2 New Fashion IPOs – Motley Fool
Clothes are a hard business to be in. J.Crew and Gap (NYSE:GPS) are both spinning out some of their more popular brands in an effort to get back on track, and investors should be able to buy into Madewell and Old Navy soon.
In this week’s episode of Industry Focus: Consumer Goods, host Dylan Lewis and Motley Fool Dan Kline dive into both businesses — what got them here, and what the future could hold for the separated companies. Learn how these two clothes retailers operate in very different segments, how Madewell is carving out a competitive niche for itself, what fallen fashion brands can do to revive their white-hot status, how spinning out successful brands can be good for an ailing parent brand, and more.
To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on Oct. 8, 2019.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It’s Tuesday, Oct. 8, and we’re talking about spin-outs in the retail sector. I’m your host, Dylan Lewis. I’ve got fool.com’s Dan Kline with me on Skype. Dan, what’s going on, my man?
Dan Kline: Not too much. We’re heading from super summer into regular summer here in West Palm Beach. Moving from the 90s to the 80s. It’s delightful!
Lewis: We’ve finally hit fall here in D.C. I busted out my jeans and hoodie for the first time this past weekend. I have to say, there’s a little spring in my step.
Kline: See, that’s a sign you’re going to be seeing less of me in the office, when it starts to get colder.
Lewis: [laughs] That’s probably wise. And jeans and a hoodie, a decent transition to what we’ll be talking about today. We’re going to be spending a lot of time talking about J.Crew taking its denim brand Madewell public. We’re also going to be talking about another retail spin-out, that’s Old Navy being spun out of parent Gap.
But before we get into the company-specific discussion, let’s talk a little bit about this mini trend that we’re noticing with these spin-outs.
Kline: Really, what’s happening here is, you have two companies owned under the same umbrella. One is struggling and one is doing well. And if that was happening in your real life, let’s say you made really good money and your spouse didn’t, it’s OK to mix those finances because nobody needs a true picture of what’s going on. But in the case of two retail brands, what you don’t want to do is have one successful brand propping up the losses for a struggling brand. Obviously, you can report and show what’s happening. But if you can’t pay your rent at the struggling brand and there’s money at the successful one, obviously, if you’re the same company, you have to use that money for certain things.
So what’s happening is these companies are breaking apart, and investors are getting a share of the sick brand and the healthy brand. And it’s putting you in a position where you really understand what’s going on, you’re probably losing a little bit of back-office synergy in terms of, you need a few more accountants, you need a payroll person, a couple of other assets; but you can really look at the health of each one. And for the one that’s not doing as well, you can make some of the tougher choices. You might have more flexibility to do so because, for example, your landlords can’t say, “Hey, you have plenty of money. I’m going to charge you more. I don’t care if this brand isn’t doing that well.” So, it’s good for investors, and good for anyone that deals with these brands.
Lewis: Yeah. I like to think of it as a chance for the true value of the successful brand to be realized. So often, those very strong results are masked by the parent company. Very often with these press releases, when you see these types of announcements, they’ll say, “We want the market to appreciate the full value of what’s going on over here.”
Kline: Yeah. You don’t want your expansion to be constrained by problems of sister companies. If you look at the two companies we’re going to talk about, both have very clear, one is struggling, one is growing very fast. You want to be in a position to put all your profits into growth, or a lot of your profits into growth, not into paying off bills for your struggling sister. This is also true in families, where you don’t want to have to do that, either.
Lewis: Spoken like someone who has had some exposure to a family business, Dan.
Kline: [laughs] No comment.
Lewis: Why don’t we kick things off by talking about the J.Crew spin-off of Madewell? For the uninitiated, Madewell is J.Crew’s denim brand. I think that they are what you think of as a very hip, millennial-focused brand in modern retail. They sell T-shirts, hoodies, jeans, tops. If you go by high fashion standards, a lot of their stuff is not particularly expensive. But I think it’s far more expensive than what you’d expect to see at a Target or a Walmart or something like that.
Kline: It’s a high price point for jeans. You might pay $40 for jeans at Old Navy, you might pay $80 for a nice pair of Levi‘s, maybe $100 for a pair of Guess jeans. I don’t know, I haven’t bought them in a long time. This seems like a somewhat high price point that is being pushed up a little bit by the company being trendy and a brand people want to have.
Lewis: Yeah, the numbers that I’ve seen looking around online, most of their jeans tend to retail between about $100 and $150. A lot of their women’s tops come in around $70 or $80. Definitely some premium pricing there. You see that bear out in the financials and some of the margins that they’re able to get, at least on the gross margin side. This is a successful brand. It’s one that has a lot of mindshare with younger consumers right now currently, in the Chinos Holdings category for J.Crew — which is a little confusing for folks.
Kline: Yes. Chinos, for those of you who are a little bit younger, is slang for jeans back from like the ’70s. When it gets spun off, it’s going to be called Madewell, which makes a lot more sense. What’s interesting is, everything you can say about Madewell now is how I felt about J.Crew when I was in college. It shows you a little bit about how trendy these things go. You can be a very hot, trendy brand — which J.Crew was, for a long time — and when you lose your way, it’s very difficult to get back.
Lewis: Yeah. I think that this is a situation where you see exactly why all these retail companies invest in these sub-brands. It is very common for what seemed like the stalwart retail companies to have all of these sub-brands associated because you want to have a little bit of optionality with wherever consumer tastes might go.
Kline: Yeah, it’s a major hedge. One of the things you see here is, these are both high price points. They’re not getting any hedge against price. But they are getting a little bit of a hedge against trends. With jeans — we’ll bring this up over and over again — there is also the possibility of becoming a stalwart brand, meaning that this might be red-hot right now — and at various points, Levi’s have been red-hot, Guess has been red-hot, but they don’t necessarily fall to the depths that may be J.Crew has fallen to, or some of these other brands have. It is possible that Madewell becomes a standard for jeans. Again, the demand won’t be as huge and won’t grow as fast, but we’ve bought Levi’s for, what, 40, 50 years? It’s a really long time. And it is possible that this happens here — though perhaps not all that likely.
Lewis: Yeah. To put some numbers to the brand, we have these breakouts thanks to their filing with the SEC. Revenue for Madewell was just over $600 million for their most recently completed fiscal year, which is up 32% year over year. In the prior year, they’d grown revenue at 27% year over year. So there’s some accelerating growth there. I think some of that is the fact that, yes, the clothing looks good. As a brand goes, they’re an inclusive brand. You see diverse models, you see them accommodating people of all different shapes, which is awesome. And they’re very focused on sustainable fashion, which I think has become very in vogue in response to so much of the fast fashion that we’ve seen over the last decade or so.
Kline: They’re also focused on sustaining their user base. I think this is a digital lesson to be learned. 60% of their customers are in a loyalty program. That’s really important for driving repeat sales. Let’s say you put a model out. At $150, maybe it doesn’t sell as well as you would have hoped. Well, you have 60% of your customer base. You can go to them and say, “Oh, my God, these new $150 jeans, we’ll give them to you for $99.” That’s a way to prevent failure, move inventory, stay relevant, stay in touch, make people feel a little bit special by offering them some deals, or maybe some product early, and being connected to your user base in a way that’s much better than hoping they walk by you in the mall and remember, especially for a brand that only has 130 or so stores.
Lewis: Yeah, I’ve been really impressed with how e-commerce-oriented this business is. I think it’s really an indication of where the industry is going and some of the best practices that a lot of other retailers should be adopting. You mentioned just over a third of their sales coming via e-commerce. I’m actually seeing a lot of articles about their organic search strategy, their ability to bring customers to their website for e-commerce transactions, on things that are not branded terms. A branded term, in SEO parlance, would be someone being like, “I’m searching specifically for Madewell jeans.” What we are noticing with them, people that are mining the data here, is that people just searching for jeans, or just searching for a type of skirt, are coming to their site, which shows not only are they winning when it comes to getting mindshare, but they’re winning in terms of their e-commerce strategy as well.
Kline: Yeah. Also, think about terms like “jeans that fit.” When you’re making a jeans company that’s very focused on being inclusive and body positive, that makes it a lot easier for someone to come in. I know my wife who’s skinny struggles with finding jeans. It’s just the way sizes work. It’s not an easy thing. If you have a company that’s embracing that, which Madewell is, it makes it easier for you to be willing to go there. If it’s a digital sale, and they’ve got all the returns set up really well, that’s also something that’s very important. A lot of the traditional retailers, if you order pants online — I’m wary about doing that — and they show up and they don’t fit, it’s a hassle to return. Companies that are digital native like Madewell, that’s baked into the process. It’s very, very simple to try clothes on, find the right fit, and figure out exactly what you want, and then reorder. You might go to a store once and then have a digital relationship going forward. That’s something that company has embraced along with this, “Hey, we’re going to figure out how to find pants that fit you.”
Lewis: Dan, you mentioned the retail footprint. I think just over 130 Madewell stores right now. One of the growth levers for this business is going to be them continuing to open stores. We’ve seen pretty good numbers when it comes to comps for them. I think around 10% for some of the recent quarters. But they’ve laid out that they want to open 10 to 15 fairly large stores, mostly in some pretty prime areas, over the next couple of years.
Kline: They’re 3,000-square-foot stores. It’s a pretty typical mall clothing store. But they’re looking at what’s happening. I think it’s fair to say that with malls, there are going to be winners and losers. The top-tier malls that are attracting all these digital native brands, that still have anchor stores that are doing well, that are replacing failed stores with gyms or hotels, those are going to be the malls you want to go in, the ones where the customer with more money to spend is going to come to. Madewell’s in a really good position. Even successful malls are having trouble. Chains like Forever 21 going bankrupt are creating huge holes in malls. It gives a company that could pick, and they could say, “Look, we’re going to come to somewhere in South Florida. That could be West Palm Beach, it could be Palm Beach Gardens, it could be Miami, it could be Boca. And we’ll play the five or six malls in those regions against each other to get either better terms or shorter term deals.” This gives them a lot of leeway. They don’t have to be in every mall. They can do what Peloton is doing, and just pick the right place to be, where their customers are, where it’s a little bit of like, “Oh, wow, that’s the mall that has a Madewell?” I think that’s a very strong brand positioning piece. You want to feel special. You want to feel exclusive. You don’t want this to be an everywhere brand.
Lewis: Yeah. For people that have not seen their retail footprint, and haven’t come across one of their stores yet, you can think about their store placement very similarly to how Warby Parker chooses their locations. If you look over in Washington, D.C., I pass the Madewell on 14th Street in northwest D.C. all the time. That is only a couple of blocks from the Warby Parker that’s over in Shaw. Both of these are scene type of places. There are a lot of bars, there are a lot of places where people go get cocktails, nice coffees, there’s a lot of those boutique style gyms. They are putting themselves in pretty prime real estate with most of the locations they’re in.
Kline: Yeah, prime locations, and places where it’s an event, it’s something to do. Warby Parker has the problem of, it’s a little bit awkward to get five pairs of glasses in the mail and then try to figure out which ones work. It’s really something that having a retail footprint helps. I know. I tried 15 different pairs before going to LensCrafters and buying glasses. In this case, with people being more and more comfortable buying clothes online, and in general, you’re probably not changing sizes all that often — let’s hope not — a very select footprint is going to lead to creating that relationship, and then the ability to maybe check in once a year. I know that if I needed jeans, and perhaps I should buy some new jeans, I would think about going out of my way to find a Madewell, get my sizing down, work with someone, figure out what I need, and then as time goes on, if I want to order more, or there’s a style I like or something, perhaps I would then do a digital sale.
Lewis: I think the struggle in talking about some of these businesses sometimes, Dan, is that we are not exactly the target market for them. Madewell actually does have some men’s fashion items as well. Over the last couple of years they’ve spent a lot of time developing those lines. They are primarily thought of as a women’s brand right now. They’re trying to change that. That’s another growth lever for them.
Kline: So I would have walked into a Madewell and realized, “This is not a great fit for me,” which also would be beneficial.
Lewis: Yes. Going forward, you might have some more luck. But in preparation for the show, I was talking with both my girlfriend and one of my good friends, Laura in D.C., and just getting a sense of where they stack up. They’re both regular customers of this kind of store. Basically, in their eyes, it’s Madewell and Everlane. Those are the two big millennial brands. They operate in a very similar space. The pricing is very similar. The focus on sustainable fashion, very similar. With both those brands, I think the attitude for a lot of consumers has been can’t stop, won’t stop. Like, this is good stuff. We’re happy to have it coming in and in our wardrobes. It’s this thing where people recognize it. “Oh, you’re wearing Everlane. Oh, you’re wearing Madewell.”
Kline: And there’s a huge growth area that Madewell can absolutely move into because of its connection with its customers. That’s custom-sized-to-order. We’ve talked about it on this show that I ordered a couple of pairs of pants from one of the companies that advertises a lot. I won’t say who they are. To say they didn’t turn out well would be putting it badly. They fit fine, but they look like the high-waist pants Apu wears on The Simpsons. If you could marry some of that to style, and knowing your customer, maybe being able to measure them in a store instead of them doing it at home, that’s the next frontier for all of these established retail brands. A company that’s built up from the ground digitally is really well positioned to do that. The fact that they’re trusted also makes it easier for them to ask a customer to make that leap.
Lewis: Dan, I mentioned can’t stop, won’t stop as the theme for consumer attitudes toward Everlane and Madewell. If you look over at parent company J.Crew over the last couple of years, its can’t stop is slowing down. That’s been the issue with this business. Why don’t we paint a picture of what’s been going on over there?
Kline: J.Crew is in a position where they have to close stores. Sales have been slowing down. It’s one of those where they’re just not connecting with the customer base. We talked about earlier in the show, when you’ve fallen out of fashion, it’s very hard to get back to it. I think J.Crew is in some way a brand that, when its core customers aged out, it didn’t replace them. It’s maybe a brand I could have worn in my 20s, but perhaps not one I’m looking to in my 40s, no matter what they do.
Lewis: For me, I didn’t realize that J.Crew stopped being cool, honestly. [laughs] I’m looking at the pants I’m wearing right now, I’m wearing J.Crew pants. Obviously, I’m behind the times, even though I like to think of myself as fairly hip. They’re still selling to plenty of customers. But you look at what’s going on with the business, the top line sales decreases, and it’s clear, they have fallen out of favor.
Kline: Yeah. They’ve got $1.7 billion in debt. That’s not the biggest number we’ve heard in retail, but when you have that, it becomes very difficult to throw a lot of things at the wall and see what sticks. They’re also being hurt by… I’m not going to say declining mall traffic. I think the reality is mall traffic has only decreased slightly. But I think it’s fair to say declining mall spending, meaning that customers are still going to the mall, but they’re browsing a bit and buying a pretzel. J.Crew clothes are still cool in the fact that they look cool. They still make a fashionable pair of pants. You’re a very fashionable guy, Dylan.
Lewis: [laughs] Thank you! Thank you for reassuring me, Dan!
Kline: But it’s not a brand my 15-year-old son is talking about. It’s not a brand my 18-year-old cousin is talking about. It’s not Members Only; they wouldn’t mock me for showing up in it. But it’s just not in the zeitgeist at the moment. Again, if you’re not selling foundational pieces that people need, it’s very hard to deal with that cycle. Sales were down 7% in the past year. They’re bleeding money. You have to make decisions to close stores. Closing stores is expensive, because you often have leases. Ideally, they would have closed some of their stores and put Madewells in, but chances are the stores they’re closing are in malls that they wouldn’t want to have Madewells in. They really need to be in a position to restructure that company, and this break is going to let them do that.
Lewis: It’s funny, I’m thinking about it now, and the last time I was at a J.Crew, even though I own plenty of J.Crew stuff, was to buy a suit. I own plenty of things that are made by them. But I bought them secondhand at Buffalo Exchange in D.C. I think that, as you get older as a brand, and people go through the cycles of cleaning out their closet because it’s fall and wanting to sell stuff, and the market supply on the secondhand side gets a little bit deeper, that is something that can bite some retailers, too.
Kline: Yeah. And who is the J.Crew customer anymore? The preppy college kid? They’ve moved through Vineyard Vines, and who knows what they’re wearing now? These are very fickle markets. It’s one of the challenges of being a fashion company. If you are selling to young people, young people get older, and their needs change. The next group of young people inherently rejects what the previous group was into. This is a very challenging market, where you have to stay with the cycle, and it’s inevitable you’re going to fall out of favor. But you have to get back to it. J.Crew has not been able to have that second run. We’re going to talk about Gap later. Gap is struggling right now, but through my lifetime of being an occasional Gap customer, or a major Gap customer when I was in high school, they’ve had four or five periods where they were very, very hot, followed by periods where they were cold, or as they are now very, very cold. J.Crew has just not been able to make that cycle work.
Lewis: Yeah, I think Gap was the retailer of the ’90s. Right? That’s what everyone pictures when they’re picturing the cast of Friends on the couch in the coffee shop. It was such an iconic brand.
Why don’t we switch over and talk about Old Navy and Gap? When you’re thinking Old Navy, the dynamic is similar with the parent company. But this is a brand that operates in a totally different space when it comes to consumer spending.
Kline: These are much more differentiated brands. I actually like Old Navy as an investment more than I do Madewell for one reason — yes, Old Navy is doing fashion. On some level, they have to hit with customers. On the other hand, as a parent, there is an age where your kids don’t care about fashion. For me, it was up until about 10. My son didn’t care. Then he started to really care. You’re just like, “I need pants.” Old Navy sells cheap pants that are reasonable quality. They sell jeans that, for an adult are somewhat disposable jeans, because they wear out; but for a kid who’s growing quickly, that doesn’t matter. So the sustainability of Old Navy, because it can sell to younger age groups, or even just, “I’m trendy for most of my clothes, but I just need a cheap hoodie because it’s going to be cold,” there’s a very defensible part of that business.
Gap really hasn’t changed its menu. It still sells a lot of denim and things that are just not at the moment all that popular. They haven’t really been able to pivot. Part of that is because they do own other brands and those brands have staked out different territory that have prevented Gap from going there. Again, this needs to break off. Old Navy’s literally going to open 600 to 800 stores going to markets they haven’t gone into. I’m fairly bullish on that prospect.
Lewis: Yeah. Some of the other brands under that Gap umbrella — we have Banana Republic, and I believe Athleta as well. Right, Dan?
Kline: Yeah. Athleta has been a mild success story, but it’s not that much of a stand-alone brand the way Old Navy — who doesn’t know Old Navy? Old Navy has giant stores. Whereas Athleta is more of part of the Gap brand. Banana Republic has its own problems. It’s a high price point, maybe even a little higher than Gap, with a diminishing return. This is a case where, you are getting Old Navy, which is growing quickly and has the ability to expand at a time where its size of store is something retailers are desperate for — they will be able to go into any community, look at any shopping plaza, whether it be a mall, or in their case, they have a lot of off-mall locations — and somewhat name their own price because there aren’t a lot of people opening 20,000- to 40,000-square-foot stores. There are a lot of vacancies. That’s basically one floor of a closed Sears, and a lot of malls have closed Sears. You could put, say, office space or a gym up top, and an Old Navy, and your problem is solved. So there’s really big potential.
They’ve managed to keep their clothing semi-fashionable — I don’t think anyone thinks of Old Navy as all that hip — for 20 years. It’s really been a long time where this has been an acceptable default, nobody’s going to mock you too badly if you’re wearing it kind of brand.
Lewis: And they’ve always managed to be affordable. There’s a clear difference between Old Navy and Madewell here. You’re thinking about buying clothes for your family or something like that, it’s a lot easier to be like, “OK, we’ve got a young kid,” or, “I’m going to be wearing this around the house while I’m hanging out with my young kid, and yeah, it’ll probably get stained, so I’ll spend $10 or $20 on this shirt rather than $50 or $60 on a very well-made shirt from Madewell that is probably going to get tomato sauce on it at some point.”
Kline: Yeah, and it’s important to note, Old Navy contributed 85% of Gap’s profits. It’s clearly doing its work. And as a parent, I can tell you, I don’t spend that much money on clothes. You joke that I wear a uniform. I do. I own a billion of this shirt. I live in a hot climate, so I wear a T-shirt most days. But when I lived in a Northern climate and needed cold weather stuff, I shopped at Old Navy quite a bit. I work from home alone. I don’t need to impress anybody from a fashion point of view. Just buying a sweatshirt to wear around the house or to go to Starbucks or whatever, it just wasn’t that important. That’s always going to be a niche for Old Navy that, even if the fashion part of its brand falls off, and the 17 to 22 year olds think the brand is really uncool for a while, that’s OK because Dad’s always going to be uncool, and kids below a certain age have never cared about cool. At its height, maybe Target is equal. But generally, I’d say Target’s a step below in terms of brand perception. It’s a very smart space. It’s a company that has been putting up big growth, but some of its proceeds have gone to cover for losses at its sister brands.
Lewis: The one thing that gives me a little pause when I’m looking at Old Navy is, they have over 1,100 locations. It might even be 1,200 at this point. The plan over the next few years is to open 800 stores. From a growth perspective, that sounds awesome. To really meaningfully grow your top line by adding more locations is great because then you have not only the growth that’s coming from same-store sales growth, you also have all this other growth coming as well. But 800 stores is a big jump from where they are now.
Kline: That doesn’t worry me that much because of the general contraction in department stores. They’re adding 800 stores. Yes, there’s other companies growing, but most of those are discounters. TJX Companies — Marshalls, T.J. Maxx, HomeGoods; Ross Dress for Less; Five Below. Those are growing retail companies. This is a uniquely positioned fashion brand that works in almost every market. If a parent used to buy their kids clothes at Sears, Old Navy is a very logical substitute for a Sears with a more predictable inventory than many of those stores that I just listed out. Look, I don’t know exactly how many malls and retail areas are appropriate in the country, but 2,000 to me doesn’t seem crazy when you look — we have an Old Navy here in West Palm Beach that draws locally. We could probably support one in three or four other towns here. In other, more densely populated areas, I could see there being a few. These aren’t stores that you’re necessarily going to travel far to go to. There is just a demand in almost every middle class or higher community, and maybe even a demand in some struggling communities, because it is decent stuff that’s not very expensive.
Lewis: My reason for pause is just that so much of the growth story is built on them building out that footprint. I look over at Madewell, and I see, they have around 130 stores; the plan is, for every year, to add about 10 to 15 stores. That’s not a crazy growth rate when it comes to your physical locations. The comps are doing well. You’re growing over 20% based on just that 10 to 15 per year pace. That’s pretty solid.
Kline: There’s also a bit of a digital disconnect here. It’s worth it for a company that’s making $50 on a $100 pair of jeans to deal with occasional returns and eating that cost, even to eat the cost of shipping overall. Old Navy, which does have a website, doesn’t really push their digital business that much because, if I’m buying four items and it’s a $45 sale total, you run into some difficult margins when you get into who bears the cost of a return, or, do I have to then go to a store to return it. It’s not a super digital-friendly model, especially when some of its customer base is a growing, changing size, its merchandise turns over somewhat quickly. They could definitely do better with things that are wardrobe perennials like jeans. They’ve sold the same model of jeans for a lot of years. They could make it easier to buy those online and make it more a part of their model. Maybe they wouldn’t need as many stores. Certainly, their stores should do everything they can to embrace omnichannel with buy online pick up in store, and buy online return in store. A return where you can try something else on and leave satisfied is much better than repeating the delivery cycle.
Lewis: Now, Dan, investors cannot get shares of either of these businesses yet. We are talking hypothetically. Neither one has actually been fully spun out. Is there one of these businesses that you look at and say, “Yeah, I’d prefer to own shares of that one,” if either?
Kline: The honest answer is, I don’t like any of these companies enough to own them. If I had to buy one, it would absolutely be Old Navy because I see a bigger customer base. We don’t know what the ceiling is for these boutique, expensive brands. Warby Parker, UNTUCKit, Madewell. There are obviously only so many people who can buy $100 jeans or $150 jeans. We’ve seen top-tier jeans brands — True Religion as a recent example — go white-hot and then go ice cold. I don’t like that.
I wouldn’t bet against the Gap making a comeback. But I do think they’re facing pricing issues at what they’re charging. J.Crew, that one seems like almost the worst of them. Old Navy, my mom can shop there for my son, my son can shop there for himself without too big a budget, my wife and I might pick up things that we’re going to use in incidental ways. It has a broader audience. It’s a much more casual spend. To run to Old Navy and buy a pair of jeans and some socks won’t cost you $50. That’s accessible to a lot of people. I think accessibility for a retail store is going to be pretty important when you’re talking about 2,000 locations.
Lewis: Yeah, I think you’re absolutely right. I think folks that are interested in retail should definitely take note of what Madewell is doing. I think that their model here, and being digital native, is going to be the one that a lot of other brands follow. Their connection to their customers, their loyalty and rewards program, all of that kind of stuff is so important for being able to push people to your website so that you can have a retail footprint and have that showroom and be in the big places in all these major cities; but then also be accessible across the globe.
Unfortunately, when I look at the numbers for that business, the valuations that I’ve seen thrown around — we don’t know for sure yet — is somewhere between $2.4 billion and $3 billion. At the low end, that puts them at like 45 times trailing earnings, which is a bit rich for me, especially because this space is so fad-driven.
Kline: Yeah. As an investor, this is a final warning, we don’t know how these companies are going to assign value to each piece they spin off. The number that’s been reported, but it means nothing, is that Old Navy is going to be about 80% of the total value of Gap. But don’t buy into the parent company just so you can get a piece of the other one. Wait until they’ve actually set these numbers, then do an evaluation. Also, look at what the added costs are going to be from splitting this stuff up. This is a very preliminary, “are these good brands,” not, “are these good investments.” Until you know the underlying numbers, you really can’t tell if they’re a good investment.
Lewis: Yeah. I think, if anyone wants a good visual on the lightning in a bottle effect of retail, take a look at the stock charts from Urban Outfitters or Gap over the last 10 to 15 years. There are those clear moments where the concept caught on, people were really loving it. And there are clear periods where they fell out of favor. Unfortunately with a lot of these types of brands, that’s just the nature of the business. It’s hard to stay on top for an extended period of time. Pretty much, there’s always a brand new thing that gets people excited.
Kline: It’s sort of inevitable. Old Navy is somewhat insulated from that, but they’re not insulated from competition and other people seeing their success at a lower price point and going after it. You’re seeing that to an extent with the Target owned and operated brands. And it wouldn’t shock me if some other fashion retailers spun off or created, call them value brands.
Lewis: Dan, I think we’ll wrap things there, man. Thanks for hopping on today’s show!
Kline: I appreciate you having me!
Lewis: Alright, listeners, that will do it for this episode of Industry Focus! If you have any questions or thoughts on Madewell, Old Navy, all these types of things we discussed on the show, shoot them over to [email protected], or you can tweet us @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes, or you can watch videos from this podcast and a ton of extra content over on our YouTube channel. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don’t buy or sell anything based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass today! For Dan Kline, I’m Dylan Lewis. Thanks for listening and Fool on!
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