Unlocking U.S. Gap’s Valuation Gap (updated March 2, 2019 at 12.30 PM CET)

In volatile times, sometimes the best path forward is to take separate paths entirely.

Gap’s split from Old Navy leaves questions unanswered about the slower-growing company but at least unlocks a lot of value

By guest author Elizabeth Winkler from Wall Street Journal

That seems to be the conclusion reached by Gap Inc., GPS 16.18% which announced on Thursday that it is splitting into two publicly traded companies: Old Navy, and a new company (yet to be named) that will comprise its remaining brands, including Gap, Banana Republic, Athleta, Intermix and Hill City. Given the company’s struggle to revive sales at Gap, its flagship brand, that appears to be a wise decision.

Sales at Gap have been steadily declining, even as consumer spending was buoyed last year by rising wages and tax cuts. In August, Chief Executive Art Peck called the brand’s performance “unacceptable.” By November, the company said it was contemplating closing hundreds of stores. Same-store sales at Gap were down 5 % for the fourth-quarter and for the year—a marked deterioration from a year earlier.

The company’s other brands are not struggling quite as much. Same-store sales at Banana Republic were down 1 % for the quarter and up 1 % for the year, while at Old Navy they were flat and up 3 %, respectively. Old Navy alone brings in around USD 8 billion in annual sales—nearly half of the company’s total.

But, it is some back-of-the-envelope math that best illustrates why the stock surged by 25 % in after-hours trading Thursday, February 28, 2019, Gap’s enterprise value-to-sales ratio is currently less than a third that of leading fast-fashion retailers and its price/earnings ratio less than half as high. If applied to an independent Old Navy, the implied value of the rest of the company would be close to zero, which it clearly is not.

The unnamed company would not have Old Navy’s sales to prop it up any longer, and the weakness of the remaining brands, especially Gap, will become increasingly apparent. Meanwhile, Old Navy isn’t quite a Zara, H&M or Uniqlo, and probably won’t be as richly valued. Yet the two halves may well be worth more than the whole was before the announcement.

There will be more gains to come if the separation prompts much-needed changes at the slower-growing rump, but investors should wait for evidence before chasing the stock any higher.

Gap to split into two Public Companies

Apparel maker will separate fast-growing Old Navy from struggling Gap brand that once ruled America’s malls

By guest author Khadeeja Safda, she covers the U.S. retail industry, including brick-and-mortar chains and e-commerce players. She joined the Journal in 2013 after graduating from Columbia University.

The apparel retailer is separating the fast-growing budget brand from the rest of the business, creating two publicly traded companies. The planned breakup is an acknowledgment of the two chains’ diverging fortunes and how much Gap has lost its once-powerful grip on American consumers.

For several years, Old Navy has outperformed its sister brands Gap and Banana Republic with its lower price-points and catchy marketing. Old Navy now exceeds the original brand in sales, making up nearly half of Gap Inc.’s USD 16.6 billion of sales in 2018.

At its height in the 1990s, Gap stores ruled America’s malls and largely dictated the nation’s casual aesthetic with its khakis and white tees. Gap was so much a part of the national culture that the actress Sharon Stone wore one of its shirts to the 1996 Academy Awards. The brand’s television commercials featured celebrities wearing its bluejeans.

Nowadays, many consumers aren’t willing to pay $80 for a pair of jeans, forcing the brand to rely heavily on sales and markdowns. It has lost market share to fast-fashion chains like H&M and Zara. Gap’s market value tumbled under $10 billion from its 2000 peak of roughly $40 billion.

Wardrobe basics have also evolved since Gap’s heyday, with many customers now opting for exercise-friendly fabrics instead of denim. In an effort to revive the namesake brand, the company has closed stores, changed leadership and updated merchandise.

Comparable sales declined 5% in 2018 at the namesake brand, and the company said Thursday it plans to close another 230 of its stores over the next two years, or about 20% of its global fleet. Old Navy’s comparable sales rose 3% for the year.

Gap Inc. CEO Art Peck will continue to run the parent company, which will include the Gap brand, Banana Republic, Athleta, Intermix and new athletic brand Hill City. It will be renamed and have about USD 9 billion in annual revenue. Old Navy CEO Sonia Syngal will run the newly separated company, which generates about USD 8 billion in annual revenue.

“The other brands overlap each other but overlap Old Navy less,” Mr. Peck said on a conference call with analysts Thursday. He said separating the two would allow both to make quicker decisions and focus their investments.

Mr. Peck has long said the brands have advantages over their competitors because of the parent company’s combined size. On Thursday, he said the company hasn’t yet decided how to split the customer data among the units. “We do have customer overlap,” he said. “That’s something we need to sort out.”

Robert Fisher, chairman of Gap Inc.’s board and the son of the company’s founder, said the move follows a review by the company’s board.

“It is clear that Old Navy’s business model and customers have increasingly diverged from our specialty brands over time,” he said in a statement. The Fisher family controls about a third of the stock.

The transaction is targeted to be completed in 2020, the company said.

Gap shares surged 25 % to USD 31.80 in after-hours trading on the news, which was disclosed after markets closed. The stock has languished in recent years and had closed Thursday’s session at USD 25.40, down from USD 34 a year ago.

Old Navy was founded in 1994 by former Gap CEO Millard “Mickey” Drexler to compete with rivals that were undercutting Gap’s prices. He named the discount brand after a bar in Paris. Within four years, sales at Old Navy reached USD 1 billion. The brand now has more than 1100 stores in North America.

Some analysts have said that Old Navy’s rise has expedited the Gap brand’s demise. “When your prices are lower and it’s essentially the same merchandise, you’re going to cannibalize the sales at the higher-end brands,” said Sucharita Kodali, a retail analyst at Forrester. “There’s no differentiation.”