How Dual Share Classes Present Under Armour Inc Investors With a Unique Opportunity

Under Armour (UA 1.57%) (UAA 1.29%) has officially begun trading under its new ticker symbols this week -- the price gap between its two share classes has consistently widened over the past half year to as much as 30%.

In this episode of Industry Focus: Consumer Goods, Vincent Shen and Seth McNew break down the driving factors behind this move and why founder-led companies often utilize similar structures for their own companies. They also discuss CEO Kevin Plank, competing visions in a major market, and emerging trends for the sports apparel industry.

A full transcript follows the video.

This podcast was recorded on Dec. 6, 2016.

Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen, and it is Tuesday, Dec. 6th. For this episode, I am happy to welcome Fool.com contributor Seth McNew to the show. He is joining us via Skype from Denver, CO, I believe. You can never be sure with Seth, because you do so much traveling. How are you, man?

Seth McNew: Good, I'm good. Thanks for having me back.

Shen: So, how many places have you been to in the past week? Two weeks? Month? How many places have you traveled to?

McNew: I do do a bit of traveling. I think, in the last month, I've probably been in six or seven cities, I guess.

Shen: There you go. I'm quite envious. But, all college towns, right?

McNew: Yeah. I mean, this last week, I was in Minneapolis, at the University of Minnesota. A college town, but it's still a city.

Shen: Absolutely. Getting to the main topic for our show today, I want to talk a little bit about dual share class structures. After seeing the news last week that Under Armour would be changing up its ticker symbols, and after covering some of the oddities that have come about as a result of their three share classes, we can talk more about the ultimate implications for investors and look at some of the more interesting developments in the sports apparel industry that would seem to buck the trend of what a lot of people associate with retail. Seth, why don't you kick us off? Can you give us a quick rundown on what the changes were that they announced last week? And what it generally means?

McNew: Sure. Last week, Under Armour announced that they are again changing their ticker symbols. This is the second change this year. The idea is that their shares right now are UA and UA-C. Those are the two publicly traded ones. The UA shares will turn into UAA, and the UA-C shares will turn back into the plain UA.

Shen: What is the main difference? I know that, ultimately, it comes down to the voting rights. But, what is otherwise the main incentive for this structure, where you have these multiple different classes?

McNew: Right. It just comes down to voting shares. You have your voting shares, which right now are the UA, will be the UAA. Then the non-voting shares, which is the UA-C, and will be just UA. Then you have another class of shares, UA-B, which is owned by Kevin Plank, and those are the main voting shares. Lots of companies, like Google, have these kinds of different classifications for voting and non-voting shares. What's really interesting is, while there's usually a bit of a price disparity between the two, there's a very big disparity with Under Armour. As of today, it's nearly 20% between the voting and non-voting shares.

Shen: Yeah, I think that's what most people have assigned the most significance to this news. It seems like Under Armour is trying to shift and address this spread that has grown quite consistently. I should note that previously, it was the UA and the UA-B. Those B-class shares, as you mentioned, Plank owns all of those. I think there's about 35 million or so of them. Due to the 10 votes per share that those get, versus the one vote on A shares, he has about a 65% voting interest. So, overall, he has control of the company. It's not, frankly, uncommon among these founder-led companies. It's their vision. They started it.

I think, a lot of investors, if you're buying into Under Armour, you very much understand the fact that you're buying into Plank's vision, and that he has been the driving force behind this company with everything that has done so well in terms of its growth, its expansion, but also any hiccups here and there. But overall, I think people are quite happy with how the company has performed, the returns the shares have had. We can get to some of the weaker trading that's been seen in the past year. 

But, there was essentially a one-for-one share dividend issued. For every class A or class B share you held, you got a class C share back in April. That 20% disparity has been pretty consistent, now. It feels very odd, when the economic interests of these shares is exactly the same. It really comes down to those voting rights. And the thing is, for individual investors like our listeners and ourselves, we are not going to be accumulating enough shares to have a major voting interest anyway.

If you're an institutional investor, it certainly becomes much more valuable, you can have more input with management, maybe get a place on the board. But for ourselves, there was a discussion about this on an episode of Market Foolery last week as well, and they basically break it down to the fact that you really should just be getting into those class C shares, enjoying that 20% discount. If you believe in this company and its long-term vision, which we'll talk about more, that seems like the right way to go. Is it not? Doesn't that just seem like a huge opportunity for someone who's trying to buy in and get a, essentially, 20% discount?

McNew: Right. With most companies, there should be a disparity. It's valuable for a large investor to be able to have some say in the company and where it's going with your voting. But with Under Armour, it's just a moot point. Kevin Plank, like you said, owns 65% of the votes. So there's nothing that any investor -- whether you have shares that are voting or non-voting -- are going to be able to do for this. So, at least for the foreseeable future, until that changes, that he doesn't have total control, these non-voting shares definitely look to be like a great discount to what looks like a great company. 

Shen: Yeah. I should add, though the spread between the two publicly traded share classes have seen recently, that 20%, is high. I think it was actually higher at one point. I believe it almost reached 30% based on closing prices at one point. But, it's not completely unique to Under Armour. Another company that we've spoken about recently on this show is Viacom. They have their class A shares, class B shares. Same situation: Class A shares have the voting rights and class B does not. Again, economic interests are the same. They share equally in dividends. If the company is ever liquidated for any reason, again, they share equally in the proceeds from that between the two classes. But the majority of those class A shares are held by National Amusements, which is controlled by the Redstone family, and gives them their power and control over Viacom.

The thing is, I'm not sure how much you've been following this story, Seth, but I feel like in the past year, people really saw a little bit, potentially, how significant that voting interest and that influence can be, when you hear about the power struggle between Shari Redstone, between the CEO and other members of the management team, which have since been booted from the company. The thing is, if we look back even 10 years, the spread for those two classes of Viacom shares at one point topped 25%, similar to the Under Armour situation. But, I think the really interesting thing to note is, while that spread had decreased in the more recent years, in 2016, or in the past year or so, with the company making headlines with this power struggle, that spread between the two share classes has grown to about 10% to 13%, where it sits now. I think it's an instance where investors can be reminded that, for us, personally, those voting rights might not be that valuable. But for the more institutional players, it does absolutely play a role in that decision you make before you take a big position in the company.

McNew: Absolutely. And hopefully Under Armour won't experience nearly as much drama as that company experienced. It's been a bit of a soap opera these last few months. (laughs) 

Shen: Yeah. Refocusing on Under Armour, could you give us a little bit more of a view in terms of Plank, and what we can expect in the next five to 20 years? And, generally, how do you view some of the initiatives he's pursuing? We know he's been pushing a lot with technology and investing, that's generally what drove their big share price drop earlier this year, was the announcement that they wouldn't hit their guidance for 2018. They'd hit on the top line, wouldn't hit with their operating income, but his reason being, "We're going to take some of that money and invest back in the company." What are your thoughts here?

McNew: To me, as a shareholder, whether it's voting shares or non-voting shares, I'm more bullish on Under Armour knowing that Kevin Plank is going to remain in a dominant leadership position. To me, I think Kevin Plank has already shown in the last two years just where his long-term vision can take the company. Look five to ten years ago, when footwear was laughed at, or getting into the connected fitness space with these mobile fitness app acquisitions. In the last couple of years, those seemed like they were maybe very expensive, and not the company's core competencies. Here, we see, this year, footwear has turned out to be 25% of sales, and one of their most important growth segments. They have over 190 million users across their connected fitness platforms. So, you start to see these long-term trends. The idea that Kevin Plank is completely focused on the long-term, past 2018, like you said, the big share price drop was because Kevin Plank came out and said they're no longer foreseeing that they're going to make their 2015 goal of reaching $800 million operating profit by 2018. The short-term analysts really hit the stock on that, but looking past 2018, it's because of these investments that he and his company are making into some future trends.

Shen: Yeah. I should note, since the C class share dividend was issued when they did the split, the C shares are actually down about 43%, and the original A shares are down around 30%. The stock has taken a bit of a beating in the last six months or so. I think the big thing we can tie ourselves to, or at least keep in mind, is what you mentioned. That's just a view or guidance up to 2018. That's two years. If you're taking a more Foolish view of this, and you're looking 10 years out or even longer, and you believe in the incredible performance the company has been able to deliver year-over-year, in terms of its double-digit growth, top and bottom lines ... we'll talk a little bit more, I think, about more specific initiatives in the next few minutes.

But again, keep in mind, with this more bearish trading the shares have experienced, that's based on a 2018 view and the fact that Wall Street research analysts have these very complex evaluation models that are built, very much, on guidance like that. So, sure, the cut hurts. But, again, that's just a two-year view of the company. Probably not the way, for example, I'm sure you, Seth, view its longer-term prospects.

McNew: Right, of course. We're looking at a company for much more than the next year or two. But, what looks really attractive about the stock now is that it's trading, looking out just one year at expected earnings, the stock is trading at one of the lowest price-to-future-earnings that it's ever traded at, at about 35 times for the non-voting shares and 44 times for the voting shares. Right now, to me, that looks like a discount, a chance to get into this company for a cheaper valuation than you would have ever been able to. And if you're looking past next year, to the next five or 10 years, that valuation starts to look a lot more attractive.

Shen: Yep. Let's get into some of the specifics. I think there's been a lot of activity in one city specifically that I think is really interesting. This is in New York. Not only Under Armour, but its two biggest competitors, those companies being Nike and Adidas, are pursuing some very big investments in large -- I guess, just taking a big stake in these huge stores in the city. Can you explain to me a little bit of what they're thinking? Because, generally, people see a lot of other chains, think about Macy's, they're reducing their footprint, whereas here, these companies are building out these huge facilities. How do you view this, in terms of how it bucks the trend, in terms of people moving to spending online and away from a brick-and-mortar store locations?

McNew: It all started here just a couple weeks ago with Nike opening their massive new store in the Soho District of New York City. We're talking about a 55,000 sq. ft. five-story building right in the middle of one of the most expensive parts of New York. The store looks incredible. Each level is a different theme or a different sport. There's a basketball court inside the store where users can come in and test out new products, they can play on the court, and there's some really neat digital tech features that will give players real-time coaching and feedback that connect to their Nike Mobile app, and record their stats and save all their favorite gear. There are similar things for soccer and running. It's a massive store, and there's so much going on there. They're also hosting celebrities and professional athletes coming in, hosting seminars inside the store, it looks great.

Shen: Yep. Of course, not to be outdone, Adidas opened a similar flagship location not that long ago as well, right?

McNew: Yeah. This was just last week. This is right on 5th Avenue. It looks the same -- not quite as big, but still massive, four stories, over 40,000 square feet. It kind of looks the same. They have fitness consultants in there, they have trainers, a full concierge desk, a cafe, some other interesting features like same-day hotel delivery for people who are traveling in New York, some kind of running analysis so people can pick the perfect shoes that work right with their stride. All of it is a very tech-infused kind of feel.

Shen: Yeah. For Plank, with Under Armour, what has their response been? From what I hear, they're actually taking over a very famous space within the city, right?

McNew: Right, yeah. So, obviously Nike has had the lease, and Adidas has had the lease, for a while. Under Armour, earlier this year, announced that they'd taken over the very famous FAO Schwarz toy store, that's the toy store right in the middle of New York, the massive space that has been in so many movies. Under Armour will be taking over that lease starting in 2019, they hope to open a store there.

Shen: I'm not sure how much detail they have been able to provide in terms of what to expect from this location. But I get a sense, based on what the competitors have done, a more interactive experience they want to offer, where it's not just somewhere you go to shop for your shoes or your clothes, it's more of a destination. I have seen this take hold, in terms of apparel and retail, not with just these sports apparel brands, but another really good example of this is with Urban Outfitters. They have opened these test pilot locations in New York, and Austin recently, and a few others, where they're trying to combine an event space for music or some type of local craft market with the obvious apparel part of the store, of the retail experience, but also with a restaurant as well. Obviously, I think a lot of people were scratching their heads when they made the Vetri acquisition, this pizza chain.

Another example beyond Urban Outfitters, if you look at what a Bass Pro or a Cabela's does, these stores are destinations unto themselves. So, it's kind of interesting to see this take hold. While some retailers are pulling back, others may be taking -- if you even look at Amazon, how they're starting to test and expand these physical brick-and-mortar locations, having come full circle, seeing that regardless of how important e-commerce will become, and the benefits that it offers, and we'll talk about that a little bit more -- is you'll come full circle and see some very interesting, it seems more so marketing benefits, to having locations like these. Right?

McNew: Right. And you're right, we don't really know what that Under Armour store is going to look like, but from what they said in their releases, it'll be the "greatest single retail store in the world." It's almost more of a marketing attempt by these companies -- they can plant their flag, and really show what they have to offer without trying to sell as much gear through that one specific location. It's really more of a chance to showcase, have an event center, have people come in and test out products. Then, by having a really connected e-commerce strategy to those brick-and-mortar stores, they're able to make all of that work together.

Shen: Yeah. Tell me a little bit, then, about what your view is, besides these stores. Interesting, it's really cool to see these developments, and how they're trying to leverage their spaces with their broader strategy. But what do you think, then, is going to be really important for Under Armour going forward, driving their actual top and bottom line? 

McNew: Look, I know Under Armour certainly has some risks ahead of itself. It's investing in some very long-term future trends. Going forward, the things they're working on now with expanding internationally, working on their footwear, making sure that they understand a connected retail strategy between partners like Kohl's as well as a really important direct-to-consumer and e-commerce strategy, those are the kinds of things that are going to continue driving the quick growth that we've seen in the last five years, forward for the next five or 10.

Shen: Can you elaborate a little more on the direct-to-consumer? I think that's very relevant now. We had a show recently where we talked about Black Friday, the holiday shopping season overall. I think a lot of people, if you have been following consumer trends in the past few years, you've generally seen headlines indicate that more and more spending dollars are moving online, foot traffic is not quite as strong as it used to be, these doorbuster deals don't get people out quite as much, because they're spreading out their spending, and online stores are making that much more possible.

McNew: Yeah. I don't know how much shopping you did over the last couple weeks through all the Black Friday and Cyber Monday, but to me, it felt like the exact same deals for about two weeks. I don't think there's any longer a need to have a specific time that people are forced to buy something. I think that makes sense. Companies are seeking to cultivate customers for the long-term. It's no longer about trying to get a one-off hit, and every year trying to produce some sort of deal that's going to get you a small sales growth. It's about cultivating long-term customers that know and understand your brand. That's why direct-to-consumer is so important. It's much easier for a company like Nike or Under Armour to have that, to own and control that customer relationship, when they're sending the product directly to the customer instead of through a Foot Locker or a Dick's or, as we've seen with Sports Authority as it's gone underwater, they can also really make sure they control inventory, make sure they understand trends that are happening, and plan accordingly.

Shen: Yeah. I think the big investments that Under Armour made, with the connected fitness apps, for example, ultimately it's a move to better understand who your customers are. Now, you mentioned, with their direct-to-consumer strategy, and how removing that middle man gives them a better view of what is in demand, what features or fashion trends are resonating more with their customers, and which lines and products they are selling better.

As we wrap up our discussion, anything else, in terms of the connected fitness and the e-commerce that you think is notable, worth mentioning, for Nike, Adidas, or Under Armour? We'll go from there.

McNew: Yeah. I think it's important to watch what these companies are doing specifically to grow their e-commerce footprint. You have companies like both Nike and Under Armour, which both have opened new mobile apps this year at that are connected to some of their fitness apps, that can get even more data from the users and market to them more effectively. You're looking at country-specific new dot-coms opening up around the world. Nike opened up 20 new country-specific sites around the world last year, doubling to 40. That's a way that they can spread their footprint further, while also keeping everything within this e-commerce world.

Shen: OK. Thanks, Seth. I will leave it at that. It seems to me like you are, generally, someone who I consider to be one of our big followers of Under Armour. I know you've been to a lot of their events, and generally a fan of the vision that Plank has. It sounds to me, with the ticker symbol change, not much of a fundamental shift there, but the core idea being, right now, because of that spread, it seems like a good opportunity, if you are taking that longer-term view -- even if you currently hold class A shares. I'm not sure about your own view of this, but you could sell out of those, and increase your position in Under Armour, in the true fundamental economic interest of the company, you could increase your position by 20% by just moving your shares over to the discounted class C.

McNew: Sure, you could do that. Or, just like I've done, just increase your position with buying those class C. And, this change happens tomorrow. So, I guess we'll see after tomorrow how much that gap closes.

Shen: Yeah. Thanks a lot, Seth, for joining me. It's great having you on.

McNew: Thanks, Vince.

Shen: That wraps up our discussion of Under Armour and these dual share classes for today, but you can reach out to us and the rest of the Industry Focus crew via Twitter @MFIndustryFocus, or send us any questions via email et [email protected]. 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 during the program. Thanks for listening and Fool on!