Gap's Remaining Brands Will Offer Little To Investors After The Proposed Old Navy Spin-Off
Earlier this year, Gap Inc ( GPS ) announced plan to split itself into two independent, publicly-traded companies – an independent Old Navy, and a yet-to-be-christened new company (“New Entity”) that would include a smaller portfolio of niche brands in denim (Gap), upper middle-class fashion (Banana Republic), female athleisure (Athleta), and men’s performance lifestyle (Hill City).
A Look At Gap’s Historical Revenue And Profitability
Gap has added over $1 billion in total revenues in the last three years, growing at an average annual rate of 3.4%.
This growth has been driven almost completely by Old Navy, which contributed more than 95% of the revenue growth over this period.
Old Navy’s strong revenue growth coupled with a lower tax rate has helped the company’s net income margin expand from 4.4% in 2016 to just over 6% in 2018.
However, Gap Inc’s iconic brand, Gap Global, has continued to struggle. The brand has lost roughly $300 million revenues over the last three years, falling at an average annual rate of 5.4%. Gap Global’s contribution to total revenue has gone down from more than 35% in 2016 to about 31% in 2018.
How Will The Spin-Off Impact New Entity’s Revenue And Profitability?
Trefis expects New Entity’s 2019 revenue to be around $8.6 billion. We expect minimal revenue growth for the company over the next couple of years
New Entity is expected to add just $140 million in revenues till 2021, growing at an average annual rate of just 1.6%.
This growth is likely to be driven by the company’s fastest growing brand, Athleta. Athelta is expected to grow in the low double-digits over the next couple of years.
Banana Republic’s revenue is projected to remain flat while Gap Global’s revenue is likely to continue to decline over the next couple of years
Moreover, the company’s net income margin is expected to decline to around 4.5% as it will actually be more expensive to run two separate companies, each of which will have its own CEO, board of directors, insurance policies and administrative teams. Higher operating expenses coupled with a lower revenue growth are all likely to weigh on the company’s net income margin.
We Estimate A $10 Price For New Entity Inc. Based On The Following Forecasts:
Gap Global has delivered a rather soft performance over the last couple of years. The brand has consistently struggled and delivered negative comp growth in the last five years. The brand’s revenue has declined and the company has closed more than 200 stores over the last two year, with another 130 stores expected to be shuttered by the end of 2019.
Moreover, we do not expect the spin-off to help revenues in the near term, although expenses are likely to go up. In addition, the reasons quoted by the management for the spin-off are not justifiable. The management expects the spin-off to help optimize the physical footprint and also improve its digital platform. It is rather surprising since the company has already undertaken these efforts.
Taking all this into consideration, we are valuing the New Entity at $10 per share, much lower than our current price estimate of Gap Inc of $27 (assuming every investor receives a share of Old Navy and New Entity for each outstanding share in Gap).
Rationale For Trefis Price Estimate:
Since the spin-off is expected to be completed by the end of FY2019, we are valuing the company based on FY2020 estimates
We are valuing the company at about 9.5x projected FY’20 EPS, higher than the Gap’s current trading multiple of 7x. However, this multiple is lower than the trading multiple we currently have for Gap of 12.2x, as Old Navy’s forms a significant part of the current entity.
Based on our forecast, New Entity’s adjusted EPS for fiscal 2020 is likely to be around $1.05. Using this figure with our estimated P/E ratio of 9.5x, this works out to a price estimate of $10 for New Entity’s shares.
What’s behind Trefis? See How It’s Powering New Collaboration and What-Ifs
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