KATE Kate Spade & Company

By Suzanne Kapner and Joshua Jamerson 

Coach Inc. agreed to acquire rival Kate Spade & Co. for $2.4 billion, as the purse maker seeks to tap younger consumers when growth in the handbag market has stalled.

Sales of handbags have slowed as women have traded down to smaller, less expensive bags and aggressive discounting both in stores and online has pressured profits. The proposed merger would combine two big U.S. players, and create a company with $5.9 billion in annual sales and 1,300 retail stores and outlets around the world.

On Monday, Coach Chief Executive Victor Luis said there is little overlap between customers of the two brands, especially since Coach has tried to move upscale in recent years. The attraction of Kate Spade was its appeal to younger shoppers, Mr. Luis said, adding that only 10% of consumers say they buy both brands.

"Kate Spade has the highest penetration among millennials within our competitive set," Mr. Luis said in an interview. "Millennials offer a market that is substantial in terms of size and allows us to recruit younger customers."

The handbag market has slowed to about 2% growth from as much as 15% growth six years ago, said Craig Johnson, an analyst at Customer Growth Partners. Coach has responded by targeting a slightly older and wealthier client with higher-priced bags, which has created a gap for younger 20-something shopper that it can fill with Kate Spade, Mr. Johnson said.

Mr. Luis said he still had confidence the handbag and leather goods space is better positioned than other corners of retail. "Consumers continue to shift dollars away from apparel to handbags, accessories and footwear," he said.

Coach will pay Kate Spade shareholders $18.50 a share in cash. That represents a 28% premium to Kate's closing price as of Dec. 27, the last trading day before a Wall Street Journal report that Kate was exploring a sale of the company after coming under pressure from an activist shareholder. The company confirmed it was reviewing such options in February.

Both companies, based in New York, have battled a retail environment that has been challenging, especially for designers with significant exposure to department stores, where traffic has declined. U.S.-based luxury brands are also negatively affected by a strong U.S. dollar.

Coach had revenue of $4.5 billion in the fiscal year ended July 2016, down from more than $5 billion a few years ago. Kate Spade, which shed several apparel brands to focus on its handbag business, had revenue of $1.4 billion in the year ended Dec. 31.

Sales at Coach have started to grow again in recent quarters as it pulled back from department stores, closed a third of its full-priced stores in North America and reduced promotions. The company said it plans to reduce online flash sales as well as distribution in off price chains like T.J. Maxx for Kate Spade after the deal closes, which is expected to occur in the third quarter.

Mr. Luis said 35% of Coach stores overlap with Kate Spade stores in North America but he didn't plan widespread closures following the combination. However, analysts said there were still too many stores given the sluggish mall traffic.

"Anybody who's been to Woodbury Common outlets and seen two Coach (women and men) and two Kate Spade stores (accessories and apparel) all within 30 yards of each other doesn't need a rocket science degree to know that the combined company doesn't need all that space," Mr. Johnson said.

Coach does plan to expand Kate Spade outside the U.S., particularly in China and Europe, where the brand has a few dozen stores and outlets. And Mr. Luis said there is an opportunity to buy out some joint venture partners or distributors in those regions.

Kate Spade shares rose 8% to $18.35 in Monday morning trading, while Coach shares gained 6% to $45.30.

Coach has been on the hunt for acquisitions as Mr. Luis seeks to build a collection of brands and respond to the rapid rise of Michael Kors Holdings Ltd. Coach approached Burberry Group PLC about a takeover last year but was rebuffed. It acquired shoe maker Stuart Weitzman Holdings LLC last year. On Monday, Mr. Luis said Coach might still seek small deals but the Kate Spade transaction would leave little room for another large transaction in the near term.

The brands will be kept separate and there are no plans to cross sell products at each other's stores, executives said. Mr. Luis said his intention was to retain key Kate Spade employees including Craig Leavitt, who will continue to serve as chief executive of the Kate Spade brand.

The transaction is subject to the tender of a majority of the outstanding Kate Spade shares as well as regulatory approvals.

Kate Spade can terminate the transaction if the company is offered a superior proposal from another suitor, and Coach can terminate the deal if Kate Spade's board no longer supports it. Either circumstance would require Kate Spade to pay Coach an $83.3 million termination fee.

Either company can call off the deal if it isn't complete by Feb. 7.

Write to Suzanne Kapner at Suzanne.Kapner@wsj.com and Joshua Jamerson at joshua.jamerson@wsj.com

(END) Dow Jones Newswires

May 08, 2017 11:29 ET (15:29 GMT)

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