One of the biggest ways companies compete with one another is through product innovation. Corporations are able to invest profits back into the business in the form of increased hiring, new marketing campaigns, and more research and development. All these efforts represent different strategies that companies employ to breed new products and services.
However, from time to time, companies may make strategic investments in similar businesses or outright acquire them. One of the sectors experiencing the most consolidation right now is luxury retail. In early August, Capri Holdings (CPRI 2.10%) received a takeover bid from fashion rival Tapestry (CPRI 2.10%). Given the deal has not yet closed, this could be an interesting opportunity to scoop up some shares in Capri Holdings. Let's dig into why.
Part of a broader trend
Capri Holdings is the home of iconic brands such as Versace, Michael Kors, and Jimmy Choo. While some investors may view the deal as an indicator that Capri's business is struggling, I see something different.
The luxury retail sector has been no stranger to brand consolidation in recent history. For example, earlier this year, L'Oréal acquired cosmetics company Aesop in an effort to help spearhead an otherwise mundane presence in China. And in late August, e.l.f. Beauty added some strength to its skincare portfolio by acquiring Naturium.
My suspicion is that high-end luxury retailers are consolidating in an effort to take on industry powerhouses LVMH Moët Hennessy Louis Vuitton and Hermès International. Each of these conglomerates has built a strong business on the backbone of a fiercely loyal customer base across the globe. As a result, shareholders in Louis Vuitton and Hermes have enjoyed market-beating returns for years. Now, it's time for the competition to catch up.
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How should you play this?
While the boards of directors of both Tapestry and Capri Holdings have approved the deal, the transaction must also be approved by Capri shareholders and go through customary regulatory procedures. This brings me to my first point.
Per the terms of the transaction, Tapestry would acquire Capri Holdings for a total enterprise value of roughly $8.5 billion, or $57 per share. As of the writing of this article, Capri shares trade for about $52 per share. Given the difference between Capri's current share price and Tapestry's proposed offer, there is a potential merger arbitrage opportunity. But let me be clear: this is an incredibly risky strategy.
One of the biggest and most explicit risks in a situation like this is that the deal could fall apart. Should this occur, Capri's stock could spiral downward. Moreover, as the deal process lingers, momentum traders could easily enter the picture and manipulate the stock. For these reasons, I'd encourage investors to zoom out and consider other strategies outlined below.
I'd caution owning Tapestry or Capri stock independently if the acquisition fails. LVMH Moët Hennessy Louis Vuitton and Hermès International have so much influence in the luxury sector, that other fashion enterprises are feeling the pressure and resorting to mergers and acquisitions as quick paths to growth. But given the amount of deal activity the luxury retail sector has experienced this year alone, investors should be thinking about the probability of this transaction getting approved.
Considering the long-term potential of the combined business should be a top priority in a situation like this one. Since the proposed structure of the deal is cash, my approach would be to initiate a position in Capri and subsequently reinvest profits in the combined entity. As competition in the luxury retail space continues to gain steam, reserving some exposure for the sector can help diversify your portfolio and be a winning formula in the long term, as the chart above illustrates.
My stance is that the combined operation has greater potential to fend off competition and owning shares in Tapestry post-acquisition could present an interesting way to invest in luxury goods beyond the traditional heavy-weights.
