Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

Burberry stock seems to be inflated by hope value. Shares in the U.K. luxury group rose 7 percent on Tuesday after the Financial Times reported that a mystery investor was building a 5 percent stake, triggering speculation of a possible takeover or activist assault. Burberry would be a tricky target.

There's no doubting the attraction of the raincoat-maker. It's a unique asset with a powerful brand. Plus the company has the potential to be run better. Sales growth is lackluster; costs are high. The operating margin, at 17.5 percent, is uninspiring. Investors have got accustomed to luxury groups achieving closer to 30 percent.

Another luxury giant might think it can drive Burberry harder, as well as lifting revenue by shifting the group's clothes and accessories through a bigger global network. Burberry's sales are hovering at about 2.5 billion pounds ($3.6 billion). Suppose these can be lifted 2 percent, and margins nudged up to 20 percent. That would add about 70 million of operating profit annually. Taxed at 25 percent and capitalized at Burberry's current 20 times multiple implies 1.1 billion pounds of value creation.

The difficulty is that Burberry is already expensive. Its price to earnings ratio is higher than that of most peers. The shares, at about 14.62 pounds, value the group at 6.5 billion pounds. That's 1.2 billion pounds, and 22 percent higher, than its average value over the last three months. Shareholders would surely demand a premium of at least 30 percent to sell control of a scarce asset like this.

Ready to Wear
Burberry shares have performed better than some rivals since the start of the year
Bloomberg Data

Another snag is that there aren't many obvious bidders: the most plausible is Paris-based LVMH. Private equity interest looks unlikely. Burberry would be a big bite even for a consortium. Of course, a previously secretive Asian buyer is possible.

While a takeover's difficult, there may be enough here to build an activist campaign based around balance-sheet optimization and sharper governance. Burberry is ungeared, and the leadership combo of chairman John Peace and creative director Christopher Bailey as CEO has not yet delivered the operating efficiencies investors crave. Burberry needs to provide more evidence of its ambition here, and go into its results in May as if it were already mounting a takeover defense.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Amends plausible bidders in fifth paragraph)

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