Last year in August, struggling Capri Holdings, known for its brands Michael Kors, Versace and Jimmy Choo, received a bid from competitor Tapestry. Capri’s stock surged by 50%. However, the Federal Trade Commission (FTC) wants to block this deal in fear of market concentration. As the deal still hasn’t closed and court hearings are ongoing, the stock lost now the complete bid premium. It fell even back again to 2012-levels. Is the stock a buy now?

Summary and key takeaways from today’s Weekly
– Buying what one knows respectively well-known brand names is an often practiced strategy by novice investors.
– However, the case of Michael Kors (now Capri Holdings) proves that this can be fatal, if one is not aware of what’s going on in the business, at least rudimentary.
– The stock of Capri Holdings is back to its levels of 2012.

This is a story of rather unprecedented extent.

While calling off and blocking deals of strategic importance or regarding questions of pretend national security are not uncommon (certain resources or semiconductors come to my mind, in France even supermarket chains – see here), this case here is about hand bags – hardly a topic of such importance.

Whether you want to call it the luxury sector, affordable luxury or wannabe luxury – it is hard to describe this seemingly unrealizable transaction as being so critical that the FTC would need to step in.

It does not affect the broad population negatively.

But exactly this has happened, effectively blocking this deal since it was announced. It should have been closed already, but it isn’t. The European and Japanese agencies already haven given their green light.

After having surged by about 50% in response to the bid, the stock of Capri Holdings (ISIN: VGG1890L1076, Ticker: CPRI) has given up all gains by now.

Today, it is not only trading where it was before the deal.

Even worse, it is trading where it has already been in 2012.

Where there are issues, there should be chances, right?

This is question I want to answer with this Weekly.

As it is said that luxury will always remain in high demand, the stock is certainly worth a check. In fact, I have even been a shareholder myself way before I started this blog, so I am familiar with the company to a certain degree. I think it must have been somewhere around 2017 or so, when shares were changing hands for roughly the same price like today.

But the fundamental setup was quite a different one back then.

I sold my position after a 50% gain, if I remember correctly. Rightly so, as looking backwards this has proven to be close to a high the stock would never see again until today – despite massive buybacks and two acquisitions!

I am going to discuss the development of the company over the last decade, its current fundamentals as well as comment on the valuation.

Is there a steal to be made?

The average total return of my best stock ideas well above the benchmarks, beating the S&P500 and the iShares MSCI World ETF.

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How Michel Kors’ stock fell out of grace

Personally, I have never had the perception that Michael Kors was a luxury brand.

Even though it sells its products at a premium price, I have not seen anything special in it, besides the fact that I am not out for luxury brands, but for quality at a fair price. The MK hand bag I once bought for my wife had to be returned and exchanged twice due to quality issues after a short time.

Maybe that’s why my view is rather negatively influenced.

But my analysis will be objective.

I am mentioning Michael Kors here, because today’s Capri Holdings in its early days consisted only of Michael Kors.

The stock I owned back then also had the name Michael Kors.

Michael Kors became Capri Holdings after its acquisitions of first the shoe brand Jimmy Choo in 2017 and later also the iconic Italian brand Versace in 2018.

Michael Kors spent more than 3.3 bn. USD for both names – that’s roughly 80% of today’s market cap so certainly not just two small tuck-ons.

The deals were not financed out of own cash flow generation as we’ll see.

When they were announced, the stock of MK – at least for a certain time – was trading even above the bid of 57 USD it received itself last year. That was also around the time when I left the boat, as certain things disturbed be.

Things have changed – unfortunately, for the worse.

The name change also happened in 2018 to better reflect a multi-brand powerhouse.

At least, this was the intention.

^{source: Capri Holdings (both, see here)}

The already then struggling Michael Kors brand was enriched by even more fragile and low-margin colleagues. While I understand that successful turnarounds can be quite lucrative, what I do not understand is how three sick entities shall level up each other.

Michael Kors up to a certain point was growing sales while having strong operating margins of 30%. That’s indeed worthy to be called luxury.

But first margins dropped, then sales started to top out.

Below are the numbers for the brand Michael Kors – from the last year as a stand-alone company (fiscal year 2017 until end of March 2017) and then the latest available numbers per calendar year end 2023.

Over the last seven years, the brand Michael Kors has been trending sideways. One could say, the positive news is that it hasn’t dropped.

Since then, operating margins have been dropping like a stone, though.

With a strong cash-rich balance sheet, management wanted to acquire growth.

Since FY 2017, i.e. the last standalone MK year, sales in total have grown by 20%.

So, the acquisitions must have contributed something to the whole, haven’t they?

While the brand Michael Kors managed to stabilize and even increase operating margins again to an at least respectable level of around 20% (though still way below the former 30%), both, Jimmy Choo and Versace, even if many people won’t believe it, until today are truly poor additions.

They both have low single-digit operating margins – so much for luxury brands!

Even though there were better numbers in the past and they managed to grow sales (Versace generates roughly 40% more sales and Jimmy Choo 17% since they joined Michael Kors), it is rather safe to say that 3.3 bn. USD spent for a bit of growth and lackluster earnings contribution is far from a success story.

Taken together, the run-rate for Jimmy Choo and Versace is about 1.6 bn. USD in yearly sales. That’s quite a disappointment, especially as margins are so weak.

What about cash flow generation?

Both, operating and free cash flow, peaked before the acquisitions started, indicating that they have increased costs, but not delivered to the bottom line.

The current numbers are even lower compared to the last two standalone years of Michael Kors.

During the same time, Michael Kors / Capri Holdings aggressively repurchased stock, partly financed through own cash flow generation, but also through debt.

The latter especially applies to the last few years.

The acquisitions also made it necessary to load up on debt. We have already seen the development from net cash to net debt above.

Here, is the development of net debt (green line) compared to share repurchases (blue columns) and acquisitions (black columns).

Buybacks were conducted especially at prices between 35–50 USD which back then was not even such a bad idea. The next big tranche was last year.

But you have seen above that debt increased meaningfully.

As a consequence, cash flow per share growth is far from impressive (bottom right chart). Over the last twelve months, it was 1.90 USD – basically the same like in FY 2014.

^{source: TIKR}

Even though management was successful in reducing shares outstanding significantly (top left chart) and on a net basis by more than 40% over the last ten years, unfortunately, it did not prevent the stock from dropping further.

Today, we have a not growing entity with difficulties in generating substantial cash flow, while being heavily levered.

Free cash flow over the last twelve months was only 223 mn. (in the years before somewhere between 500–600 mn. USD), compared to net debt of more than 3.7 bn. USD.

That’s quite a lot of leverage.

I wrote this longer intro, to show the younger history and current condition of Capri Holdings, the company that in last August, received a takeover bid of 57 USD per share which sent the stock 50% higher:

This would have been the golden parachute for stock holders who bought at higher levels.

As it looks now, the deal is unlikely to happen.

Or if, it should at best be viewed only as a bonus option.

If one wants to invest in the stock of Capri Holdings, it must be on the basis of believing in a successful turnaround with better margins.

And one has to be okay with the debt load, which personally for me, is too high.

But let’s look at the current valuation, especially as the share count is way lower than in the past, effectively making the stock cheaper than ten years ago – at least on an equity basis.

Here’s the market cap to free cash flow multiple:

On an equity / market cap basis, the stock looks quite cheap even.

But we need to add debt as heavily levered companies often trade for low multiples.

In fact, there were times when the stock was cheaper on an enterprise value to free cash flow basis, namely when debt was not that high and the stock down.

Today, we are paying 25x the current free cash flow.

Even being more generous and assuming that Capri Holdings manages to return to a free cash flow of 500 mn. USD – which they first have to prove they’re able to – then the current enterprise value of 7.6 bn USD (and 5.8 bn. USD ignoring leasing liabilities) results in a multiple in excess of 11x still.

I think 10x is a more realistic multiple than 25x (respectively and likely something in between), but both are too high.

The company does not pay any dividend and buybacks at such low cash flow levels are unlikely to be conducted in a meaningful amount.

Even if they put the entire 200 mn. USD into it, that buys back 5% of the current equity valuation. Repaying debt would likely be the better choice.

This buyback potential certainly looks better compared to Big Tech stocks, but Capri Holdings has its own set of risks. The brands are not developing as they should. They are far from being success stories.

My gut feeling tells me that the stock could fall to the 20s, even the low-20s.

I think I will have a look at the next earnings results, due 24 May 2024. Until then, I won’t do anything regarding this name, at least certainly not at these prices.

There’s no need to hurry.

Conclusion

Buying what one knows respectively well-known brand names is an often practiced strategy by novice investors.

However, the case of Michael Kors (now Capri Holdings) proves that this can be fatal, if one is not aware of what’s going on in the business, at least rudimentary.

The stock of Capri Holdings is back to its levels of 2012.

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