Comparing American and European Luxury M&A Trends by Annabelle Williams W'20

The luxury market has increasingly trended towards consolidation of key industry players. Does this focus on M&A dilute brand value or simply signify a change in corporate governance? Historically speaking, European luxury holding companies have been a fixture of the luxury market for the past half-century. The first to employ the method of large-scale luxury holdings was French SA Kering, under the leadership of Francois Pinault. The European model then gained steam in the 1990s, with major bidding wars by Kering and what was then Gucci Group, for brands such as Fendi.

One of the major benefits of these consolidated models are their financial disclosure provisions. Indeed, individual cash flows segmented by brand are not required in disclosures, so the overall health of the conglomerate is the only public financial information. In other words, if one of the brands in a group’s portfolio is in the red, the holding company can apply the net income and retained earnings from another, more profitable brand to offset the losses, and mask them from the public. This implies that no investors or customers ever fully understand how much a particular brand is struggling.

This disclosure  advantage is appealing to American companies, which have long struggled to brand themselves as luxury fashion houses, and instead (as in the cases of Calvin Klein and Ralph Lauren), operated mostly in the apparel sectors. American brands cannot lean on the longstanding heritage that European fashion houses claim.

The three major players in the consolidated luxury market are all based in Europe. French SA Kering (Gucci, YSL, Alexander McQueen, and Puma are among its brands), as mentioned above, came first, followed in short order by French SA LVMH (holding Louis Vuitton, Moet, Hennessy, Givenchy, and Christian Dior) and Swiss SA Richemont (Cartier, Dunhill, Montblanc and more).

Interestingly, the United States luxury market has staved off the European model of corporate consolidation. Instead, the US market is typically characterized by M&A activity like any other industry, with one established brand acquiring another. Take the recent example of Coach’s $2.4 billion acquisition of competitor Kate Spade, or its 2014 purchase of luxury shoe brand Stuart Weitzman. Another prominent example of acquisition activity happened in July 2017, when Michael Kors acquired Jimmy Choo, the brand that rose to prominence for its distinctive high heels, thanks in part to Sex and the City’s Sarah Jessica Parker.

Where does the inherent difference in these two consolidation strategies come into play? First, we must consider brand value. Indeed, while the  European model preserves individual brand value because large holding companies do not have a brand of their own which can distort the one they acquires, American companies with already-established consumer perceptions increasingly often acquire their direct competitors. However, not all American businesses have ignored the European precedent. As Michael Kors CEO John Idol alluded to, when speaking about the strategy of imitating Kering and others: “... we are really looking to build an international luxury company, and less so brands that ... have a greater reliance on wholesale than its own retail strategy.”

Both Michael Kors and Coach faced issues of brand devaluation through the early 2000s; branding experts described their approach as “accessible luxury.” Coach moved to dispel this misconception first with their 2015 acquisition of Stuart Weitzman, and then continued to cater to millennial consumer bases with their Kate Spade acquisition, a demographic in which Kate Spade has significant market share.

Another metric of the success of M&A activity in the luxury retailer industry are stock ratings and associated notes. The October 5th, 2017 ratings for Michael Kors and Coach provide a good snapshot of short-term directions for each corporation. Following the deal’s announcement on October 5th, Piper Jaffray downgraded Coach’s stock from Overweight to Neutral, citing the need for Coach to “digest” the Kate Spade brand. Piper Jaffray further mentioned the need for Coach to restructure its business into a “house of brands.” This was cause for concern for some investors because it potentially lengthens the time needed for Coach to take a seat at the table with major luxury market players. S&P put it at the same level as Kors, with a BBB- rating, the lowest investment-grade rating possible.

With regards to Kors’ acquisition of Jimmy Choo, the early October valuation narrowly avoided junk ratings from S&P, Moody’s, and Fitch. Kors’ stock only just cleared for the lowest investment-grade classification! Clearly, both ratings agencies and the sell-side are both unsure of the feasibility of this Kors/Jimmy Choo merger. However, while stock classifications reveal the market’s short-term opinions of the company, they are only one component for predicting the future success of a merger; especially mergers like these with transformative effects on the luxury sector.

What does this consolidation mean for competition and oligopoly in both the American and Euro luxury markets? One theory is that bidding wars for smaller, designer-owned labels may soon become forums for luxury conglomerate giants to engage in competition. In turn though, operating in an increasingly oligopoly–based market disadvantages smaller brands and companies.

Coach, if it plays its cards right, can use its new acquisitions to boost its status in the luxury market. Its handbags may well be a Veblen good, with demand that increases proportionally to price, given the right branding and an increased emphasis on luxury. However,  if Coach fails to brand itself as true luxury and sticks to an ‘in–between,’ it may fail to effectively compete in either the luxury or the apparel markets. Michael Kors, too, needs to be deft in its  takeover of Jimmy Choo; the caché of the latter should bolster its parent company, but success in that will depend on branding efforts for both parent company and its subsidiary.

Luxury brands are tricky to preserve. Conventional rules of consumer behavior and demand need to be adjusted to suit a high-income, status-seeking market. But when maintained well, both by creative directors and business managers, dividends and valuations can be extremely high. Unsurprisingly, eight out of 100 of Interbrand’s 2017 Most Valuable Brands fall into the luxury sector; clearly indicative of the market power these companies possess.

Perhaps it’s time for American giants to truly come to the table in one of the most quintessentially European markets—luxury and high fashion. The Kors and Coach acquisitions should provide a basis on which to predict future successes for each would–be “house of brands,” and the American luxury market writ large.