Despite the downgrades, the ‘great KATE deal’ consensus, and people not wanting to place a bet long-side on the perennially underperforming Coach after a 32% YTD run – this call is not over. In fact, I’d argue that it’s just beginning.
- The reality is that ‘the space’ is not dead. This is a solid business with high (sustainable) returns and a very defendable per-capita unit consumption story and stable ASPs. It’s like the athletic category – but better. Yes, I’m serious. The problem is that it went through a period of overbuilding that is at the back end of a bottoming process.
- In that context, Coach is a survivor – meaning it has terminal value. That’s a simple question that needs to be answered ahead of what should be an extreme bifurcation in multiples – ie we see 6-8x multiples in Retail, and 30-40x – with little in between (kind of like the Nifty Fifty in the 60s and 70s, and the dot.com bubble in the late 1990s). Coach is definitely a survivor – both the Coach brand and more importantly, Coach, Inc.
- The crux of the deck we presented last week is that Coach is setting up to be one of the best accelerating growth and cash flow stories in Retail – with a 40%+ earnings beat over the next two years and RNOA going from 19% to 30%. Have fun shorting that.
Here’s the link to our 40-page Black Book. Some of the more salient slides are as follows…[TAIL modeling assumptions and detailed quarterly puts/takes at the end of this note.]
COH Black Book Link: CLICK HERE
-- Brian McGough
No one line item drives this story – it’s got ‘big balance’. This is acquired growth for a year at a ‘day 1 accretive’ price, and then real organic growth in day 366. In other words, unlike stories like Hanesbrands, Ascena, Wolverine, or Tailored Brands that blow up when the acquisition cycles, Coach has gas in the tank to keep beating expectations.
Sorry, but ‘the space’ does not stink. Units per capita bottomed in 2009, and are holding stable in a modest uptrend of 1.3x-1.4x per capita. Population + ASP = mid single digit category growth with Coach share loss ebbing, KORS imploding, and COH controlling one of the best-growing assets in ‘faux luxury’.
There’s a big difference between ‘synergies’ and simply operating Kate better. This is where COH management has kept expectations so low. Lux deals are not about cost cutting – ever. If you see that, then run for the hills. Biolsi’s model gets us to $700mm in incremental EBIT by 2020, and over $1bn in CFFO.
KATE/Coach overlap = the most complimentary EVER? Remember when Adidas bought Reebok? I do. I worked at Nike back then. That was one of those 'high fives' while having your fourth beer in the Friday ‘booze garden’ while watching Kiss play live on the Ronaldo field. Adidas and Reebok had 90% overlap by category. Paul Fireman orchestrated one of the best deals Retail had seen in a decade. Then the merged entity hemorrhaged 80% of its combined share. I think Coach/KATE will be the opposite.
Why does KATE have well above-average store productivity, and ‘worst in class margins?’ = Bad Management. KATE management was great at brand building – weak at best operationally, and being public. That’s an easy fix for Coach. In fact, Craig Leavitt (KATE CEO) already got booted (willingly) as that was the only way he could get his $25mm check (the same misaligned incentive that resulted in such a low deal price).
Big licensing optionality. This was under almost every radar – and was even under ours until a few weeks ago. Coach has four meaningful licenses. KATE has 19. Not all can be taken back – nor does COH want them back. But remember when Roger Farrah either pulled licenses back in house or jacked up royalties? There you go…
KORS = Defensive, expensive, no natural synergies and big customer overlap. Basically, it’s everything COH/KATE is not.
MODELING ASSUMPTIONS
