The FTC wants to block a big handbag merger to preserve competition. '10,000 alternatives' could complicate its case.

By Bill Peters

'No one gets hurt' if they can't buy a luxury handbag, analyst says

When the Federal Trade Commission on Monday sued to block Tapestry Inc.'s acquisition of Capri Holdings, the agency said it was trying to make handbags made by brands like Coach, Kate Spade and Michael Kors more affordable to middle-income shoppers, who have to shell out hundreds of dollars, at times, for a single bag.

But as markets digested the agency's allegations - namely, that the $8.5 billion deal would fuse together two archrivals and suppress competition in the handbag industry - Wall Street analysts and others had their doubts.

The deal would put fashion brands like Michael Kors, Versace and Jimmy Choo - owned by Capri (CPRI) - and Coach, Kate Spade and Stuart Weitzman - owned by Tapestry (TPR) - under one umbrella. And while the FTC said the deal would push up prices and hinder competition within the so-called "accessible luxury" industry, an area it said was unique from other tiers of luxury goods, analysts and other experts said the industry was still rife with competition.

Jeffrey Oliver, a partner at the law firm Baker Botts and a former attorney at the FTC, said via email that the complaint from the current FTC was one of a few that likely would not have been drawn up by its predecessors. And he said both sides would face challenges in court.

"The FTC will have to show that these bags really don't compete with the 10,000 alternatives waiting on the other side of a Google or Amazon search," he said.

"The state of entry barriers - particularly in the age of the internet and its ability to connect shoppers quickly with alternative sources of supply - will also be highly contested," he added.

However, he said that the FTC's complaint, some of which was redacted, suggested the agency had its hands on a number of internal documents indicating that both companies were often engaged in head-to-head competition. The companies will likely have to explain those documents in court, he said.

The New York Times reported last week that the FTC was gearing up to block the deal. Citi analyst Paul Lejuez, in a research note last week following the Times report, said that Tapestry and Capri combined would have about 12% of the global handbag market. But he said there was "no good reason" for the deal not to go through, noting a proliferation of other options at Amazon and Macy's.

"So if the concern is higher prices, consumers could easily find substitutes," he said. "We view handbags as highly discretionary ... and no one gets hurt if they aren't able to buy a fashion handbag."

Jefferies analyst Ashley Helgans, in a research note on Monday, estimated that the deal had a 60% probability of closing. That was down from an earlier call for 70%. But she said the deal was still likelier to close than not, "given the competitive and discretionary nature of the broader handbag market along [with] low barriers to entry."

Shares of Tapestry fell 2.2% on Tuesday. Capri lost 3.8%.

The companies announced the acquisition deal in August. They expect it to close this year.

The deal arrives as consumers remain cautious about spending on high-end fashion, as they navigate higher prices for groceries, rent and other essentials. And it comes as Tapestry tries to get bigger through acquisitions, to potentially compete with much larger luxury-fashion giants in Europe like LVMH, which owns Louis Vuitton and Dior. Tapestry currently has a market cap of $9.3 billion. LVMH's (FR:MC) is around $428 billion.

Capri said in February that its fiscal-third quarter sales fell 5.6%, amid "softening demand for fashion luxury goods." However, Tapestry said that month that its fiscal second-quarter sales rose 3%, and raised its full-year profit outlook.

Both companies, in response to the FTC's action on Monday, said that the agency misunderstood the intense competition in the luxury fashion industry.

"The bottom line is that Tapestry and Capri face competitive pressures from both lower- and higher-priced products," Tapestry said in a statement on Monday. "In bringing this case, the FTC has chosen to ignore the reality of today's dynamic and expanding $200 billion global luxury industry."

However, in its complaint, the FTC argued that "accessible" luxury was different from the luxury offered by, say, Louis Vuitton and Hermes, which can charge thousands of dollars for a handbag and generally target wealthier customers. The handbags from Coach, Kate Spade and Michael Kors were less expensive, and the shoppers targeted by those brands tended to fall into the middle and working class, the complaint alleged.

The agency also said that Coach coined the term "accessible luxury" more than two decades ago in an effort to carve out a niche between mass market and "true" luxury. Later, the companies and their industry peers adopted similar terms, such as "affordable luxury," "aspirational luxury" and "accessible luxury," the complaint said.

In the years that followed, the complaint said, the industry began to use that term to describe a "very distinct handbag product." That is, one largely made in Asia with higher-quality materials at modest prices, as opposed to cheaper, mass-market products made in bulk in China from less expensive materials and higher-end handbags made largely in Europe.

"With jawdropping prices at multiples of the offerings of Coach, Kate Spade and Michael Kors, true luxury handbags are not substitutes for 'accessible luxury' handbags," the complaint alleged.

Jonathan Lazarow, a partner at the law firm Ambrose, Mills & Lazarow, said it was too early to tell whether the FTC could stop the acquisition.

He said he felt like Tapestry and Capri had a strong case for the deal. However, he said the FTC could still slow it down or discourage the companies from pursuing it. They could also ratchet up pressure for either company to spin off one or more of its brands.

Still, Lazarow, who has a background in private equity, retail-industry consulting and the accessories and jewelry industries, said that in order for a U.S. company to compete with the likes of LVMH or Kering, which owns Gucci and Balenciaga, someone would probably need to bulk up via acquisitions. And he said the boundaries between "true" luxury and "accessible" luxury were sometimes blurry.

"The same woman who buys a handbag every year from Coach or Kate Spade or Michael Kors might also, every couple of years, buy a handbag from Louis Vuitton or Dior," he said.

And the competitive dynamics in luxury might also be a bit different from, say, the grocery industry, where the FTC has sued to block the merger between Kroger Co. (KR) and Albertsons Cos. Inc. (ACI) to keep food prices lower.

"In luxury, to begin with, nobody needs a handbag," Lazarow said.

-Bill Peters

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04-23-24 2202ET

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