By  on January 6, 2015

Coach Inc. isn’t going to find the solution to its problems in Stuart Weitzman.

That seemed to be the reaction Tuesday from investors after Coach revealed it will acquire the Weitzman footwear brand from Sycamore Partners in a transaction valued at $574 million, with $530 million paid up front and up to $44 million in earnouts over three years. The deal, which is expected to close in May and will immediately be accretive to earnings as well as expand Coach’s market share in footwear, comes as the company’s management team — headed by chief executive officer Victor Luis and creative director Stuart Vevers — continue with their ambitious and still unproven strategy to turn Coach into a lifestyle brand.

The accessories firm was forced to develop that strategy since its growth has been undermined by newer competitors such as Michael Kors and Kate Spade gobbling up market share. The bad news is that Kors and Spade now are also struggling in the U.S. as the overall handbag market slows.

After news of the Weitzman acquisition broke, Coach shares hit an intraday high of $37.10, up 1 percent from Monday’s close of $36.73, before dipping south by 1.2 percent to close at $36.29 in Tuesday’s trading session. Perhaps there was some element of sympathy pains given that shares of Kors and Spade also declined, with the sell-off triggered by a downgrade of Kors by Credit Suisse analyst Christian Buss. Shares of Kors saw the most activity, dropping 8.4 percent to $66.87, with more than 15.7 million shares changing hands compared with a three-month average of 3.5 million. Spade slipped 4.4 percent to $29.57. Shares of all three firms trade on the New York Stock Exchange.

Buss downgraded Kors to “neutral” from “outperform” due to, in his view, the “dramatic ramp in promotional activity seen across the U.S. retail landscape for the brand’s handbags.” His new target price for Kors shares is down to $79 from $103.

In a study tracking handbag discounting over the October through December time period, Buss said Spade markdown activity on its e-commerce platform “is the highest of all the brands, with almost 50 percent of product on sale.” But Sterne Agee’s Ike Boruchow is keeping his “buy” rating on Spade shares. Boruchow believes the online sale stockkeeping units for both Kate Spade New York and Kate Spade Saturday were down year-over-year in December.

Regardless of who is marking down what, the fact remains that the underlying problems inherent in the handbag sector, Coach’s core business, aren’t going away anytime soon. That means Coach might be struggling for an even longer period than projected.

That wasn’t lost on the Wall Street crowd, with many analysts lukewarm at best over the Weitzman acquisition.

Morgan Stanley & Co.’s Kimberly C. Greenberger noted that Coach is likely to add debt to its balance sheet, concluding that “debt financing to fund the acquisition now leaves less financial flexibility for later….If turnaround efforts either take longer than anticipated or fail to materialize, future cash flow may not be sufficient to cover operating needs, capital expenditures and the dividend at current levels.”

Randal J. Konik at Jefferies said, “Though we recognize the potential for synergies with Coach’s own footwear business as it leverages learnings from the deal, improving the core handbag business remains the primary lever for this story.”

Wells Fargo’s Paul Lejuez said, “While we believe Weitzman is a relatively strong brand, and has the potential to improve/expand its product line, we do not believe the acquisition does much to solve Coach’s existing brand puzzle.”

Lejuez noted that Weitzman’s $300 million in annual volume plus e-commerce and wholesale sales puts the brand’s revenues at $500 million to $600 million at retail, and with the purchase price representing almost 2x wholesale revenue, he concluded the acquisition was “no bargain.” The Wells Fargo analyst also concluded that Weitzman “would be a nice tuck-in acquisition for a company that was on its feet, not a saviour for a brand that is struggling.”

W. Baird’s Mark R. Altschwager said enthusiasm for the deal is “tempered given the potential distraction amid an intense transformation strategy for the Coach brand.”

While Cowen & Co.’s Oliver Chen saw pluses for the acquisition on the long-term value side of the equation, he cautioned that there could be integration risk given that Coach is used to organic growth rather than expansion through a mergers-and-acquisitions focus.

Sterne Agee’s Boruchow concluded: “Under normal circumstances, a leading American handbag brand acquiring a leading American footwear brand would be a reasonable strategy, but Coach may have too many balls in the air right now. On top of that, we believe the business is currently burning through cash in the U.S. [With U.S. operations continuing to struggle], negative cash flow, a potential $1 billion in debt moving onto the balance sheet and a new acquisition to integrate into the global business — management has their work cut out for them.”

The analysts’ reaction was on top of questions over the potential of the Weitzman business itself. Potential buyers who spoke with WWD under the condition of anonymity said they balked at the $600 million plus asking price for Weitzman either because they weren’t as optimistic about the brand’s international growth opportunities — Weitzman as an established brand is already in select overseas markets — or had some concerns over how long Stuart Weitzman, founder and ceo of Stuart Weitzman Holdings, LLC, would continue with the business.

On Tuesday, Coach said Weitzman and the existing management team would continue with the company after the deal is closed. Neither executives at Coach nor Stuart Weitzman would comment, citing the current quiet period leading to Coach’s release of second-quarter earnings on Jan. 27.

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