Kate Spade & Company: The Crown Jewel Begins To Shine, For Investors And Bidders

| About: Kate Spade (KATE)
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Shares of Kate Spade & Company (NYSE:KATE), formerly known as Fifth & Pacific and Liz Claiborne, have delivered solid returns for investors over the past year, returning almost 96% as investors applauded stellar results at kate spade, and the company divested Lucky Brand and Juicy Couture to focus on kate spade. The company's performance over the past 5 years is even more notable, with shares returning over 1,100%, driven by both continued growth at Kate Spade & the recovery of the broader retail sector. However, we believe that despite Kate Spade's rally, there is more upside remaining. Now that the company has divested Juicy Couture and Lucky Brand, management can focus on its crown jewel: the kate spade brand. The company's Q4 and full-year 2014 results point to continued growth for kate spade, both in the United States and abroad, and as management moves forward with deleveraging its balance sheet, and investing in and expanding the brand, we expect the true value of Kate Spade & Company to be unlocked as its crown jewel (kate spade) begins to truly shine, either via a sale of the company to any number of potentially interested suitors, or through a re-rating of the company's multiples as its equity becomes fairly valued in relation to its outsized growth prospects vis-à-vis its competitors. On a PEG basis, we see upside of over 40% for Kate Spade & Company, and potentially more if any number of suitors step up and bid for the company. In this article, we will discuss the history of Kate Spade & Company, its performance in 2013, its performance relative to its peers and its valuation, as well as the possibility of an offer for the company. Unless otherwise noted, financial statistics and managerial commentary will be sourced from the following: Kate Spade's Q4 2013 earnings call, its Q4 2013 earnings presentation, its 2013 10-K, or its Q4 2013 earnings release (note: when referring to the company as a whole, we will use the term Kate Spade; the lowercase stylized kate spade will be used in reference to the brand itself).

Kate Spade, A History

Kate Spade traces its origins to 1976, when it was founded as Liz Claiborne by designer Liz Claiborne and her partners. Going public in 1981, Liz Claiborne earned the distinction of being the first company with a female founder to break into the Fortune 500. However, as the years wore on, Liz Claiborne lost its way, its stock peaking at $46.40 in February 2007. When William McComb assumed the role of CEO in 2006 (he led the company through its transition into Kate Spade, stepping down alongside the company's Q4 earnings release and handing control to Craig Leavitt), Liz Claiborne had ballooned to an assortment of over 30 brands, losing focus just as the economy began to weaken. McComb took action, steadily trimming the company's brand portfolio until even Liz Claiborne itself was sold to J.C. Penney (NYSE:JCP) in October 2011 for $267.5 million. The new company was renamed Fifth & Pacific Companies, focusing on its remaining slate of brands, which included Juicy Couture, Lucky Brand, Adelington Design Group (jewelry), and kate spade. And it is this latter brand that would prove to be the crown jewel of the company. The kate spade brand came under the control of Liz Claiborne in November 2006, when the company acquired it for $124 million from majority owner Neiman Marcus, which put it up for sale in September 2005. The kate spade brand itself was launched in 1993 in New York, and today features three distinct segments: the namesake kate spade brand, Jack Spade for men, and the new kate spade Saturday line, catering to a younger and more casual customer.

Fifth & Pacific entered 2013 with four distinct brands: Lucky, Juicy, Adelington, and kate spade, selling two of those as the year went on. The sale of Lucky was completed on February 3, 2014 for $225 million, and the sale of Juicy Couture was announced in October for $195 million. Together, these two divestitures are expected to bring in $370-$380 million to Kate Spade, and we will discuss the company's financial position in much more detail later. With the sale of these two brands, the company is now left with kate spade and Adelington, and in conjunction with its transformation, Fifth & Pacific changed its name to Kate Spade & Company, thereby cementing the prominence of the kate spade brand and the rebound that the company has experienced since the financial crisis, when its stock was trading below $2 (shares closed at nearly $34.22 on February 28, 2014).

The continued growth at kate spade has allowed Kate Spade to reverse its fortunes after years of mediocre performance, and the company achieved progress on multiple financial fronts in 2013, growing EBITDA, narrowing net losses, and trimming its operating and free cash flow burn. Furthermore, management has laid out a clear path to further strengthening the company's balance sheet, ending its free cash flow burn, and moving Kate Spade to sustained profitability, which will happen in 2014 as the full earnings power of kate spade begins to flow to the company's bottom line.

2013: A Year of Progress, A Year of Transformation

2013, both in terms of the key holiday quarter and the year as a whole, was a solid year for kate spade, with sales and EBITDA growing by double digits. However, before we continue with our discussion of kate spade's performance, it is important to add a preface. Kate Spade, which ended the fourth quarter of 2013 as Fifth & Pacific, included the operations of Juicy Couture in its reported financials for the quarter and the year, thereby obscuring the true performance of kate spade. Going forward, we will present adjusted financials for kate spade & Adelington (the company's remaining brands) where possible, excluding the results of Juicy Couture and Lucky. However, operating and free cash flow data will be based on Fifth & Pacific's consolidated performance, for the company does not provide brand-level cash flow data. We begin our overview with Kate Spade's Q4 and full-year 2013 cash flow performance, which includes the results of Juicy Couture, and treats Lucky as a discontinued operation.

Cash Flow: Narrowing the Burn

Kate Spade made significant progress in trimming its cash burn during 2013, and posted significant growth in free cash flow during the key holiday quarter. The table below breaks down Kate Spade's cash flows for Q4 2013 and the year as a whole, reconciling the company's 2013 10-K and its Q3 2013 10-Q to create full cash flow statements for Q4 2013. Per share data for both Q4 2013 and 2013 as a whole will be based on Kate Spade's current outstanding count of 123,398,368 shares, and per share data for Q4 2012 and 2012 as a whole will be based on Kate Spade's outstanding share count of 119,822,091, as listed in its 2012 10-K.

Kate Spade & Company Cash Flow, Q4 2013 & 2013 (in Thousands of $)

Q1-Q3 2013

Q4 2013


Q1-Q3 2012

Q4 2012


Net Income (Loss)







Adjustments to Arrive at Income (Loss from Continuing Operations)







Income (Loss) From Continuing Operations








Depreciation & Amortization







Impairment of Intangible Assets







Loss on Asset Disposals & Impairments







Deferred Income Taxes







Stock-Based Compensation







Foreign Currency Translation Losses (Gains)







Gain on Acquisition of Subsidiary







Gain on Sales of Trademarks







Loss on Extinguishment of Debt














Operating Cash Flow ex-Changes in Working Capital







Changes in Working Capital

Accounts Receivable














Other Current & Non-Current Assets







Accounts Payable







Accrued Expenses & Other Non-Current Liabilities







Net Change in Income Tax Assets & Liabilities







Net Change in Working Capital







Operating Cash Flow From Continuing Operations







Net Cash Used in (Provided by) Discontinued Operations







Operating Cash Flow







Capital Expenditures







Free Cash Flow







Free Cash Flow From Continuing Operations







Pro Forma EPS







Shares Outstanding







Operating Cash Flow from Continuing Operations per Share







Free Cash Flow from Continuing Operations per Share







There are several key elements of Kate Spade's cash flow statement that warrant attention. In Q4 2013, consolidated operating cash flow from continuing operations rose by more than 170% to $92.043 million, and free cash flow surged from less than $28 million to almost $92 million (we remind investors that for the sake of comparability, cash flow from continuing operations should be examined, not Kate Spade's total cash flow, which, depending on the time period, either deflates or inflates the company's cash flow from continuing operations. On a full-year basis, cash burn from continuing operations narrowed to just $5.066 million, down over 86% relative to 2012. Free cash flow burn from continuing operations (defined as cash flow from continuing operations less capital expenditures) narrowed from $99.473 million in 2012 to $83.18 million in 2013 as a meaningful ramp in cash flow was offset by increased capital expenditures tied to kate spade's expansion. With the divestiture of Juicy Couture and Lucky, Kate Spade's 2014 cash flow figures are likely to be materially above its 2013 metrics; we will provide more insight into Kate Spade's balance sheet and cash forecasts a bit later.

EBITDA & Operational Performance: A Year of Growth, A Year of Investment

We turn now to a discussion of Kate Spade's EBITDA performance. In its Q4 2013 earnings release, Kate Spade arrives at pro forma EBITDA via the following formula:

(Consolidated Segment EBITDA) - Unallocated Corporate Costs - Other Expenses + Net Foreign Currency Adjustments

On this basis, Kate Spade posted pro forma EBITDA of $65.208 million in Q4 2013, up 35.84% from Q4 2012; full-year consolidated EBITDA came in at $83.706 million, up 18.5% versus 2012. However, Lucky and Juicy Couture held back EBITDA growth during Q4 2013 and 2013 back. When Kate Spade's EBITDA is examined on an ongoing basis, the company's growth is far more notable, as shown in the table below. We note that our calculation of pro forma Kate Spade EBITDA is similar to the company's own; we take segment-level EBITDA for kate spade and Adelington Design Group, and subtract unallocated corporate costs, other expenses, and add back net foreign currency translation adjustments.

Kate Spade & Company EBITDA, Q4 2013 & 2013 (in Thousands of $)

Kate Spade Pro Forma 2013 & 2012 EBITDA

Q4 2013

Q4 2012

Y/Y Change



Y/Y Change

kate spade Sales







Adelington Design Group Sales







Total Kate Spade Sales








kate spade Segment EBITDA







kate spade Segment EBITDA Margin







Adelington Design Group Segment EBITDA







Adelington Design Group Segment EBITDA Margin







Consolidated Segment EBITDA







Consolidated Segment EBITDA Margin







Unallocated Corporate Costs







Other Adjustments







Kate Spade Adjusted EBITDA







Kate Spade Adjusted EBITDA Margin







On this basis, Kate Spade grew EBITDA by over 50% in Q4 2013, and almost 69% in 2013 as a whole, driven by solid sales growth at kate spade. We note that these EBITDA figures may be slightly conservative, for they fail to net out certain corporate-level costs. In its Q4 2013 earnings presentation, Kate Spade noted that if Lucky and Juicy were to be excluded from Q4 2013 results, pro forma EBITDA would have come in at $57 million, a 54.05% increase relative to Q4 2012; our EBITDA calculations produced a figure of $54.462 million for Q4 2013. But since Kate Spade does not provide a breakdown of unallocated corporate costs, we are unable to craft exact figures.

Performance at kate spade was driven by a robust 30% increase in comparable sales in Q4 2013 (inclusive of the brand's e-commerce business), with sales per square foot rising 14% to $1,265, up 14% year-over-year and marking the 14th consecutive quarter of growth in per square foot sales. But while kate spade posted solid revenue growth in 2013, its EBITDA margins, at least on paper, appear to create cause for concern, given that margins fell 300 basis points to 17.56%. While some of the decline can be attributed to a 90 basis point contraction in segment gross margin due to increased non-handbag promotional activity, much of the decline in segment EBITDA margin in 2013 can be attributed to conscious decisions undertaken by management to position kate spade for future growth. First, the accounting impact of consolidating kate spade's Japanese business into its own financials diluted margins (the company bought out its Japanese joint venture partners in Q4 2012). With comparable sales growing in Japan by 26% in Q4 2013, we see no reason to suspect that there is a fundamental operational issue within the Japanese market. However, yen-related headwinds did impact EBITDA margins in 2013. Second, the brand has invested into expanding in Southeast Asia, gaining full control of its store base and business in Hong Kong, Macau, Taiwan, Malaysia, Singapore, Indonesia and Thailand from Globalluxe for $34 million, with the transaction closing on February 11, 2014. Now that Kate Spade has largely completed its divestitures, the company can focus on expanding kate spade internationally. The company opened dozens of new stores around the world in 2013, including 40 across North America, 7 in China (bringing its Chinese store count to 20), 2 in Brazil, and 6 in Japan. The takeover of kate spade stores from Globalluxe brought 27 stores under Kate Spade's control, accounting for $52 million in total kate spade sales in 2013. On its conference call, Kate Spade outlined a long-term goal of having 66% of its global retail footprint outside of North America, specifically calling out China and Southeast Asia as a long-term opportunity. We look to Kate Spade's Q1 2014 earnings call for more color on 2014 store expansion opportunities.

The third impact on margins was incremental dilution from Jack Spade, kate spade's men's brand. However, management noted that to date, Jack Spade sales account for a immaterial portion of kate spade's overall sales, and that it is "too early" to pass judgment on Jack Spade's ultimate success. We expect more color on the brand throughout the course of 2014. Finally, the fourth impact to margins was the ongoing expansion of kate spade Saturday, which was launched in March 2013.

As mentioned in the introduction, kate spade Saturday targets a more casual customer, and one that is more entry level relative to the full kate spade brand. Kate Spade's long-term goal is to utilize kate spade Saturday as a way to expand its customer base and addressable market and eventually drive customers to the higher price kate spade brand. Outgoing CEO William McComb had the following to say about kate spade Saturday on the company's earnings call:

"We launched the Kate Spade Saturday brand this past March, carefully leveraging operating expense where that makes sense, but distinctly targeting that brand as a new business for more entry-level customer and one that is inherently more casual. The timing of this investment is critical in my view. We need the asset to address the distinct high-opportunity customer groups as we expand around the world. I personally view 2013 for Kate Spade Saturday as the year not unlike 2008 for Kate Spade New York: foundational, establishing, awareness-generating and filled with learning and early traction with a new demographic."

Management spoke at length about the growth that kate spade Saturday is seeing. Accessories now account for a majority of the brand's sales, driven by solid results in handbags, as well as new marketing efforts such as a pop-up holiday store at New York's JFK airport. With average price points 50% below kate spade, kate spade Saturday is playing a key role in capturing new customers and instilling loyalty to kate spade in them from an earlier age, and capture as much of their incremental increase in fashion and accessory spending as they age and acquire more disposable income. Kate Spade began its marketing efforts by utilizing its sizeable database of kate spade customers to single out potential kate spade Saturday customers, but as CEO Craig Leavitt noted on the company's earnings call, the proportion of kate spade Saturday customers drawn from kate spade has continued to fall month after month since the brand's launch, and is set to continue falling in 2014. For Kate Spade as a company, kate spade Saturday is a key long-term initiative in strengthening the brand, expanding its addressable market, and ultimately positioning the company for future sales and profit growth. We note that when the incremental dilution of kate spade Saturday investments and Jack Spade is backed out from kate spade's segment EBITDA, EBITDA margins would have been "nicely" above 20% for 2013 as a whole.

Before we continue to Kate Spade's guidance for 2014, we wish to briefly discuss the performance of Adelington Design Group, the company's 2nd remaining brand. Adelington is a remnant of Liz Claiborne long-term relationship with J.C. Penney, and the segment serves J.C. Penney via exclusive agreements covering the Liz Claiborne and Monet jewelry lines. The Liz Claiborne New York line is also available through QVC, and Adelington also holds the license for the Trina Turk jewelry line. Consolidated Adelington sales fell by over 27% in 2013 to $60.219 million, accounting for 7.5% of Kate Spade's total sales (and around 10.36% of total EBITDA), with the weakness driven by the segment's sizeable exposure to J.C. Penney. Of the more than $22 million decline in Adelington sales in 2013, $12.5 million was attributed to decline in the sale of Liz Claiborne jewelry; a further $6.6 million of the decline was caused by the exit of the DKNY brand, which was completed in Q3 2013. However, with J.C. Penney showing tentative signs of recovery, Adelington's performance in 2014 is likely to improve relative to 2013, and Kate Spade management has noted that year-to-date, the segment is showing improved financial performance.

We turn now to Kate Spade's guidance for 2014. For all of 2014, Kate Spade is forecasting pro forma EBITDA of $115-$125 million, inclusive of $165-$170 million in kate spade segment EBITDA (guidance excludes Juicy Couture and Lucky). At the midpoint of its guidance ranges, this implies 48.09% EBITDA growth for Kate Spade on a company-wide basis, and 28.36% EBITDA growth for the kate spade brand, with comparable sales forecast to grow 10-13% during the year. The main driver of decelerated comparable sales growth relative to 2013 is a forecast reduction in promotional activity, which will help drive EBITDA margin expansion. For all of 2014, Kate Spade is forecasting kate spade brand EBITDA margins to increase by 100 basis points, driven by continued expense discipline across kate spade, as well as productivity gains from recently completed and ongoing investments that the company is making.

Kate Spade is in the process of overhauling its e-commerce and point-of-sale platforms to deliver better service to its customers, and drive efficiency gains within its stores. During 2013, the company completed an overhaul of its domestic e-commerce platform, launching it with new technology sourced from eBay (NASDAQ:EBAY). This has resulted in a transaction capacity increase of 100% relative to 2012, and gives kate spade a platform for growth as the brand continues to expand. The company is in the process of expanding its e-commerce presence in Europe, with its new U.K. platform set to launch in the 2nd half of the year, with other key European markets to follow. Kate Spade is aiming to upgrade and overhaul its ship-from-store and in-store pickup capabilities in Europe, and COO George Carrara has stated that European e-commerce is a top priority for Kate Spade. But just as important is the overhaul that is taking place within kate spade's own stores, namely overhauled omni-channel point-of-sale systems that have allowed kate spade's employees to better engage with customers. Kate Spade is now in the process of rolling out revised mobile point-of-sale systems across its store base, with the rollout set to be complete in Q2 2014. Of further note are ongoing marketing investments that Kate Spade is making, and these have also pressured segment-level margins at kate spade, in exchange for long-term growth in the company's customer base. The total customer database at kate spade grew by 55% in 2013, and 60% of customers are now under the age of 44, with a "noticeable mother daughter dynamic" occurring within kate spade's stores. We expect these investments to begin paying off in 2014, with EBITDA margins recovering as Kate Spade leverages these investments.

We turn now to a discussion of Kate Spade's balance sheet and capital expenditure forecasts, but before we do, we wish to lay out our third and final financial statement for Kate Spade: its full-year income statement. The creation of a 2013 income statement for Kate Spade is made more challenging by several confounding factors; the earnings release provided by Fifth & Pacific (just prior to its change into Kate Spade & Company) includes the results of Juicy Couture, thereby clouding the company's underlying performance. Furthermore, we are unable to create a pro forma Kate Spade earnings release for Q4 2013 due to the fact that the company reports segment-level depreciation only on an annual basis, thereby precluding a calculation of exact segment-level depreciation & amortization expenses for kate spade and Adelington Design Group.

Our calculation of Kate Spade's full-year 2013 pre-tax income is based on the following formula:

Kate Spade Adjusted EBITDA - (kate spade Depreciation & Amortization + Adelington Design Group Depreciation & Amortization) - Net Interest Expense - Other Expenses

After arriving at the company's pre-tax income, we then apply the full-year tax rates for 2012 and 2013 reported by Fifth & Pacific to Kate Spade's estimated pro forma pre-tax income, and then calculate EPS by using the diluted share count reported by Fifth & Pacific in its Q4 2013 earnings release.

Kate Spade & Company 2013 Income Statement (in Thousands of $)












Depreciation & Amortization






EBIT Margin



Adjusted Interest Expense



Other Expense, Net



Pre-Tax Income



(Provision) Benefit for Income Taxes*



Adjusted Kate Spade & Company Net Income



Diluted Shares Outstanding



Adjusted Kate Spade & Company EPS



*The reported tax rate for 2013 was 20.8% and 36.04% for 2012

As the table above shows, Kate Spade posted estimated pro forma EPS of $0.04 in 2013. While this was a meaningful improvement relative to 2012, there is much work remaining. The key culprit in suppressing Kate Spade's earnings power is not operational weakness at the company, but rather its debt load. In 2013, Kate Spade paid over $46 million in interest on its debt; when compared to pro forma EBIT of just over $55 million, this is a material sum. However, on its earnings call, Kate Spade laid out a clear pathway to a much stronger financial profile, and with it, a much more profitable company.

Balance Sheet & Capital Expenditures: A Clear Path to Being Back in the Black

Driven by multiple years of unprofitability and negative free cash flow, Kate Spade's balance sheet, at first glance, does not appear to inspire confidence in the company's financial condition. Kate Spade ended 2013 with $130.222 million in cash, and $390.794 million in debt. The bulk of this debt is in the form of $382.209 million in 10.5% notes due April 2019, with the remainder consisting of $8.995 million in capital lease obligations and short-term borrowings from its credit facility. While Kate Spade's balance sheet is not ideally positioned as of the end of 2013, the company has laid out a clear long-term pathway to strengthening it, driven by both refinancing its debt and structural increases in operating cash flow.

As part of its 2014 guidance, Kate Spade is forecasting pro forma interest expenses of $30-$45 million in 2014, driven by a planned refinancing of the company's 10.5% notes. We note that at the midpoint of this guidance, Kate Spade would reduce interest expenses by $8.999 million. Based on this cut in interest expense alone, Kate Spade would see a 7-cent boost to EPS (based on year-end 2013 diluted shares outstanding), equal to a 175% increase in EPS. Kate Spade's 2019 notes become callable on April 15 at 105.25 cents to the dollar, and COO George Carrara has said that depending on the speed at which the notes are refinanced, interest expense could fall to the low end of the company's guidance range. At $30 million, interest expenses would be reduced by $16.499 million relative to 2013, leading to a 13-cent boost in EPS.

Kate Spade's management also laid out a long-term target of driving its debt down to zero, beginning in 2015. And while the company has projected negative free cash flow in 2014, its forecasts call for net debt to rise to around $300 million by the end of 2014, an increase of just $40 million relative to the end of 2013 (recall that free cash burn from continuing operations came in at $83.18 million in 2013). Kate Spade is forecasting $140 million of capital expenditures and investments in 2014 to drive further growth at kate spade, both in the United States and internationally. Included with that forecast is the planned conversion of about 30 select high-performing Juicy Couture stores into kate spade stores.

While Kate Spade's balance sheet may not be as strong as those of its peers, the vast majority of the company's debt is not due until 2019, and by then Kate Spade will be far more profitable than it is today. Management has laid out a clear path to cutting interest expense, thereby creating a significant tailwind to EPS (complementing the continued growth of kate spade), and cash outflows are set to narrow in 2014, and assuming that the company's trajectory remains on track, we expect positive free cash flow in 2015. We also note that Kate Spade ended 2013 with $450 million in net operating loss carryforwards.

Peer Comparison & Valuation

Kate Spade's primary competitors are Michael Kors (NYSE:KORS), Coach (COH), Burberry (OTCPK:BURBY), and LVMH (OTCPK:LVMUY), and while Kate Spade does trade at a premium to its peer average, its growth across sales, EBITDA, and EPS is far above that of its peers. Furthermore, as we will show, Kate Spade's PEG ratio (based on fiscal 2014 EPS) is well below one. We break down Kate Spade's valuation and forward estimates relative to its peers below (note: share prices and consensus estimates are accurate as of the close of trading in New York, London, and Paris on February 28, 2014).

Kate Spade Peer Comparison


Kate Spade

Michael Kors




Peer Average

KATE Premium





BRBY (London)

MC (Paris)






€ 134.85

Shares Outstanding






Market Capitalization





€ 68,475,975,186

Gross Cash





€ 3,392,000,000

Gross Debt





(€ 8,730,000,000)

Net Cash (Debt)





(€ 5,338,000,000)

Net Cash (Debt) per Share





(€ 10.51)

Non-Controlling Interests





€ 1,028,000,000

Enterprise Value





€ 78,233,975,186

Adjusted Share Price





€ 145.36

Fiscal 2013 Sales





€ 29,149,000,000

Fiscal 2014 Sales





€ 31,488,200,000

Fiscal 2014 Sales Growth








Fiscal 2015 Sales





€ 34,106,900,000

Fiscal 2015 Sales Growth








Fiscal 2016 Sales





€ 36,752,000,000

Fiscal 2016 Sales Growth








3-Year Forward Sales Growth








Fiscal 2013 EBITDA





€ 7,279,000,000

Fiscal 2014 EBITDA





€ 7,864,000,000

Fiscal 2014 EBITDA Growth








Fiscal 2015 EBITDA





€ 8,597,000,000

Fiscal 2015 EBITDA Growth








Fiscal 2016 EBITDA





€ 9,284,000,000

Fiscal 2016 EBITDA Growth








3-Year Forward EBITDA Growth








Fiscal 2013 EPS





€ 6.83

Fiscal 2014 EPS





€ 7.76

Fiscal 2014 EPS Growth








Fiscal 2015 EPS





€ 8.63

Fiscal 2015 EPS Growth








Fiscal 2016 EPS





€ 9.44

Fiscal 2016 EPS Growth








3-Year Forward EPS Growth
















Fiscal 2014 EV/Sales








Fiscal 2015 EV/Sales








Fiscal 2016 EV/Sales








Fiscal 2014 EV/EBITDA








Fiscal 2015 EV/EBITDA








Fiscal 2016 EV/EBITDA








Fiscal 2014 P/E








Fiscal 2015 P/E








Fiscal 2016 P/E








Fiscal 2014 PEG Ratio








While Kate Spade does trade at a premium to its peers across EV/Sales, EV/EBITDA, and P/E metrics, we note that across all three metrics, Kate Spade's forward growth is far above that of its peers. Over the next three years, EPS at Kate Spade is set to grow by over 179% annually, versus less than 14% for its peers as the company slashes interest expenses and boosts kate spade EBITDA margins. And while Kate Spade's 3-year forward sales growth lags that of Michael Kors, we note that the company's EBITDA is set to rise by almost 300% by the end of 2016, versus less than 130% for Michael Kors.

While Kate Spade may seem expensive on an absolute basis, such presumptions fail to hold up to scrutiny when the company is valued on a PEG basis. Based on fiscal 2014 EPS estimates, Kate Spade trades at a PEG ratio of just 0.72, well below 1, and even further below the average 1.53 PEG ratio its peers trade at (Coach is excluded, for its PEG ratio is inflated due to its lack of EPS growth between fiscal 2014 and fiscal 2016). Were Kate Spade to be valued at a PEG ratio of 1, its shares would be worth $48.04 (after adjusting for $2.11 in net debt per share). Based on the company's February 28 closing price of $34.22, that is equivalent to upside of 40.39%. However, if Kate Spade were to be valued at the average PEG multiple of its peers, its shares would be worth $73.63, equal to upside of over 115%. Despite solidly outpacing its peers in sales, EBITDA, and EPS growth between now and 2016, Kate Spade trades at a meaningful PEG discount, both on an absolute and relative basis. We believe that as 2014 progresses, and the standalone earnings power of Kate Spade begins to emerge, that this discount will close, yielding further gains for Kate Spade's shareholders. However, gains may also come from outside the company, for there are any number of potential suitors that stand to benefit from bringing Kate Spade into their brand portfolios.

Takeover Potential: Who Might Bid on the Ace of Kate Spade?

Takeover speculation regarding Kate Spade has been in circulation since at least April 2012, when Liz Claiborne was nearing its transformation into Fifth & Pacific. Industry analysts have long believed that there are multiple potential suitors for Kate Spade, ranging from private equity firms that may be interested in capitalizing on the rebound in Kate Spade's cash flows, to any number of strategic suitors that can take the kate spade brand to the next level. Among the possible strategic buyers that have been named are PVH (NYSE:PVH) and VF Corporation (NYSE:VFC), which could fold kate spade into its diverse brand portfolio alongside its high end 7 For All Mankind brand. In addition to PVH and VF Corporation, Coach has been named as a potential suitor. Although the company is in the midst of its own turnaround, Coach's pristine balance sheet could be used to finance a takeover, allowing it to boost its sales, EBITDA, and EPS growth, and help staunch its market share losses to Michael Kors. Alternatively, LVMH could emerge as a bidder, given the company's proclivity to purchase growth through M&A. Acquiring Kate Spade would further reduce LVMH's dependence on Louis Vuitton, and increase the diversity of its handbags and accessories portfolio.

Kate Spade could further boost the chances of a bid for the company by divesting Adelington Design Group; industry analysts have argued that Adelington would create more value for shareholders if it were sold to make Kate Spade a pure play on the growth of the kate spade brand. A sale of the division would further strengthen Kate Spade's balance sheet and potentially make the company more attractive to prospective suitors. While we stress that our bullish thesis on Kate Spade is predicated on the company as a standalone entity, we believe that there is a clear rationale for a takeover of the company. The kate spade brand is one of the fastest growing high-end brands, and there are multiple suitors with the both the financial ability to execute a deal and the strategic rationale to do so.


While it is true that Kate Spade & Company has seen a sizable rally over the past 12 months, we believe that as 2014 progresses, further gains will be realized. Kate Spade's growth is far superior to any of its peers, and on a PEG basis, the company trades at sizeable discounts, both on an absolute and relative basis. Kate Spade is making meaningful investments, both here in the United States and around the world into the kate spade brand, covering e-commerce, its store base, and its marketing to drive further awareness of the kate spade brand and expanded its customer base and ensure long-term loyalty. We believe that 2014 will be a solid year for kate spade as a brand, and Kate Spade as a company, as its true earnings potential begins to crystallize. Even on a standalone basis, we believe that Kate Spade is well positioned to create further value for shareholders, with more upside possible if a suitor emerges.

Disclosure: I am long KATE, KORS, COH, LVMUY, BURBY, PVH, VFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.