Fitch Ratings does not expect any rating implications following Coach, Inc.'s (Coach) announcement to acquire Stuart Weitzman Holdings LLC, a leading designer and manufacturer of women's luxury footwear. Coach will pay approximately $530 million upfront and another $44 million to Sycamore Partners contingent upon the successful achievement of selected revenue targets over the three years following the closing of the acquisition anticipated to close by May 2015. Fitch expects Coach will finance the transaction mainly with cash on hand; as of Sept. 27, 2014, Coach had $661 million in cash and $247 million in short-term investments mostly held overseas.

Stuart Weitzman generated net revenues of approximately $300 million for the twelve months ended Sept. 30, 2014, which would add over 6% to Coach's revenue base of $4.7 billion. The acquisition is expected to be accretive to earnings per share, exclusive of transaction-related charges. Assuming EBITDA margins in the 15% to 20% range, Fitch estimates Stuart Weitzman EBITDA to be $45 million to $60 million.

Coach currently does not have any long-term debt in its capital structure but will need to access the markets in fiscal 2015 (ending June 2015) to issue debt to fund its new headquarters. The total cost of land/construction for the headquarters is expected to be $750 million, of which the remaining $550 million will be incurred in fiscal 2015 and fiscal 2016. Fitch expects leverage (lease-adjusted debt/EBITDAR) to increase from 1.5x to the mid-2x range by the end of fiscal 2015 (ended June 2015), assuming debt issuance of $750 million or modestly higher sized to the total cost of the headquarters and a portion of the acquisition price. Fitch expects leverage to remain in the mid-2x over the next 36 months. There could be negative rating implications should Coach finance a meaningful part of the acquisition with debt, driving leverage above the mid-2x range.

KEY RATING DRIVERS

The ratings reflect Coach's strong positioning in the premium bags and small leather good market with a #1 share of the domestic market and #2 globally, high EBITDA margins, and reasonable credit metrics. However, the company's North American business, which accounts for two-thirds of total revenue and EBITDA before allocating corporate expenses, is experiencing significant pressure on top-line growth and profitability due to lack of newness in product introduction and brand messaging. There has also been an influx of participants that have aggressively built share in the entry level luxury price points that Coach competes in.

As a result, the North American business is expected to contract by over 20% over the next two years to $2.5 billion from $3.1 billion in FY2014 (ended June) and a peak level of $3.5 billion in FY2013. Fitch expects the North American EBITDA (before allocating corporate expenses) to decline to around $750 million in fiscal 2015 from $1.4 billion in fiscal 2014 and a peak level of $1.6 billion in fiscal 2013. It could decline to below the $700 million level in fiscal 2016 before stabilizing or growing modestly thereafter assuming comp store sales turn positive.

The ratings are therefore contingent on Coach's ability to maintain strong momentum in its international business as it grows its presence in China and enters Europe to offset some of the North American decline. Coach's international operations, which generated $1.6 billion or 34% of total revenue in fiscal 2014 has experienced compound revenue growth of 12.5% over the past five years and Fitch expects similar growth rates for the next three to five years. China accounted for two-thirds of the growth with sales growing from $55 million in fiscal 2009 to $545 million in fiscal 2014.

Fitch expects overall top line to contract by 10% over the next two years to $4.3 billion and EBITDA to decline to $1.1 billion from $1.5 billion in fiscal 2014, with the growth in the international segment somewhat offsetting the sharp decline in the North American business. Fitch expects the EBITDA margin to decline to the mid-20% range from 36% - 37% in fiscal 2011 - 2013.

As of Sept. 27, 2014, Coach had $661 million in cash mostly held overseas and $247 million in short-term investments. Coach has a $700 million unsecured domestic bank facility with a maturity date of Sept. 9, 2019. As of Sept. 27, 2014 and June 28, 2014, there was $170 million and $140 million outstanding on the facility.

Coach generated strong free cash flow (after dividends) of $700 million to $800 million between F2011 through F2013. However, FCF dropped to approximately $285 million in fiscal 2014, given a $325 million decline in EBITDA and $90 million of spending on Coach's new headquarters. The total cost of land/construction for the headquarters is expected to be $750 million, of which $550 million will be incurred in fiscal 2015 and fiscal 2016. In addition, non-headquarters capex is expected to accelerate to $350 million in fiscal 2015 from the $220 million annual level in fiscal 2012/2013 as Coach spends heavily on its remodeling activity and international expansion.

As a result of this and further deterioration in EBITDA to the $1.1 billion level, Fitch expects FCF to decline around $400 million annually over F2015 and F2016.

RATING SENSITIVITIES

A positive rating action would be driven by the improvement in Coach's core North American business with comparable store sales growing in line with or better than the mid-single digit growth Fitch expects for the domestic luxury space and total EBITDA improving to the $1.5 billion to $1.6 billion range that would drive leverage to the low 2x range and enable Coach to be FCF positive.

A negative rating action could result in the event of worse than expected top-line, profitability and cash flow trends driven due to a deterioration in its brand or market positioning in the low-to-mid tier luxury market; a slowdown in the momentum of Coach's international business; and/or a sustained increase in leverage above the mid-2x range.

Fitch currently rates Coach as follows:

--Issuer Default Rating (IDR) 'BBB'

--Shelf registration of senior unsecured debt securities 'BBB'

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

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