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Summary

  • Women's fashion is a fickle business (this is a good thing for those that seek to understand the ebb and flow of art/style and more relevantly FOMO/envy culture).
  • Last year, Coach traded at a >100% premium to Michael Kors -- since that time, KORS has usurped dominance in the eyes of the market.
  • ... now trading at a remarkable >60% premium to Coach.
  • I am now recommending a long Kate Spade -- short KORS pair trade until the market cap differential converges, at least from a 4:1 to 2:1 ratio.
  • ... a 100% upside in KATE; 50% downside in KORS -- or until KORS buys KATE.

Introduction

In my brand-value focused Tesla (NASDAQ:TSLA) article, Tesla Brand is Crown Jewel To Major Automakers, written this past December at $137 -- I referenced Michael Kors' (NYSE:KORS) trouncing of incumbent, Coach (NYSE:COH) -- as a way to illustrate the reality of Tesla's rapidly increasing brand cache at the expense of incumbent automakers. In both cases, I disregarded P/E multiples and near-term growth projections -- instead focusing on qualitative, intangible sentiments that drive the herd-like behavior of consumers (not unlike the behavior of investors).

It is perfectly reasonable to do this, if we: 1) agree markets are generally efficient, 2) use relative valuation to exploit special situations 3) pair trade to help eliminate market and industry-specific risk.

My Edge

To set up this Kate Spade (NYSE:KATE) bull thesis (and Michael Kors bear thesis) -- I don't think I can articulate the edge I have more clearly than quoting the aforementioned article. Please observe the situation from last year:

"The highest conviction investment idea I have ever had (with virtually no chance of significant loss) was to pair trade [a newly emerging] brand, Michael Kors, and a 70 year old incumbent, Coach, over the past year (buy KORS and short COH). Speaking with my fashionista sister-in-law and many other women -- it was unmistakable that Michael Kors products were, and are, far more desirable to key customer segments. The stronger brand was trading in and around a 50% discount to the brand whose lunch it was eating.

So although Coach had, and even still has, greater sales and net income than KORS -- because of this increasingly obvious brand strength -- the market is now also convinced that it is only a matter of time before KORS ramps up distribution to become more profitable than Coach. (KORS now has a higher market cap with a much higher multiple). This is rational, forward-looking behavior -- finally.

Though, there are distinct differences between ramping up handbag production and automobile production, I do believe the Tesla brand is, in a very similar way, already stronger than BMW, Audi, Mercedes, etc. At least for the consumers that currently matter -- the affluent. Side by side with the excitement of the Model S, all of these brands seem dull and tired. Like owning a BlackBerry (NASDAQ:BBRY) and a Coach bag in 2011 (what will happen 2-3 years later?). Thus, a very large and growing portion of wealthy people -- who are into their cars -- are jonesing after the Model S. The question now is production and distribution -- something that perhaps a few other companies might have a capacity for…"

Let's bring it back to handbags and women's fashion.

In the same way that Michael Kors leapt ahead of Coach in brand power, as many as 2-3 years before it did the same in market cap; and not unlike the way Tesla is seemingly making the brand cache of Audi, Maserati and Lamborghini irrelevant -- I'm now convinced that Kate Spade (along with Tory Burch*) has Michael Kors by the neck. This is evident from my ground-level research in Toronto, conversations with my my fashionista sister-in-law and others, as well as Internet sources I am not, at the moment, willing to divulge.

Quantitatively bent investors must remember that customer taste acts as a leading indicator, preceding financial performance. Late adopters will always be left holding the bag (pun intended).

KORS: $16.3 billion : Kate Spade: $4.1 billion

= ~ 4 : 1

*Tory Burch is a privately owned 'affordable luxury' brand that does convolute the comparison. This is a non-issue, however, utilizing the pair trading strategy -- shorting the brand-at-risk, Michael Kors.

Source: Don't Be Left Holding The Bag: A Kate Spade, Michael Kors Pair Trade

Additional disclosure: And also short KORS