• Gap shares were up by more than 20% in pre-market trading.
  • The retailer is to spin off its Old Navy brand into an independent, publicly-traded company.
Gap is to spin off Old Navy as a standalone company

Gap is to spin off Old Navy as a standalone company

US speciality retailer Gap Inc has announced the closure of 230 of its namesake brand stores and revealed plans to spin off the group's Old Navy brand into an independent, publicly-traded company.

The split will see Old Navy become a standalone company while the group's remaining Gap, Athleta, Banana Republic, Intermix and Hill City labels will operate under a yet-to-be-named business (NewCo).

The spin-off will enable each company to maximise focus and flexibility, align investments and incentives to meet its unique business needs and optimise its cost structure to deliver profitable growth, Gap said.

"Following a comprehensive review by the Gap Inc board of directors, it's clear that Old Navy's business model and customers have increasingly diverged from our specialty brands over time, and each company now requires a different strategy to thrive moving forward," explained Gap chairman Robert Fisher. "Recognising that, we determined that pursuing a separation is the most compelling path forward for our brands – creating two separate companies with distinct financial profiles, tailored operating priorities and unique capital allocation strategies, both well positioned to achieve their strategic goals and create significant value for our customers, employees, and shareholders."

"Both companies will be well positioned to capitalise on their respective opportunities and act decisively in an evolving retail environment" - Art Peck

CEO Art Peck added: "We have made significant progress executing on our balanced growth strategy and investing in the capabilities to position our brands for growth: expanding the omni-channel customer experience, building our digital capabilities and improving operational efficiencies across the company. Today's spin-off announcement enables us to embed those capabilities within two stand-alone companies, each with a sharpened strategic focus and tailored operating structure. As a result, both companies will be well positioned to capitalise on their respective opportunities and act decisively in an evolving retail environment."

Gap expects to effect the separation through a spin-off that is intended to generally be tax-free to its shareholders for US federal income tax purposes.

Following the separation, Peck will lead NewCo as CEO and president, while Sonia Syngal, current president and CEO of Old Navy, will continue to lead the brand as a standalone company. Syngal has led Old Navy since 2016. 

Both NewCo and Old Navy, which have about US$9bn and $8bn in annual sales respectively, will remain in San Francisco, with NewCo based in Gap's current headquarters and Old Navy remaining at its current location.

The transaction is currently targeted to be completed in 2020.

230 Gap stores to close

Meanwhile, in a move designed to "revitalise brand health", Gap has announced a plan to restructure its specialty store fleet, including shuttering about 230 Gap locations over the next two years. It is understood that the closures will mainly be in North America.

"The remaining specialty fleet will serve as a more appropriate foundation for future growth of the brand across the specialty, outlet and online channels," Gap said. "There will be a healthier channel mix after the restructuring, with nearly 40% of sales coming from online, and the remainder split fairly evenly between the specialty and value channels."

The company estimats an annualised sales loss of about US$625m as a result of the store closures and said it expects pre-tax costs associated with the actions to be in the range of $250m-$300m, with the majority expected to be cash expenditures. Gap estimates that these actions will result in annualised pretax savings of about $90m.

The news follows a promise by Peck toward the end of last year that he would quickly take action on the stores he said are a "drag on the health and a drag on the performance of the brand."

Two months later, Gap announced the closure of its Fifth Avenue flagship store in New York.

In its fourth-quarter and full-year earnings release yesterday (28 February), Gap reported a rise in net income to US$276m for the 13 weeks to 2 February, from $205m in the year-ago period. The company's gross margin was 35.6%, a decrease of 120 basis points compared with last year.

During the first quarter of fiscal 2018, Gap adopted a new revenue recognition standard, ASC 606. Excluding the impact of presentation changes from this adoption, gross margin was 34.2%, a decrease of 260 basis points compared with last year, largely driven by elevated promotional activity at Old Navy and Gap brand.

Net sales, meanwhile, dropped to $4.62bn from $4.78bn last year. Excluding the presentation changes, net sales decreased 7%. Total comparable sales were down 1% compared with a 5% increase last year.

Within this, comparable sales were flat at Old Navy versus a 9% rise last year, while both Banana Republic and Gap saw declines. The brands reported comparable sales falls of 1% and 5% respectively. 

For the full year, net income totalled $1bn, up from $848m in 2018, while gross margin was 38.1%, a decrease of 20 basis points compared with last year. Excluding the impact of presentation changes from the adoption of the new revenue recognition standard, fiscal year 2018 gross margin was 36.8%, a decrease of 150 basis points compared with last year.

Net sales, meanwhile, reached $16.58bn from $15.86 last year. Excluding the presentation changes, net sales increased 1%. For fiscal year 2018, the company's comparable sales were flat compared with a 3% increase last year.

Within this, comparable sales increased at both the Old Navy and Banana Republic brands, with Banana Republic up 1% compared to a decline of 2% last year, while Old Navy rose by 3%, versus a 6% rise in the prior year. At Gap, however, comps were down by 5% this quarter and by 1% in the same period last year.

Looking ahead, for fiscal year 2019, the company expects reported diluted earnings per share to be in the range of $2.11 to $2.26, with comparable sales forecast to be flat to up slightly.

"Gap is not the only preppy logo brand with a short shelf life"

Maureen Hinton, global retail research director for GlobalData, notes while Gap started the fashion trend for the US preppy style casual brands, others, such as Abercrombie & Fitch, have since taken over as the latest must-have logo brand.

But their popularity is short, she says; "Ubiquity kills them off and fickle fashion followers move on to a new brand."

Like Gap, Abercrombie & Fitch fell out of favour and has suffered negative sales and profit growth as a result. But it is not alone, Hinton explains.

"UK brands that have emulated this American style, such as Superdry and Jack Wills, face the same problem; they have a short spell in the fashion sun, around three years, generating strong growth, then they wilt and have to evolve into a brand that can offer more than just a logo to bring in customers.

"These brands are neither sports brands, such as Adidas and Nike, or fashion brands such as Zara or H&M, and their casual clothing ranges can be bought anywhere at a fraction of the price without the logo. So when the logo goes out of fashion customers no longer see the value, and shift their spend elsewhere – which is one reason Old Navy is performing well – it offers good value.

"When Abercrombie & Fitch came to the UK in 2007, there were queues to get into its store, today there are no longer queues – instead there are queues at Supreme, the latest fashion must-have logo, and one that should take care it has a long term plan for the brand as it is reaching peak recognition."