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Investment in Coach Inc.

Team4
- Marga Manzo
- Cecilia Xu Liu
- Prashant Khorana
- Dushyanth Damodaran
- Shun Ito

You are neither right nor wrong because the


crowd disagrees with you. You are right
because your data and reasoning are right. ~
Benjamin Graham

Executive Summary
We recommend that LEAPORD should GO AHEAD with the deal. Coach undervalued, and now is the
time to capitalize on this excellent opportunity
Coach is a compounder, not a typical fad or quick-to-die scheme, with a long history of reinventing
itself
Over the past decade, the company's sales increased at a compound annual rate of 21.1%, while
earnings per share grew 31.1%. But recently, the stock price has slid 37%YTD while the S&P 500 has
generated a +6.5% YTD return
Coach currently trades at 6.8 x EBITDA and 12.6x forward price to earnings. If we assume that Coach
ultimately trades towards its average forward multiple of 15.5x over the next three years(and closer to
the peer median of 11.8x EBITDA), the purchase will be $56.26
We believe that the short-term pessimism is merely consumer irrationality and social proof - where
the market is punishing a long-term term product-centric innovator. Our investment thesis is grounded on
the the belief that Coach will continue to establish itself as an affordable luxury leader, and will continue
to expand its presence internationally
The structure will essentially comprise of financing from FOSUN for the bulk of sponsors equity; the
leverage will be 7x Debt to EBITDA. The Exit IRR will be 20%~ at a multiple 11x same as entry multiple

Business Overview - Segment


Sales

Operating Profit Margin


90.0%

6,000
5,000

4,763

5,075

80.0%
4,806

70.0%
60.0%

4,000

50.0%
40.0%

3,000

30.0%
20.0%

2,000

10.0%

1,000

0.0%
06/2012

0
06/2012
06/2013
06/2014
Other
International
North America

North America

Supported by middle class in emerging countries,


International sector remained stable growth during past
three years

International

06/2014
Other

The North American business segment maintained a


higher operating margin than International did
o 65% to 70% of North American retail sales were
generated from outlets, with margins
o This segment is at risk of losing a very large
middle-class market

Although in a descending trend, Other (includes


licensing and disposition) attained 55% margin as of
2014
o Despite satisfying profit from licensing royalties,
Other accounts for less than 1% of total revenue

Overall luxury industry is maturing and slowing down:


revenue dropped by more than 5% in fiscal year of 2014
While North American represents around 65% of total
sales, its revenue went down by over 10% in 2014

06/2013

Growth Story

Over a decade ago, Coachs top and bottom lines took a hit as its styles missed the mark. Sales slowed
in the mid-to-late 1990s as both high-end designers and lower-end rivals muscled onto its turf. But in
1996, Lew Frankfort hired Reed Krakoff from Tommy Hilfiger, and what followed is history as the two
refocused the company, bringing in new styles, collections and fabrics

Coach is the embodiment of affordable luxury a coveted brand at prices a third lower than high end
peers

In recent years, Coach has successfully made handbags the shoes of womens wardrobes. American
women, it seems, are finally learning what Parisian women have known for decades: Accessories make
the outfit. American women are finally starting to see the handbag as the shoes in their wardrobe.

We believe mens category sales could hit $1 billion in the next few years. Men are more likely these
days to move into non-tradational luxury categores(i.e. instead of just watches, wallets, to luxury
briefcases/work bags etc.)

Looking to Japan as a guide, where market share has grown from 2% - 3% in the 1990s to 17% today,
there is plenty of room for Coach to take share of the global luxury goods market. We see obvious
parallels to the companys opportunity in China today, with current market share estimated at 5% and
growing

Market Overview

Based on Euro-monitor (see graph below) the Chinese consumer market of Luxury is about to surpass the US
Market with a CAGR of 11%

The rising Chinese middle class will continue to provide a long-term middle catalyst to our investment thesis

The total worldwide luxury goods market is expected to compound 4% to 6% annually reaching sales of $327
billion through 2015 (Bain & Company: Luxury Market Whitepaper)

Growth is largely driven by China, expansion into mens categories and greater online distribution and sales
(CAGR of 12%, highest in the world; see Euro-monitor Luxury report)

Competitive Overview

Burberry - an iconic affordable luxury brand that is over 100 years old - eclipsed $400m in sales 2001.The
Company will surpass $4bn in March 2017. It has taken Burberry, roughly 16 years to go from $400m to $4bn
in sales. But thats typical - Ralph Lauren took at least 15 years. Coach: 16 years. Hermes: 22 years, and
Tiffany's: 25 years. Like Mark Twain said History doesnt repeat itself, but it sure does rhyme. We believe
that new and fast growing competitors havent faced the challenge of re-inventing themselves yet

Michael Kors reported roughly


$400m in sales for its fiscal
2009; the company has
guided over $4 billion in sales
a non-sustainable number,
when you look at other
competitors

We do not think that fast growing peers


like KORS and Kate Spade have
invested enough in their brands to
establish themselves as a long-term
luxury player yet

Risks
International Strategy
Coachs long-term growth strategy, and multi-year turn around plan relies heavily on its plan to expand
internationally. If the Chinese double-digit growth assumption doesnt realize, the plan might fall apart.
Furthermore, the assumption of expanding in Europe relies on the assumption that customers will buy-in to the
idea of affordable luxury.
China growth risk
Our Concern about Chinas economy, is one that is shared by many forecasters. With an overheated realestate economy, and poor transparency, its difficult to forecast if the double-digit growth will remain stable.
Margin Compression
Coach continues to expand into non-traditional categories for both men and women but margins are generally
lower in these categories. The companys pricing power remains strong, but margins could compress if nontraditional categories grow at faster rates.
Brand Erosion
If management stretches too far with its transformation plan, they risk diluting their brand and damaging the
core business. Re-inventing the company brand is not an easy task.
Competition
Coach benefits from unparalleled brand loyalty, but new entrants are attacking the incumbents niche every day.
Management has done a tremendous job reinventing itself over the decades and it will have to continue to do
so to maintain leadership in the industry.

Preliminary Valuation
DRAFT

Message box
Valuation
30.00

Share price performance

Offer price: $56.26


35.00

40.00

45.00

50.00

55.00

60.00

65.00

Premium
58.0%

3 months

6 months
12 months
FV/EBITDA
FV/EBIT

Comparable companies analysis


PER
(in USD Millions)
Coach Inc.

Offer price: $56.26 (58% premium to current share price)


We add enough premium to Coachs recent share price but didnt
to the value estimated by multiples
Coachs multiple is lower than peer companies due to its
short-term decline for restructuring
Coachs shareholders recent turnover is 7/7/2014, therefore,
book value for current shareholders would be around $35

Burberry Group plc

Market
Cap

Enterprise
Value

Revenue

Gross
Margin

EBITDA
Margin

9,600

8,871

4,806

68.6%

27.2%

0.1

12.6

6.8
1,109.3

D/E

P/E

EV/
EBITDA

1,111,818

1,111,411

3,984

71.2%

25.2%

0.1

20.3

LVMH Mot Hennessy

88,992

94,495

40,424

65.4%

24.6%

0.2

19.1

9.5

Michael Kors Holdings Ltd.

15,500

14,545

3,589

61.0%

32.9%

0.0

21.1

12.3

Ralph Lauren Corporation

14,600

13,615

7,505

57.9%

18.0%

0.1

20.1

10.1

PVH Corp.

10,000

13,377

8,251

52.5%

11.1%

0.9

31.7

14.7

Kate Spade & Company

3,400

3,664

1,419

57.1%

1.2%

-12.3

50.5

215.5

Tod's Group

3,400

3,231

1,306

38.3%

21.6%

0.1

23.5

11.5

Guess

1,900

1,392

2,513

36.7%

11.0%

0.0

15.2

5.0

Median

20.7

11.9

Mean

25.2

10.5

EV/
EBIT

Deal Structure / Return Analysis (1)


Message box
Deal structure

Capital structure

FCF, D/EBITDA, D/E


(Answer to Q6, 7)

Structure
(Answer to Q6, Q9)

Return Analysis

IRR sensitivity
(Answer to Q7)

Deal Structure / Return Analysis (2)


Approach strategy
o

Growth story based on synergy creation:


Synergies rationalize the competitive bid price
Synergies prevent Coachs management from being
hostile
Pre-emptive approach:
Pre-emptive approach will deprive other potential
bidders of enough time to consider this opportunity
Approach to the management before Andrea Bonomi
announces its acquisition of Club Med because most
people think Mr. Guo is focusing on the deal
Pursue to get exclusive negotiation rights before
others come
Confidentiality
Make sure that we have to keep our consideration in
secret
In order to keep our consideration in secret, we
should approach only few potential co-investors who
have interests and expertise in luxury industry
Main potential co-investors (track record)
Permira: Valentino, Hugo Boss
TPG Capital: Bally, J Crew, Nieman Marcus, Grohe
Bill Gates Foundation: Four Seasons Hotels &
Resorts

Exit strategy

Trade sale / Secondary buyout


Higher selling price will be
achieved due to control
premium
Risk that we cannot find
buyers and lose timing to
sell

IPO
Gain capital gain after the
IPO if we hold some portion
of the stake
If investor appetite is good,
IPO price can be almost
equal to the selling price in
trade sale
Hard to exit one time,
considering the size of the
company
IPO price will be usually
lower than the selling price
in trade sale

We should pursue trade sale or secondary buyout at first. The


second option is IPO.

Conclusion / Why does the deal make sense?

When the recession hit, sales grew higher in 2009, while profit dipped single digits. Competitors all had to
take markdowns - the rest of the Luxury index saw sales fall mid-single digits and earnings slashed by a
third. Thus, even during bad times, Coach's fundamentals were excellent, with margins at 30%~ and free
cash flow generation greater than 20%~ of revenue

Victor Luis, the current president of the international group, becoming CEO in January 2014. We also think
the promotion confirms the companys focus on international growth as the primary driver of returns over the
long run

Coach has little debt on the balance sheet and $835.9 million of net cash on hand, or roughly $3 per share,
leaving the company in a formidable position to fund future investment