In a stunning turn of events, a judge ruled in favor of the U.S. government and blocked the proposed merger between handbag and fashion rivals Capri Holdings(NYSE: CPRI) and Tapestry(NYSE: TPR). The Federal Trade Commission (FTC) sued to block the merger in April after Tapestry agreed to buy Capri last year, arguing that the combination would hurt consumers and leave less affordable handbag options.
The FTC lawsuit was widely viewed as a long shot, as there was little precedence to block deals in the fashion industry and it would be difficult to prove that a deal would hurt consumers or increase prices.
Both Capri's Michael Kors brand and Tapestry's Coach brand, meanwhile, are typically viewed as accessible luxury brands. On its website, Coach has handbags priced as high as $10,000, while Kors has bags priced as high as $3,300, so they aren't selling cheap merchandise.
The news sent Capri's stock crashing, as its shares fell more than 45% while Tapestry shares climbed double-digits. Now that the merger is currently blocked, what should investors do with the stocks?
Capri
Capri, which is home to luxury brands Versace and Jimmy Choo, in addition to Kors, has been struggling since the announcement of the merger. As such, the plunge in its shares should perhaps not come as a complete surprise.
The company has seen its revenue decline for seven straight quarters, including a 13% decline last quarter, which ended in June. Kors is its biggest brand and saw sales sink 14%, with over 20% declines in Europe and Asia. Operating income for the brand, meanwhile, plunged 42%.
Things weren't any better for Versace, which saw its sales drop by 15%. Europe was its weakest region, with sales down 22%, while sales in the Americas were down 15%. Asia only saw a 3% decline in sales.
Jimmy Choo, known for women's footwear, was Capri's best-performing brand, but sales were down 5.5%. The company saw positive sales in the U.S., but Asia was a weak spot, with revenue down 17%.
Capri was in limbo for a year while it was waiting for its acquisition to go through, so it may not be surprising that its performance has been subpar. Typically, management won't make any big strategic shifts ahead of being acquired, while the uncertainty can impact company morale and cause a talent drain.
From a valuation standpoint, the crash in shares lowers Capri's forward price-to-earnings ratio (P/E) multiple to 9. However, that's a bit higher than where the stock traded before the acquisition announcement.
CPRI PE Ratio (Forward) data by YCharts.
Meanwhile, investors are left with a company that's been rudderless for the past year and now must embark on a turnaround. While the company should see renewed focus, the damage has been done and a turnaround may not be easy. Even with the huge drop, I'd stay away from the stock.
Image source: Getty Images
Tapestry
The government's blocking of the deal with Capri could be the best thing for Tapestry. The company will have to pay Capri up to $50 million if the deal is rejected, but that's a small price to pay.
Meanwhile, Tapestry, which owns Coach, Kate Spade, and Stuart Weitzman, has been performing much better than Capri. While its sales fell 2% last quarter, they were flattish on a constant-currency basis. Meanwhile, its adjusted earnings per share (EPS) fell from $0.95 to $0.92.
In addition to being Tapestry's largest brand, Coach has been its best-performing, with sales up 2% on a constant-currency basis in fiscal Q4 and 4% for the year. Kate Spade and Stuart Weitzman, meanwhile, both saw sales fall last quarter and for the entire year.
Overall, Tapestry has seen solid growth in Europe, which seems to have been Capri's weakest market, while North American sales were down slightly. Asia (outside of China) has seen solid growth, although Chinese sales last quarter were down 10%.
The company is expecting modest growth in fiscal 2025 with some slight margin improvement. It had previously said that if the Capri acquisition didn't go through, it would use its strong free cash flow for capital-allocation purposes, particularly to buy back shares.
Trading at a forward P/E of 11, Tapestry is close to trading at the levels before the merger announcement.
TPR PE Ratio (Forward) data by YCharts.
While the company has clearly performed better than Capri, it hasn't exactly been a strong grower, as sales haven't changed much during the past two fiscal years. The company now must look for another way to reinvigorate growth. Given its lack of growth and jump in stock price, the stock currently looks pretty fairly valued.
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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool recommends Tapestry. The Motley Fool has a disclosure policy.
