Coach Inc. agreed to acquire rival Kate Spade & Co. for $2.4 billion, as the handbag and accessories maker seeks to tap younger consumers amid slower growth in the handbag market.
Sales of handbags are lagging as women have traded down to smaller, less expensive purses and aggressive discounting both in stores and online has pressured profits. The proposed merger would combine two big U.S. players, creating a company with $5.9 billion in annual sales and 1,300 retail stores and outlets around the world.
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On Monday, Coach Chief Executive Victor Luis said there is little overlap between customers of the two brands, especially since Coach has tried to move upscale in recent years. The attraction of Kate Spade was its appeal to younger shoppers, Mr. Luis said, adding that only 10% of consumers say they buy both brands.
"Kate Spade has the highest penetration among millennials within our competitive set," Mr. Luis said in an interview. "Millennials offer a market that is substantial in terms of size and allows us to recruit younger customers." According to Jefferies analyst Randal Konik, millennials account for about two-thirds of Kate Spade's shoppers.
"I've been buying Kate Spade since I got my first job," said Bianca Damionne, a 22-year-old who works in New York City.
"I hope Coach doesn't change things, because I like Kate Spade now," she said on Monday while shopping in a Kate Spade shop on Fifth Avenue. "The style, the colors, everything."
The handbag market has slowed to about 2% annual growth from as much as 15% growth six years ago, said Craig Johnson, an analyst at Customer Growth Partners. Coach has responded by targeting a slightly older and wealthier client with higher-priced bags, creating a gap for younger 20-something shoppers that it can fill with Kate Spade, Mr. Johnson said.
The industry could see more consolidation, as rivals scramble to line up their own deals. "If you want growth in North America, you will have to make an acquisition, because the market is saturated," said Neil Saunders, managing director of the research firm GlobalData Retail.
Mr. Luis said he still has confidence handbags and leather goods are better positioned than other corners of retail. "Consumers continue to shift dollars away from apparel to handbags, accessories and footwear," he said.
Coach will pay Kate Spade shareholders $18.50 a share in cash. That represents a 28% premium to Kate's closing price as of Dec. 27, the last trading day before a Wall Street Journal report that Kate was exploring a sale of the company after coming under pressure from an activist shareholder. The company confirmed it was reviewing such options in February.
Kate Spade shares rose 8.3% to $18.38 on Monday, while Coach shares climbed 4.8% to $44.71.
The companies, both based in New York, have battled a retail environment that has been challenging, especially for designers with significant exposure to department stores, where traffic has declined. U.S.-based luxury brands are also hurt by a strong U.S. dollar.
Coach had revenue of $4.5 billion in the fiscal year ended July 2016, down from more than $5 billion a few years ago. Kate Spade, which shed several apparel brands to focus on its handbag business, had revenue of $1.4 billion in the year ended Dec. 31.
Sales at Coach started to grow again in recent quarters as it pulled back from department stores, closed a third of its full-priced stores in North America and cut back on promotions. The company said it plans to reduce online flash sales as well as distribution in off-price chains like T.J. Maxx for Kate Spade after the deal closes, which is expected to occur in the third quarter.
Mr. Luis said 35% of Coach stores overlap with Kate Spade stores in North America but he doesn't foresee widespread closures following the combination. However, analysts said there are still too many stores given sluggish traffic at malls.
"Anybody who's been to Woodbury Common outlets and seen two Coach (women and men) and two Kate Spade stores (accessories and apparel) all within 30 yards of each other doesn't need a rocket science degree to know that the combined company doesn't need all that space," Mr. Johnson said, referring to a shopping center outside of New York City.
Coach does plan to expand Kate Spade outside the U.S., particularly in China and Europe, where the brand has a few dozen stores and outlets. And Mr. Luis said there is an opportunity to buy out some joint venture partners or distributors in those regions.
Coach has been on the hunt for acquisitions as Mr. Luis seeks to build a collection of brands and respond to the rapid rise of Michael Kors Holdings Ltd. Coach approached Burberry Group PLC about a takeover last year but was rebuffed, according to people familiar with the situation, and it was seen by analysts as a potential suitor for Jimmy Choo, which put itself up for sale last month. Coach recently hired former Jimmy Choo CEO Joshua Schulman as president of its namesake brand.
But Choo, which is valued at over $1 billion by some estimates, would likely be too big for Coach to swallow in the wake of its Kate Spade deal. Mr. Luis said the company could make additional acquisitions in the near term, but they would likely be of a size similar to Stuart Weitzman Holdings LLC, a shoe maker it bought in 2015 for about $574 million.
Analysts say Kors is more concerned with turning around its own brand than buying a competitor at this point. It suffered from many of the same problems that plagued Coach, including overexpansion and heavy discounting. "With Kors trading in such deep value territory," wrote Mr. Konik of Jefferies in a recent report, "we believe share repurchases would be a better alternative for rewarding investors."
The brands will be kept separate and there are no plans to cross-sell products at each other's stores, executives said. Mr. Luis said his intention was to retain key Kate Spade employees including Craig Leavitt, who will continue to serve as chief executive of the Kate Spade brand.
The transaction is subject to the tender of a majority of the outstanding Kate Spade shares as well as regulatory approvals.
Kate Spade can terminate the transaction if the company is offered a superior proposal from another suitor, and Coach can terminate the deal if Kate Spade's board no longer supports it. Either circumstance would require Kate Spade to pay Coach an $83.3 million termination fee. Either company can call off the deal if it isn't complete by Feb. 7.
Write to Suzanne Kapner at Suzanne.Kapner@wsj.com and Joshua Jamerson at firstname.lastname@example.org
(END) Dow Jones Newswires
May 09, 2017 02:47 ET (06:47 GMT)