COH – This Is A Really Bad Deal

Takeaway: Coach’s purchase of Stuart Weitzman is the ultimate sign of its perennial mediocrity.

Coach’s purchase of Stuart Weitzman is the ultimate sign of its perennial mediocrity. When Michael Kors, Kate Spade, Ralph Lauren, or Tory Burch want to get into the shoe business, they use their greatest asset to get there – their own brand name.  When Coach wants to get there, it buys somebody else’s brand name. That’s almost all we need to know.

But there are so many other parts of the transaction that don’t make sense to us.

1) Coach’s $574mm bid bested that of Advent International – a savvy investor whose job it is to make high quality acquisitions. Advent was the one who stepped in to buy half of Chip Wilson’s LULU stock for $845mm as the former Lululemon Chairman backed away from the company. Advent has a very long holding period, and is not afraid of high near-term valuation. So why should Coach, which has never done an acquisition in its life, be comfortable paying more than someone with a better balance sheet/access to capital, and one of the best track records of creating value with retail acquisitions?

2) Sycamore Partners has owned Weitzman for less than a year – through its acquisition of Jones Apparel Group in February 2014. We can’t imagine that it would have shopped Weitzman so quickly if it’s view of its prospects were ‘just so good’.

3) This is an example where one private equity firm shopped a company (Weitzman), and bypassed another PE company in favor of a strategic investor who is willing to pay more with shareholder’s capital.

4) Don’t forget that Jones bought Weitzman in 2Q10. If there’s one thing you can say about JNY (and I’ll go to the mat on this one with historic examples), it’s that the company was second to none when it came to acquiring content/licenses and drawing out near-term cash flow at the expense of long term value. We’re near certain that this deal will end up costing COH well North of $574mm.

The punchline: We covered our long-standing short about nine months ago in the low $30s. The cash flow characteristics of the company were simply too attractive to us, which made an acquisition/LBO all too plausible – even if Coach is forever relegated to an outlet brand. But now the acquiree has turned acquirer. So to own Coach today you have to actually believe that 1) the (new) management team can turn around the core brand over a multi-year duration without sacrificing profitability, and 2) that this new deal will not destroy value.  We can’t believe either of those things.

If it weren’t for the likelihood that COH can engineer earnings growth for a few quarters as it integrates Weitzman, we’d go outright short today. If the stock works as earnings bounce, we’ll be the first to jump on board the short side. This one is now on our Short Bench.