5) The synergies and growth opportunities would be material. Either a RichemontCoach or LVMHCoach combination may spark greater interest in the combined entity's handbag and leather goods operations, helping Coach to stabilize and then potentially grow its North American women's business. In any combination, costsharing and margin enhancement potential would be material. For one, bringing Coach's operations inhouse would reduce a wellarmed competitor, inevitably improving the competitive profile of the luxury goods space. In particular, LVMH's global retail network would be a huge asset to Coach's line of products, as the latter seeks to diversify geographically. The recent designs at Coach have caught the eye of LVMH, and this has likely spark deal talks, even if they may not have been reported as such. It is very likely Coach has had talks with many a suitor already, with Kering perhaps close to the top of the list as well.
Wrapping Things UpCoach is certainly a risky entity that is heavily exposed to fashion trends, which are difficult for any experienced expert to predict. However, the company does pay a safe and healthy 4% dividend yield that we think offers some support to the stock in the mid$30s. Though its financial health was safer before the Stuart Weitzman transaction, we still view the prospect of a suitor scooping up shares of Coach at a substantial premium as probable. Our fair value estimate of Coach is just shy of $50. The market is being too punitive on its potential for a sustainable turnaround.