Coach parent Tapestry will buy Michael Kors owner Capri Holdings in a deal valued at $8.5 billion, creating a U.S. fashion powerhouse to challenge larger European rivals for a bigger share of the global luxury market.

U.S. luxury firms have consistently lagged their European peers in scale, limiting their ability to compete better. Paris-listed LVMH owns 75 brands, including U.S. jeweler Tiffany and fashion labels Louis Vuitton and Dior.

Thursday's deal will also bring under one roof Tapestry's more affordable luxury brands Kate Spade, Stuart Weitzman and Capri's Jimmy Choo and Versace labels.

"Scale appears to be more and more important in luxury given the resources big conglomerates can put into growing their smaller brands," Morningstar analyst Jelena Sokolova said.

The combined company generated more than $12 billion in global annual sales in the previous fiscal year, Tapestry said. That compares with about $87 billion for LVMH last year and roughly $23 billion for another European rival Kering.

Tapestry will pay Capri shareholders $57 per share in cash, representing a premium of nearly 65%. The equity value of the deal is $6.69 billion, as per Reuters calculations.

Shares of Capri hit over a six-month high of $54.52 during trading hours and closed up 56% at $53.90, while Tapestry closed down 16% at $34.67 as investors balked at an $8 billion bridge loan taken by the company for the deal.

The acquisition is also a bulwark against a looming slowdown in demand for luxury goods in the U.S. as sticky inflation forces customers to cut back on discretionary spending.

"(The weakening demand) has put pressure on Tapestry and Capri, both of which are now looking to international markets to bolster growth. There is more security in embarking on bold international plans as a larger entity," said GlobalData Managing Director Neil Saunders.

The deal will help Capri revive its Michael Kors brand under "better management" at Tapestry after weak sales in the past few quarters, analysts said.

Both companies have grown through acquisitions.

In 2017, Tapestry - then known as Coach - bought handbag maker Kate Spade for $2.4 billion. In the same year, Capri, formerly known as Michael Kors, acquired British shoemaker Jimmy Choo for $1.2 billion.

A year later, Capri bought Versace for $2.2 billion.

"We're broadening and diversifying our customer base ... that deepen our access to luxury consumers and market segments," Tapestry's CEO Joanne Crevoiserat said on a conference call discussing the deal.

The acquisition of Capri could also mark a revival in deal-making in the U.S. luxury space while European majors have snapped up high-end brands.

Last month, Gucci-owner Kering said it was buying a 30% stake in Italian fashion label Valentino. LVMH closed its $15.8 billion acquisition of Tiffany in early 2021.

The deal, which is expected to be immediately add to Tapestry's adjusted profit, is expected to close in 2024.

The transaction is estimated to generate savings of more than $200 million within three years of closing, the companies said.

Separately on Thursday, Capri reported a 9.6% drop in its first-quarter total revenue to $1.23 billion, but beat analysts' expectations of $1.20 billion, according to Refinitiv IBES data. Its adjusted profit came in at 74 cents per share, also topping estimates of 71 cents.

The company added that because of the announced deal it does not intend to provide any financial guidance at this time, and has withdrawn its previously issued forecast.

(Reporting by Aishwarya Venugopal, Savyata Mishra, Deborah Sophia and Chandni Shah in Bengaluru, Additional reporting by Ananya Mariam Rajesh; Editing by Sonia Cheema, Sriraj Kalluvila and Shinjini Ganguli)