M&A Arb Update: The Frustrating Deal That Is Capri and Tapestry
M&A Arb Update: The Frustrating Deal That Is Capri and Tapestry
What's taking so long for the deal to close (or not)?
One of the hardest parts with merger arb is playing the waiting game when not much, if at all, news has come out regarding the deal. The last time I shared my thoughts, I highlighted that I would be shocked to see any of the commissions sue to block this deal from happening.
You can read my original post below.
At the time, the market probability of the deal going through stood at just 62%. This was already dramatically down from the peak of 86% at the time of the deal announcement.
However, the price of CPRI 0.00%↑ and TPR 0.00%↑ have dramatically inverted since November’s earnings release were bullish for Tapestry and conclusive of a slowdown for Capri.
Now? The probability has dropped to a mere 47.7% at the time of writing this post.
With at least three high-profile deals being nixed by regulators (iRobot IRBT 0.00%↑, Spirit SAVE 0.00%↑, and Albertson’s ACI 0.00%↑) the impending deal I believe is just getting hit from negative fallout and suffering collateral damage.
But even if that’s true, what’s going on at the core of the deal, and have things truly changed? Let’s first go over noteworthy updates since my last post.
Since the Last Post
Two of the biggest points that have had updates were how China viewed the deal, and if Capri’s financials indeed were continuing its decline that could jeopardize the deal.
Capri did release their earnings in February after Tapestry and they were indeed not reassuring at all.
For the quarter, revenue was down 5.3% YoY and operating margins are down ~150 bps from 22.9% to 21.2%. Wholesale continues to be a challenging environment but while not ideal, it’s not a reason for the deal to suffer, just reiterates the need for them to be acquired by TPR.
On the other hand, I wrote in the prior post that the Chinese SAMR should be of no concern given its history of approving deals like this. It was basically a nothingburger.
Of course, they ended up approving the deal and while this was a positive sign, not much we didn’t already know so this too didn’t have much of an effect as we might have liked to.
Both of these updates unfortunately don’t really change anything. But let me go over some more interesting points that we need to consider and reconsider.
Downside Risk
When thinking about the break price of the deal, given how CPRI isn’t doing that well, Jefferies put out their commentary on what they believe could happen as a likely scenario.
"We view upside as limited from here and downside as underappreciated in the event of the deal closing given sales declines of acquired brands and debt load," Helgans added. "For TPR, we assume a price ~$40-$45 in the event of a deal and $45-$50 w/ no deal, leading to wtd. avg of low-$40s."
If the deal for Capri (CPRI) were to fail to be completed, Capri may have downside to mid-$20s.”
Jefferies sees a 70% chance the CPRI deal closes as there appears to be some skepticism about an antitrust review of the deal due to "relevant" market size.
Market Size
Speaking on relevant market size, in my previous note, I said
Should this deal go through, the merger would create the fourth-largest luxury goods firm with a market share of 5.1%.
However, this accounts for the broader luxury goods market globally and doesn’t account for geography or product type.
Looking at luxury footwear for instance, which Jimmy Choo, Stuart Weitzman, Michael Kors, and Versace have a hand in.
Based on 2022 figures, the newly combined company would have ~9-10% global market share within the category.
Not insignificant but it really depends on who you’re asking. I don’t quite have accurate measures for other product categories but some estimates have put NewCo anywhere from 20-35% of the market for luxury/affordable luxury handbags in the US.
That’s where things get interesting which I’m sure the FTC would likely bring up as a talking point. Even with a point like this, the “ammo” in other product categories and regions most likely won’t hold up as well.
Concessions
Because of the nature of this deal, being in luxury retail, I initially outlined that I didn’t see major concessions happening. Some mentions on Twitter talk about divesting certain brands but that makes zero sense and defeats the whole purpose of merging brands.
On the other hand, luxury is a sensitive topic when trying to label which brands should be considered in it. Pricing power and discounting heavily rely on consumers’ perception of the brand and thus, the ability to raise prices on owned goods and create leverage on wholesalers.
Michael Kors learned about this firsthand in 2015 when it overexpanded too rapidly and was forced to live a life of discounting for a while.
Simple concessions could come from NewCo’s ability to control pricing against its retail partners/wholesalers.
New Timelines to Consider
On March 6th, TPR filed1 with the EU Commission in regards to the deal with their decision to be tentatively made by April 15th. However, given TPR and CPRI’s EMEA exposure relative to other brands, people familiar with the matter believe that approval (or denial) can move a lot faster than the FTC.
As of this moment, absent any new update from the FTC in the interim, this is the nearest date that investors need to be wary of in the immediate term.
Additionally, the deal was planned to be closed by the first anniversary of the announcement date, but that’s closing in mighty fast with no real update in sight from the FTC. With the terms of the agreement, and given certain conditions are met, the deal is allowed to be extended twice past the outside date.
provided that if on such date, the condition to Closing set forth in Section 7.1(b) or Section 7.1(c) shall not have been satisfied but all other conditions to Closing shall have been satisfied or waived (other than those conditions that by their nature are to be satisfied at the Closing, but provided that such conditions shall then be capable of being satisfied if the Closing were to take place on such date), then the Outside Date shall be automatically extended for one three (3) month period and such date shall become the Outside Date for purposes of this Agreement; provided further that if on the date which is three months after the first anniversary of the date of this Agreement, the condition to Closing set forth in Section 7.1(b) or Section 7.1(c) shall not have been satisfied but all other conditions to Closing have been satisfied or waived (other than those conditions that by their nature are to be satisfied at the Closing, but provided that such conditions shall then be capable of being satisfied if the Closing were to take place on such date), then the Outside Date shall be automatically further extended for one additional three (3) month period and such date as so extended shall become the Outside Date for purposes of this Agreement;2
Again, assuming conditions are met, we could see this potentially extend into 2025 should it come to that point which means every investor needs to keep that in mind as they think about deal timing.
Closing Thoughts
Seeing this deal slowly decay as time progresses has been incredibly frustrating as I’m sure to many of you as well. I still see this deal getting completed mainly because I can’t see a clear and obvious path as to why it shouldn’t.
It’s more likely than not that the deal closes, it’s just a matter of when. Concessions in the matter, while likely not extreme, I believe can be easily obtained should the FTC just want to get a point on the scoreboard in the name of the American consumer.
It’s an interesting one for sure and I’ve sized up during Q1 during this recent price weakness. Will continue to follow the deal and update when necessary.
Until next time,
Paul Cerro | Cedar Grove Capital
Personal Twitter: @paulcerro
Fund Twitter: @cedargrovecm
I think a major part of the investigation has to do with outlet malls distribution. This was said in the 2nd request info. As for Capri financials deteriorating, that can't be an excuse to get out of the merger. Even Musk tried it with Twitter and failed legally.
Isn't the whole purpose of anti trust to protect consumers (low prices, large choice)? Why do you have to protect consumers that spend a couple of $100 for a handbags in the first place?