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Michael Kors: Building a Brand, or Cashing In on a Fad?

In 2004, the creators of a new cable TV program offered award-winning American designer Michael Kors a spot as lead judge, alongside supermodel Heidi Klum and fashion consultant Tim Gunn, on a soon-to-be-launched reality show called “Project Runway.” In it, design contestants would compete with each other, American Idol-style, to see who could create the best clothes. One or more of them would be eliminated each week until one single contestant emerged as the winner.   

Kors almost turned the offer down. “Reality show? Fashion on television?” he later admitted wondering. “I thought that only fashionista freaks, gays, and men wanting to see Heidi Klum in a short dress would watch it.”

The show premiered on December 1, 2004, and became an immediate commercial and critical success. The designer’s acidic quips and blunt criticisms were fan favorites, and before long Michael Kors had become a household name.

The Man Behind the Brand Though his celebrity was newfound, Kors’s design prowess was already well established in the fashion world. For three decades his understated, sporty, sophisticated couture apparel designs had dressed some of the world’s most fashionable women. Gwyneth Paltrow, Angelina Jolie, Renee Zellweger and Uma Thurman were among his early collection clients.

Kors had become addicted to fashion at an early age, selling his creations out of his parents’ basement on Long Island during high school. In the late Seventies, Kors left New York’s Fashion Institute of Technology after two semesters to design and merchandise a collection for Lothar’s, a now-defunct French boutique located across the street from Bergdorf Goodman’s. The well-received collection generated enough interest that Kors was able to start his own fashion line in May 1981 and sell it in luxury department stores.

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Kors’s simple, elegantly tailored clothing and formidable sales skills were a successful combination. He traveled extensively, doing “trunk shows” for wealthy clients. At the tender age of 23, he convinced Anna Wintour, then the fashion editor of New York magazine, who later became the Editor-in-Chief of Vogue, to review his collection, with great results. His sophisticated American designs were in the tradition of Bill Blass with simple, understated lines, gorgeous fabrics and minimal trims.

The Early Years His business took lots of different twists and turns throughout the next 20 years, and included collaborations with Compagnia Internazionale Abbligliamento, Onward Kashiyama, and others, culminating in a six-year stint as creative director of French fashion house Celine starting in 1997. While at Celine he won many awards, including the CFDA (Council of Fashion Designers of America) Womenswear Designer of the Year, and continued to expand his own LVMH-backed brand, launching menswear, shoe, accessory and perfume lines, and becoming increasingly known not only for his immense talent and focused aesthetic, but his work ethic, lack of pretense, and big heart. For the past two decades he has supported numerous local and global charities such as God’s Love We Deliver and the U.N. World Hunger Program.

In 2004, with new backers Silas Chou and Lawrence Stroll of private equity firm Sportswear Holdings Limited, who had purchased 85% of his company from prior partners for a reported $100,000 (and who had pockets deep enough to finance expected future growth), Michael Kors was poised to become the next fashion megabrand. The timing of the TV show could not have been better. As Project Runway episodes rolled out, a new crop of young customers began to clamor for Michael Kors product. He launched lines of affordably-priced Michael Michael Kors (cynically called “Kors Light” by the old guard) handbags, ready-to-wear, small leather goods, shoes, menswear, swimwear, fragrance, beauty, and other products. Kors appeared on the six-time Emmy-nominated TV show until 2012, as his brand awareness soared.

Meanwhile, the celebrity roster for his higher-priced couture line was still intact. First lady Michelle Obama posed in a Michael Kors dress for her first official portrait. Numerous stars and supermodels would wear Kors to the Oscars and in the top fashion magazines.

Driven by the lower-priced “lifestyle” lines, Kors’s wholesale, retail and licensing business continued to grow rapidly, with revenues soaring from $210 million in 2007 to over $800 million in 2011. In December 2011, a few months after Kors married his longtime partner Lance LePere, the company went public on the New York Stock Exchange in one of the biggest and most talked-about IPOs ever for a U.S. fashion business: 47.2 million shares were sold, at $20 per share. Within a few months the share price had more than doubled. In fiscal 2012, sales grew to $1.3 billion, and earnings doubled. In September 2012 another 23 million shares went on the market, at a price of $53 per share.

The Company Today Michael Kors Holdings posted sales of just over $2 billion in the fiscal year ending March 2013, a 68% increase over the prior year, resulting in compound annual growth of 50% for the past four years.  First quarter fiscal 2014 sales rose 55% to $641 million. Analysts have estimated sales will grow to $5 billion in the next four years.

Gross margin surged from 41% of revenue in 2010 to 69% last year, thanks to the rapid shift in product mix toward handbags and other high margin products, and the rapid opening of the company’s own stores. SG&A fell in 2013 but is expected to increase a bit next year due to the planned opening of almost 50 new stores and the move in-house of e-commerce operations. The company also plans to step up its activities in social media and marketing.

Earnings growth has been meteoric, too, increasing steadily each of the past four years, from $13 million to $398 million, and expected to reach a record $550 million in 2014.

The worldwide store count has grown from 74 in 2009 to 328 this year, with two full-priced stores for every outlet.  Consolidated same-store sales grew steadily from 36% in the fourth quarter of 2012 to 45% in the second quarter of 2013, then steadily declined to 27% in the most recent fiscal quarter. The company currently operates about 230 stores in North America and over 100 internationally, mostly in Europe, and eventually plans to have 1,000 stores globally.

Wholesale revenues come from over 2,200 major department and specialty doors in the U.S. and over 1,000 department store doors in Europe. Though its own retail store business is booming, the company remains well-entrenched in the department store channel, with 29% of its total business done at its top five department store customers, with most – 14% of total revenues  – from Macy’s. The company is making a major push toward converting wholesale doors to more productive “shop in shop” concepts to increase the productivity of this segment.

Kors also licenses its trademarks to Fossil, Estee Lauder, Marchon and other makers of fragrances, cosmetics, eyewear, leather goods, jewelry, watches, coats, footwear, men’s tailored clothing, swimwear, and other products, and sells those products in its own stores and wholesale shop-in-shops. Licensing revenues totaled $86 million in fiscal 2013. Michael Kors is the number one watch brand in U.S. department stores.

Manufacturing arranged by third-party sourcing agents is done primarily in Asia for the lower-priced lines and in Europe for the couture collections. Although most of the company’s sales are in the Michael Michael Kors brand, rather than at the higher “collection” end, the product line remains grounded in excellent design with relatively high quality materials and workmanship.

The company’s balance sheet is impeccable — no debt, multiplying cash balances, and healthy cash flow.

The company’s next major growth frontier will be in international markets. Long term, there are plans to have 600 stores in Europe, Asia, South America and other regions.

The Stock is trading in the mid-70s, putting its market cap at $15.5 billion, just surpassing Ralph Lauren, whose company is worth $15.3 billion. The stock has gained 50% in 2013, and 200% since the IPO. It was just announced that it will be added to the S&P 500 on November 1, 2013, replacing NYSE Euronext.

Building a Brand, or Cashing in on a Fad? The fashion history books are littered with stories about designers and brands that grew too fast too soon, and whose bubbles quickly burst. Kors’s stratospheric growth is reminiscent of another American designer, Tommy Hilfiger who, backed by the same Silas Chou and Lawrence Stroll, had a more than tenfold sales increase between 1992 and 2001, to $1.7 billion, before dropping to $800 million by 2008. Tommy’s sales grew by expanding wholesale, entering new categories, and growing the off-price and outlet segments. The brand was the darling of the urban hip-hop consumer. But when that demographic moved on to newer (and more authentic) urban brands, sales, earnings, and the stock price plunged.

Although Kors doesn’t break out sales by product category, CEO John Idol said that the accessories segment, which includes handbags, small leather goods, footwear, jewelry, and eyewear, comprises over 80% of the business.This puts the brand in competition with Coach, Kate Spade, Tory Burch, Marc Jacobs and up-and-comer Vince Camuto — a highly competitive space in which consumers tend to be fickle, and where design missteps can be deadly. Wall Street analysts have estimated Michael Kors’s share of the U.S. handbag market is 10%, versus 30% for Coach. But Coach has years of accessories heritage, and has built its brand slowly and carefully. The Kors price/earnings ratio in the low 30s is more than twice that of Coach. Is this a case of “too much, too soon?”

Consumers are drawn to the Michael Kors sophisticated design aesthetic and sporty attitude. The company frequently calls the Michael Kors brand position “accessible jet-set luxury,” because of its “aspirational” core customer, and reports that Michael Kors is the most searched brand on the Internet. However, The New York Times once reported that a company executive referred to the Kors brand as “Hermès for Staten Island.” Once a brand is accessible to many, and available everywhere, will the upscale fashionable woman with more disposable income still want it?

American design houses have had mixed results as public companies. Fashion is a fickle business, and consumers can turn on a brand or collection pretty quickly, resulting in unexpected changes in sales and earnings, and volatile stock prices. Kenneth Cole. Donna Karan, and J. Crew have all gone private after years as public companies, citing the need to stop focusing on the short-term at the expense of fashion innovation and the long-term health of the brand.

Is Kors company management sacrificing long-term brand equity appreciation for short-term earnings growth? The designer has already sold a reported $700 million worth of his shares in the company, and still holds only $300 million worth at current prices. Messrs. Chou and Stroll have cashed in about $3 billion worth of their shares, and CEO John Idol has sold more than $400 million of his holdings. If overexpansion results in the bursting of the Michael Kors brand bubble, members of the executive team won’t exactly be worrying about their financial security.

The company expects sales to increase 33% to $2.9 billion in 2014, a much slower growth rate than last year. Comparable store sales are expected to grow by only 20% in fiscal 2014, about half of 2013’s level. Is consumer demand already starting to level off due to market oversaturation, or is management intentionally putting the reins on growth? Only time will tell.

However, to ensure a healthy, long-term growth trend for the brand, company management would be wise to adopt the “slow and steady wins the race” principle. They should also diversify the product line beyond accessories. Apparel, for decades the main strength of Michael Kors, is a $200 billion market in the U.S., twenty times the size of accessories, and almost certainly an area of huge opportunity for the brand. They should limit promotions and keep the outlet business relatively small to avoid the dilution that has plagued the likes of Calvin Klein and rendered the term “affordable luxury” an oxymoron. And they should only enter new markets like Europe and Asia after careful consideration and planning, as many American brands have stumbled while trying to go global too quickly.

After all, when jet-setting a little too close to the sun, one can get burned.