Breakingviews: Coach and Michael Kors design a raggedy ensemble

Tapestry is paying for its latest fashion haul with plastic. The U.S. company behind clothing and accessories brands Coach and Kate Spade said on Thursday that it would scoop up rival Capri for $8.5 billion including debt. The move could help it defend share against higher-end European companies like LVMH amid a pullback in luxury spending at home, but the deal’s steep cost – and the big loan it necessitates – makes for a raggedy ensemble.

The merger would give Tapestry a makeover from American laggard to more diversified global conglomerate, bringing Capri’s higher-end brands and European footprint into the fold. The purchase price, too, looks reasonable at first blush, coming in at 9 times last year’s adjusted EBITDA versus the 18 times Capri paid when it bought Versace and Jimmy Choo.

But Capri is cheap for a reason. Struggling Michael Kors makes up the bulk of revenue, and analysts polled by Refinitiv expect already-slowing growth there to stagnate in the coming year. Shares crashed in February on disappointing earnings.

Further, the $637 million of cash in Tapestry’s handbag would hardly suffice to close the deal. The New York-based company has secured an $8 billion bridge loan to underpin the transaction, many times larger than its current roughly $1 billion in net debt. As part of its promise to nonetheless maintain an investment-grade rating, Tapestry plans to suspend its buybacks. Investors balked, sending shares down some 13%.

Still, there is some strategic logic here. Unlike Tapestry and American peer Ralph Lauren, Capri has maintained market share in U.S. apparel and accessories post-pandemic, Euromonitor data suggests. And though Capri looks in need of a turnaround, Tapestry boss Joanne Crevoiserat has pulled one off before with Coach, which found renewed interest from shoppers after the pandemic by offering trendier items like upcycled bags.

But that doesn’t translate into financial logic. The companies expect to reap a relatively modest profitability boost of $200 million from stripping out costs. Add that to the $928 million of operating profit analysts expect Capri to reach in a couple of years, according to Refinitiv, tax it at the standard U.S. corporate tax rate, and the return is 10.8% -barely above the 10.5% cost of capital Morningstar analysts attribute to the target. Though Tapestry may have scored Kors, that’s no guarantee it will secure the bag.