Description

CPRI is a fashion house that owns Michael Kors, Versace, and Jimmy Choo that is currently going through an acquisition by Tapestry, another fashion house that owns Coach, Kate Spade, and Stuart Weitzman. The merger was announced in August 2023 and is currently going through a second request by the FTC that was initiated in November. On the surface, there seems to be little antitrust issues but taking a deeper dive it becomes clear that Capri and Tapestry both own a significant market share in the affordable luxury market, the likely reason behind the anti-trust concerns. There are very few remedies that can be actioned as it would involve divesting either Michael Kors or Coach and would go against the industrial logic of the deal. On top of this, Capri’s fundamentals have been deteriorating with Q ended December results showing 6.6% YoY CC rev declines and now trading at 11x NTM P/E vs 6x before as well as showing multiple quarters of declines. A likely break price is around its previous trading multiple and would point to a share price around $25 for a 45% downside. Even accounting for the performance of peers, who have had arguably better operations, the break price goes up marginally to ~$28. Upside risk is capped at the deal going through at $57 and represents a 22% upside risk. Essentially the deal is pricing in 33% of failure where I believe it’s likely higher.

Antitrust concerns

The DOJ has ratcheted up its antitrust oversight and has become increasingly aggressive in its merger targeting. This can be seen in the recent Spirit / JetBlue and Amazon / iRobot deals along with it chasing to block the Blizzard / Activision deal. The more aggressive stance can also be seen in the recent 2023 merger guidelines which point to much more aggressive policies.

Tapestry likes to define its market as the 200B luxury goods market, and this market is definitely overly broad by antitrust definitions. It is likely the market is being viewed by the FTC as the affordable luxury bags market when placed under the hypothetical monopolist test as price actions by the affordable / accessible luxury bags market is entirely ignored by the high fashion houses (Chanel, Hermes, LV, etc.).

This tiering in price is significant as clearly TPR and CPR both do not have brands that are sold within the same tiers and any price increases will largely effect competition within the affordable segment, and specifically between Kors and Coach which are the largest handbag brands in the category in North America. This high market share also results in high diversion ratio and with high gross margins, also a high General Upward Pricing Pressure Index (GUPPI) test. By my estimates, Tapestry (31%) and Capri (14%) would combine to have a 45% share.

The likelihood of an injunction is raised with the recent second request. Historically, only 2% of transactions have a second request with 29% of those transactions being cleared as is or being won at trial. Of the remainder, 26% are completely abandoned with the rest having some sort of settlement or remedy to pass. Given there is limited likelihood of any remedy given the industrial logic of the transaction, the probabilities of the deal passing are closer to 30%. With 25 as the break price, the expect value would be $34 vs the $46 it is trading at today.

Capri as a brand

Michael Kors history is well known as a brand that started out in luxury but has discounted its brand equity away. Kors, which accounts for 68% of total revenue, discounts over 50% (sometimes up to 90%) of its goods all year round with price cuts of about 50%. Comparatively, Tapestry’s Coach discounts seasonally with periods where <10% of its products are discounted to periods of ~50%. Kors’ high discounting window shows a level of desperation to generate sales and a difficulty for the brand to pull back on promotions in any period as have consumers developed a habit for sales periods.

Capri has stopped participating in earnings calls and engaging with investors after the transaction announcement. On its most recent quarters it has seen continued declines across all its brands and as a group is still performing below pre-COVID levels. There is no reason to believe the trend will reverse with most consumers having negative feedback on Kors as a brand vs competitors. Although the pre-transaction valuation was low, it’s deserved with the recent performance and no clear signs of recovery but will be something to track.

Catalyst

FTC Announcements