Coach (COH +2.25%) might be in the middle of an expensive company transformation, but it still knows a thing or two about shopping. And what goes better with a high-end handbag than a great pair of shoes? Or rather, in this case, the company that makes the shoes.
On Tuesday, Coach announced a deal to acquire luxury footwear specialist Stuart Weitzman Holdings from private equity firm Sycamore Partners. To start, Coach will make initial cash payments to Sycamore of $530 million, followed by up to $44 million in additional payments if the acquiree achieves selected revenue targets over the next three years.
Surprised?
At first glance, the move seems surprising for at least two reasons. First, Coach itself was recently reported to be an acquisition target of $82 billion luxury giant LVMH Moet Hennessy Louis Vuitton (LVMUY +1.73%). And unlike LVMH, Coach isn't exactly known for being a diversified serial acquirer. In fact, Stuart Weitzman marks the first acquisition in Coach's 74-year history.
Second, Coach stock plunged by more than a third last year, primarily amid struggles to maintain market share in its core North American business. In addition, Coach not only just launched the critically acclaimed debut collection from new creative director Stuart Vevers, but also only recently began implementing its companywide restructuring efforts. Those efforts are expected to cost somewhere in the neighborhood of $180 million to $220 million. With all this going on you'd think Coach wouldn't be eager to add the unnecessary distraction of a half billion-dollar acquisition into the mix.
The good news
However, there are several reasons this acquisition could be great for both Coach and its shareholders.
For one, Coach remains solidly profitable despite its struggles. As such, it has the financial resources to fund this opportunistic acquisition while continuing to both pay its healthy 3.7% dividend and reinvest in its core business. During its most recent quarter, Coach achieved free cash flow of $99 million, and ended the period with over $907 million in cash and short-term investments. And not all of that will be used in this case; Coach says it will fund the purchase with both cash on hand and "other sources of financing ... in the credit and capital markets." The acquisition is expected to be accretive to Coach's adjusted earnings following its anticipated May, 2015 close.
For those worried about the distraction aspect of bringing Stuart Weitzman into the fold, Coach also insists in its press release, "Importantly, the size, scope, and vibrancy of the Stuart Weitzman brand, along with the continuity of its management team, allows for a seamless transition to Coach ownership as we continue to focus on Coach's brand transformation."
To be sure, Stuart Weitzman appeared to be doing just fine on its own. In the 12 months ended Sept. 30, 2014, the company achieved net revenue of roughly $300 million, and that's after experiencing solid 10% compounded annual growth over the past five years. Should Stuart Weitzman be able to maintain that momentum, this could prove a fantastic opportunity for Coach to realize significant incremental growth.
What's more, Coach notes, Stuart Weitzman has developed a global multi-channel distribution network with company-owned locations in the U.S. and Europe, international licensed stores and shop-in-shop concepts, and a global wholesale business with the brand available in 70 countries. Unsurprisingly, the company's existing CEO, Wayne Kulkin, will remain in place following the acquisition, and Stuart Weitzman will continue to serve under Coach as the creative director and executive chairman of his namesake brand.
For now, however, the market doesn't seem impressed, with Coach shares down around 1% in today's trading. All things considered, however, the potential rewards of this purchase appear to significantly outweigh its risks. In the end, that's why I'm convinced the pullback should be viewed as a solid buying opportunity for patient, long-term investors.
