Kate Spade Pre-Fall 2017

NEW YORK — Shares of Coach Inc. on Tuesday rose 1.1 percent a day after the accessories firm said it was acquiring Kate Spade & Co., although two of the three ratings agencies — Fitch Ratings and Moody’s Investors Service — now have Coach on ratings watch for a possible downgrade.

That’s because Coach is taking on some debt to pay for the $2.4 billion transaction. The deal will initially be funded by $2.1 billion of debt comprised of term loans and senior unsecured notes, offset by repayment of the expected $800 million six-month term loan using proceeds from $1.2 billion of excess Coach cash. The acquisition is expected to close in the third quarter of calendar 2017, which would be Coach’s first fiscal quarter of 2018.

Fitch Ratings said the ratings watch is because the acquisition “would cause Coach’s leverage to increase from the current 2.6-times level to 3.7-times on a pro forma basis at closing and decline to around 3.3-times at the end of fiscal year 2018” upon repayment of the $800 million six-month term loan. Fitch said leverage is expected to trend to under three-times over the following two years on earnings before interest, taxes, depreciation and amortization growth. The ratings agency also noted possible integration risk from potential changes to Kate Spade’s growth strategies.

Moody’s placed Coach on review for similar reasons. Moody’s vice president Mickey Chadha said, “While the acquisition gives Coach additional product lines and expansion opportunities, it will increase Coach’s financial leverage above our downward trigger of three times.” Moody’s said its review will also “focus on the likely pace of deleveraging post-closing.”

S&P Global Ratings, the third ratings agency, affirmed Coach’s “BBB-” rating, noting the outlook as stable. S&P said it was affirming all ratings on Coach, saying it was a reflection of its view of an “overall credit-neutral impact of the transaction, as the company’s strengthened brand diversification and EBITDA base offset expected weaker credit metrics.”

Dana Telsey of Telsey Advisory Group said of the deal, “An appropriate valuation is key to the success of any transaction, as we view the $18.50 per share [to be paid] entirely reasonable.” She noted that deal multiples across the retail space have averaged in the 10-times range over the long-term, while the deal for Kate Spade is at 9.2 times.

Randal J. Konik of Jefferies said after attending Coach’s sell-side analyst breakfast Tuesday morning, said, “We [attended the breakfast with new chief financial officer] Kevin Wills and came away with even greater conviction in the unfolding group structure, processes and systems implementations, which should allow Coach to become a leading luxury conglomerate.”

The analyst reiterated his “Buy” rating of Coach shares, with a price target of $53. He also said, “While the market is focused on Kate [Spade] at the moment, we take a different view and instead look further out, where we see Coach becoming an enviable house of brands with strong pricing power, distribution, growth and high returns on investment.”

Shares of Kate Spade rose nearly 0.2 percent to $18.41, reflecting the stated take out price of $18.50, while Coach shares were at $45.20. Both stocks trade on the Big Board.

For more information on Coach and Kate Spade:

Coach’s Victor Luis Talks Kate Spade, Modern Luxury and Acquisitions

Coach Inks $2.4B Cash Deal for Kate Spade & Co.

Coach’s Growing Millennial Focus Makes Kate Spade the Better M&A Play

Activist Investor Pushes Kate Spade to Sell Company

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