If Gap Spins Off Athleta, It Would Be a Big Mistake

Following news that workout apparel brand Fabletics was hiring banks and advisors in preparation for an initial public offering, speculation emerged that Gap (NYSE:GPS) might want to spin off its similarly situated Athleta brand. 

Athleta is arguably the hottest property the retailer owns at the moment, and the one demonstrating the greatest growth potential. It would be a mistake for Gap to shed the business. While Athleta would be an interesting investment on its own, Gap itself could be mired in mediocrity as a result of the split.

Women stretching on yoga mats

Image source: Gap.

Taking it easy

Athleisure clothing remains a hot commodity. Already a popular clothing choice, athleisure wear launched into the stratosphere during the global pandemic as many people were forced to work from home. 

They also exercised at home, since gyms were shut down, so the search for comfortable, dual-purpose clothing was a priority for consumers. 

Industry leader Lululemon Athletica (NASDAQ: LULU) was one of the biggest beneficiaries, and as stores reopened, consumers flocked to them. Mobile-device location data from analytics company Placer.ai says second-quarter store visits for Lululemon were up 230% compared to last year (not surprising since that’s when most stores were closed), but they’re also running almost 7% above 2019’s levels and are 30% higher than 2021’s first quarter.

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Placer.ai’s vice president of marketing, Ethan Chernofsky, says of the athleisure space, “The clear affinity that consumers have for these products is driving offline visits in a period where these same brands are actively working to expand their offline presence – a winning combination.” 

Lululemon, for example, developed new digital features, such as a virtual waitlist to let customers know when they could enter a store, and it also acquired Mirror, a connected fitness device manufacturer.

Gap itself began investing heavily in the digital sphere several years ago, including buy online-pickup in store, ship from store, and curbside pick-up. Earlier this year it began piloting DressingRoom by Gap, an online fitting room, which ought to make it easier for customers to get right-fitting clothes the first time. It also invested $140 million in a new warehouse facility, indicating it understands the importance e-commerce is going to play in the future.

Bounding into the future

Athleta is reaping the same rewards. The brand has been a strong performer for Gap almost since it was acquired in 2008, and the retailer thinks it can grow into a $2 billion brand by 2023. It hit $1.1 billion by the end of last year.

Gap is downsizing, planning to shutter hundreds of Gap and Banana Republic stores, and closing all of its stores in the United Kingdom. But Athleta is in expansion mode, with over 200 open locations at the end of the first quarter. It also plans to enter the Canadian market later this year with an online site and two stores. 

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Management notes that Old Navy and Athleta account for 66% of total company sales, making the target of 70% of sales attainable. 

Placer.ai says Old Navy and Athleta are seeing consumers return to their stores, especially the athleisure outlet, which is enjoying a surge in foot traffic compared not to just 2020, but to the year before.

Chart source: Placer.ai. Yo2Y means current year compared to two years ago.

A grievous loss

While Old Navy had been lost in the wilderness for some time, it was finding its footing again just before the coronavirus outbreak struck, helping Gap rescind its decision to spin off that chain. And though Gap is committed to expanding Old Navy’s footprint, too (it opened two dozen stores in the first quarter), Athleta is the real growth property.

First-quarter revenue jumped 56% compared to 2019 while Old Navy’s sales were 27% higher (Gap and Banana Republic were both lower). 

If Gap were to spin Athleta off, it would lose a lot of its positive momentum. Even if it were a partial spinoff, with Gap retaining ownership of a good portion of the brand, it still loses the assets on the balance sheet (albeit gaining cash up-front). The loss of those assets could be debilitating for Gap’s continued recovery and growth and make an investment in its stock less attractive.

The Athleta brand, however, would be much more attractive. It’s a growing business in an expanding niche of the apparel market that has a strong connection with its target demographic. 

When Gap announced Athleta had stolen away gymnast Simone Biles from Nike for a long-term partnership complete with her own clothing line, Biles said the choice was easy because Athleta was a company that was “truly for women by women.”

Athleta has long represented an authenticity that resonates with female shoppers, a connection Gap can’t afford to lose.

Keeping it together

Gap has not said anything about a planned separation with the apparel company. But a Gap without Athleta would undoubtedly be viewed dimly, as the halo from the athleisure brand sheds a fairly bright light on its parent.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

View more information: https://www.fool.com/investing/2021/07/23/gap-spinoff-athleta-heres-why-thats-a-dumb-idea/

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