Tapestry (TPR 1.68%) is trying to build itself into a luxury goods giant filled with powerful, high-end brands. That's a great plan. The difficulty lies in making it happen. The company's next big move will be to complete its proposed acquisition of Capri Holdings (CPRI 2.10%).
But when you look at the financial results from the third quarter for each of these luxury fashion companies, well, there are worrying similarities to the merger of Sears and Kmart. Let me explain.
Bringing together struggling brands
In its prime, Sears was a retail titan. It is not even the slightest overstatement to say that Sears helped to shape the United States. Its iconic catalog offered everything from clothing to houses (yes, you could buy an entire house from Sears). While perhaps not quite as influential, Kmart, too, was a retail juggernaut at its peak. The term "blue light special" may be a joke today, but it only exists in the U.S. lexicon because of Kmart. But by the time these two one-time icons merged, they were both struggling.
Image source: Getty Images.
The idea behind the merger was that together, the two companies would be stronger. That didn't exactly prove to be the case, and the combined entity wound up in bankruptcy court not too long after the merger. Simply put, fusing two struggling companies into one does not make that new one stronger. It just results in a bigger struggling company, the size of which can make it even harder to fix its performance problems.
This is why investors might want to take a "show me" attitude as luxury brand owner Tapestry looks to close its proposed $8.5 billion all-cash purchase of Capri Holdings. There's a lot to unpack here.
Rolling up the roll-ups?
Tapestry, formerly known as Coach, previously bought Stuart Weitzman (2015) and Kate Spade (2017). In other words, its ambition to act as an industry consolidator isn't new. That said, Capri is also a roll-up. Formerly known as Michael Kors, it bought Jimmy Choo (2017) and Versace (2019). The newest deal will, indeed, create a portfolio filled with well-known luxury brands. That's the good news.
The bad news is that not all of these brands are doing so well today. For example, Kate Spade's sales fell 5% year over year in the first quarter of its fiscal 2024. Stuart Weitzman's sales were even worse, down 18% year over year. Luckily for Tapestry, its Coach unit grew sales by 5%, and Coach accounts for a little over 75% of the company's top line. Thus, it has a much larger impact on Tapestry's performance than the weaker-performing smaller brands. Overall, sales rose by 2%.
The big takeaway is that two of Tapestry's three brands are what might be called works in progress. That's not too bad, given the relative size of Coach. But adding Capri Holdings' brands makes matters worse, not better. In the second quarter of its fiscal 2024, Jimmy Choo's revenue decreased 7%, Michael Kors' sales fell 8.6%, and Versace's top line declined 9.1%.
Michael Kors is the biggest brand of this trio, with sales that are more than twice as large as the other two brands combined. But the top line at Michael Kors still fell, meaning Tapestry is adding a big brand that's in need of some rejuvenation along with two smaller brands in the same situation.
When this deal closes, Tapestry will own six well-known luxury fashion brands. But it will only have one that's actually resonating with customers today in an industry that is driven by trends. Which brands will get the attention and the money needed to get them back on track with customers? Could Tapestry simply end up diluting the strength of Coach by spreading management's limited attention too thinly over the other brands?
Not the same, but still worrying
To be completely fair, the comparison between the Sears/Kmart merger and the Tapestry/Capri merger isn't exactly apples to apples. At the same time, there are similarities that are a bit disquieting. Rolling up luxury brands is a fine idea, but if those brands stop resonating with customers, there's a problem. And right now, five of the six brands in question aren't resonating, which suggests that Tapestry might be biting off more than it can chew as it buys Capri Holdings.
Investors might want to wait until they can see positive results that extend beyond the Coach brand before taking a leap of faith and jumping aboard here.
