A Michael Kors shopping spree

Michael Kors (MK) went shopping and splashed the cash on adding Versace to its collection. The deal makes sense strategically, but the hefty price has spooked investors. On Monday the 24th September, it was reported that Michael Kors had agreed to purchase Versace, an Italian luxury fashion brand. The acquisition for USD$2.1 billion sent the MK share price into a 5.71% nosedive by that Tuesday.Investors were bearish about Kors taking too big a bet on a buy that seems overpriced with the result being USD$615 million of market capitalisation wiped out. Are investors correct in believing that Michael Kors paid over the odds? With 2017 profits totalling a mere USD$18 million, the price paid for the Italian luxury fashion house is around 117 times their earnings. This is vastly out of proportion with the price-to-earnings (P/E) ratios of other luxury brands such as Prada (48), Burberry’s (30) and Hermès (48).Based on its free cash flow, Versace is most definitely overvalued, and the sale by Blackstone and the Versace family of their respective 20% and 80% stakes is massively successful. However, what if we take a look at the synergies? Adding to the collection, Michael Kors’ management team are placing their bets on adding prestige to the legacy of the company by association with Versace’s brand and last year’s acquisition Jimmy Choo. The companies will form the newly named conglomerate Capri.Although, given that Michael Kors reported an earnings before interest, tax, depreciation and amortisation report (EBITDA) of $1.1 billion for 2017, it seems unrealistic that the Versace association can boost the profitability of Michael Kors to the extent that incremental sales will pay back $2.1 billion anytime soon.From a strategic point of view, this acquisition makes complete sense. Retention of Donatella Versace as head of design will appease concerned aficionados. A bold plan was released to increase Versace’s number of stores by 50% totalling 300, and to develop its e-commerce capabilities. It is possible that changes to e-commerce would feature personalisation options à la Louis Vuitton. Customers could add initials to their handbags and suitcases, or perhaps such customisation would come in the style of Burberry, which places consumers in the role of designing their own iconic trench coat, selecting the style, fabric and colour.We can likely expect to see Versace borrow existing technology from Michael Kors to develop a line of branded smartwatches. It will be interesting to see whether anything will be done to shift Versace away from the purely aesthetic and move into the realm of lifestyle; the company currently boasts two hotels in Dubai and Australia. For less capital intensive investments, it could look to partner with other brands. Emulating Dolce & Gabbana’s joint venture with Martini to create a high-end restaurant and cocktail bar in Milan’s fashion district may be an interesting endeavour for instance.Versace will likely become more profitable, and Michael Kors will reap some additional revenue, but the bottom line remains, and price is the most important piece of due diligence. Financial sense seems to have been glossed over in favour of a vanity project.