Two Years On, Kate Spade Looks Like A Bad Acquisition By Tapestry

Trefis answers the question: Was Tapestry’s Acquisition Of Kate Spade A Good Move? in an interactive dashboard by detailing the rationale behind Tapestry’s (NYSE: TPR) acquisition of Kate Spade in 2017, and explaining how the acquisition of Kate Spade has impacted Tapestry’s performance. While Kate Spade has clearly failed to generate the kind of revenues Tapestry had hoped to achieve after the acquisition, it has actually weighed on Tapestry’s performance.

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Why Did Tapestry Acquire Kate Spade?

• The acquisition of Kate Spade was expected to drive steady growth in Tapestry’s revenues
• Tapestry expected revenues from Kate Spade to cross $2 billion in a few years
• Moreover, Kate Spade had great success with millennial customers, who have been the driving force behind high growth rates Tapestry had achieved since 2010. Approximately 60% of Kate Spade’s clientele were millennials, compared to just over 30% for Tapestry’s core brand – Coach. Hence, this acquisition was seen as a great addition to the company.
• Keeping this in mind, Tapestry paid $2.4 billion to acquire Kate Spade.
• The deal closed in July 2017, during Tapestry’s fiscal year 2018 as Tapestry reports on the basis of a fiscal year ending in June.

However, things have not turned out the way Tapestry expected. Although, Kate Spade’s revenues increased in fiscal 2019, the increase has been driven by new store openings, and by Tapestry’s acquisition of operational control of Kate Spade Joint Ventures in Greater China besides its taking direct ownership of the businesses in Australia, Singapore and Malaysia. Notably, the Kate Spade brand has failed to deliver positive comps growth in the last few quarters.

How Has Tapestry’s Stock Price Changed Post Kate Spade Acquisition?

• Since the acquisition of Kate Spade, Tapestry has shed nearly 60% of its value, with the stock’s price declining from over $47 at the beginning of July 2017 to less than $20 now.
• On the other hand, the S&P 500 index has increased roughly 17% over this period.

How Has Tapestry’s Revenue Trended Post Acquisition?

• Kate Spade acquisition has added more than $1.4 billion to Tapestry’s revenues. This helped Tapestry’s revenues increase from $4.5 billion in fiscal 2017 to around $6 billion in fiscal 2019.
• However, Kate Spade’s entire revenue growth in fiscal 2019 was due to an increase in non-comparable store sales, with the brand delivering negative comp sales growth for the year.
• The decrease in comparable store sales was primarily due to decreased traffic and conversion

How Has Tapestry’s Profitability Changed Since The Acquisition?

• Kate Spade has been a drag on the profitability of the company. Since the acquisition of Kate Spade, Tapestry’s operating margin has declined from nearly 17% in fiscal 2017 to below 13% in fiscal 2019

Why Has Kate Spade Weighed On Tapestry’s Bottom Line, And What’s The Forecast For FY 2020?

#1 Kate Spade Has Lower Revenue Per Square Foot As Compared To Coach

• Kate Spade has a much lower average revenue per store compared to Coach. Moreover, Kate Spade’s average revenue per store has declined over the last couple of years.
• As of 2019, Coach’s average revenue per store of $4.33 million was roughly 30% more than that of Kate Spade’s $3.36 million.
• We expect Kate Spade’s average revenue per store to decline further in 2020, while Coach is expected to see a slight improvement in this key metric

#2 Kate Has Higher Cost Of Goods Sold, As Indicated By Its Lower Gross Margin

• Kate Spade’s gross margin is lower than that of Coach, implying that Kate Spade is producing goods at a higher cost. As of 2019, Coach’s gross margin stood at 70% while Kate Spade’s margin was around 63%.

#3 Also, Tapestry Has Boosted Marketing Spend For Kate Spade Significantly In An Attempt To Drive Revenue Growth

• Tapestry has been marketing its Kate Spade brand aggressively over recent years. As of 2019, Kate Spade’s marketing expenditure stood at $700 million – representing roughly 51% of Kate Spade revenues.
• On the other hand, Tapestry was spending around 43% of its Coach revenues on marketing that brand.
• Higher production costs and elevated marketing expenses also mean that Kate Spade’s operating profitability is much lower than that for Coach
• Coach’s operating margin is more than 2x that of Kate Spade. As of 2019, Coach’s operating margin stood at 27% while Kate Spade’s operating margin was just around 12%.

CONCLUSION

• Although a two-year time frame is not enough to provide the complete picture about the impact of Kate Spade’s impact on Tapestry, the brand has surely failed to deliver in this short run.
• Revenue growth at Kate Spade being driven almost completely by acquisitions and new store openings does not bode well in the long run.
• One of the primary reasons for the brand’s under-performance has been its over-reliance on North America. As the brand generates roughly 80% of its revenues from North America, difficult macro-economic environment in the region is adversely impacting the brand’s performance.
• Further, Kate Spade is not expected to improve its performance in FY 2020, with the company expecting low-to-mid single digit sales growth driven entirely by distribution.
• Moreover, for Q1 2020, the company expects Kate Spade comps to decline in the high teens.
• To summarize, the brand has not done well in the last couple of years and it will require significant effort from Tapestry to get sales for Kate Spade above the $2-billion mark

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