Activist Investor Letter To Kate Spade
Caerus Investors, focused on investing in consumer-related equities has sent a constructive letter to Kate Spade.
We are deeply concerned about the precipitous decline in the share price of Kate Spade over the last two and a half years brought about by management’s inability to meet their own stated goals. The stock has now fully retraced the entire gains from when the former Fifth and Pacific first announced its intention to isolate Kate Spade as a stand-alone entity in early 2013. While we have long admired the growth prospects for the Kate Spade brand, we have become increasingly frustrated by management’s inability to achieve profit margins comparable to industry peers. Given the market’s lack of faith in the current management team, as evidenced by the 63% decline in the shares since the intraday high on August 11th, 2014, we believe the best path for enhancing shareholder value is to pursue a sale of the company. We strongly believe that a strategic, industry player would be willing to pay a substantial premium to add this growth business to their portfolio.
Over $3bn in equity value destroyed in the last two and a half years
We first invested in Kate Spade back in 2009 under parent company Liz Claiborne solely on the basis that the stand alone value of Kate Spade was grossly mispriced inside an apparel conglomerate with other poor performing assets and high levels of debt. We argued back then for the break-up of the company and were gratified when the Board finally made the decision to act in 2013. Shareholders were rewarded as the stock surged above $40 over the following year. Since those successful moves, material shareholder value has been destroyed by wasting time, energy and money on the former sub brand Kate Spade Saturday and management has missed interim sales and margin targets on 3 different occasions.
We are writing to you and the Board to let you know that real change is needed at Kate Spade. The equity market is grossly under-valuing the future growth opportunity of the business and the Board must act in the best interest of shareholders to maximize value for the company.
EBITDA Margins are woefully below peers
EBITDA margins at Kate Spade are 400-1000bps below peers. Management has simply not delivered on stated margin targets resulting in the market doubting the prospects for the business.
Current Valuation Reflects little to no growth despite a 20% revenue and 42% EBITDA CAGR
At one point during calendar year 2014, Kate shares traded at over 35x consensus EBITDA. Today, Kate Spade shares now trade at <8x consensus 2017 EBITDA, a multiple below where the predecessor company Fifth and Pacific sold both Lucky Jeans and Juicy Couture, brands with far inferior growth prospects than Kate Spade.
Management and the Board have both stated on multiple occasions they see a path to $4bn in retail sales for Kate Spade, double the current run rate.
Revenues at Kate Spade this year are estimated to grow 11% versus the two closest peers where revenues are growing 2%. EBITDA is expected to grow 21% versus peers where EBITDA is expected to contract at Michael Kors and grow 16% at Coach. Sadly, with a growth rate in revenues and EBITDA equal to or significantly higher than peers, Kate trades at a discount to the peer set on EV/Sales and at a discount to Coach on EBITDA.
Paths to Value Creation
As you might imagine, shareholders (ourselves included) are incredibly frustrated. Kate Spade still has a large market opportunity yet the equity valuation reflects a low/no growth valuation. The only logical conclusion to make as a result of the dramatic share price decline is that shareholders have lost confidence in management and their ability to increase EBITDA margins toward the peer set.
We think Kate Spade would make a great acquisition candidate for a strategic company in the lifestyle accessories category. The Company’s margins are well below peers with material opportunity for expansion as licensing revenues grow and the business scales over time. Kate is still under penetrated overseas with a nice runway for growth. A potential buyer would be able to realize material cost and revenue synergies over time allowing for the ultimate expansion of EBITDA margins toward the peer set. Simply using a reasonable precedent growth company multiple of at least 12x EBITDA would warrant a share price in excess of a 50% premium to the current price. In fact, in March of this year Samsonite acquired Tumi for over 15x EBITDA and 3x revenues. We strongly suggest the Board consider this option as public equity investors have all but given up on the Kate Spade story.
We think the brand equity is extremely strong but better suited in the hands of a larger, more experienced, global player that can more effectively grow the business.