If you bought Nike (NYSE:NKE) stock around the time that the sports apparel titan purchased Converse, you'd be sitting on massive long-term gains today. Nike is up over 700% since mid-2003, compared to a 160% increase in the broader market.
The Converse brand has had some painful growth struggles lately, though, and they highlight the core challenges facing Nike's broader business.
Getting a deal on shoes
When Nike bought Converse in July of 2003, management paid just over $300 million for one of the oldest athletic footwear franchises around. It was tiny, yes, at $200 million of annual sales compared to Nike's almost $11 billion at the time. But the company had an awesome streak of design and marketing successes, beginning with Converse brand sales in 1908 all the way up to retro-style shoes like the Chuck Taylor All Star franchise.
Nike saw this portfolio as an opportunity to expand into lower price points than the Nike and Jordan brands that typically commanded $150 or more. They also bet they could boost the franchise by marketing its products internationally.
Nike was right. The Converse brand booked over $2 billion in revenue last year and brought in $477 million of profit, or about 10% of Nike's overall earnings. Put another way, Converse routinely generates more earnings per year than the total that Nike paid to acquire it just 14 years ago.
The Converse business is struggling right now, though. Profits have declined in each of the last two fiscal years, and Nike recently announced a 16% quarterly revenue slump for the franchise. On the bright side, Converse managed double-digit growth in the China market. However, sales and profitability shrank in the U.S. as management sought to reduce retailer inventory to match up with lower shopper traffic.
These challenges mirror Nike's broader business struggles. The sports apparel titan has lost some pricing power in the ultra-competitive U.S. market, and that's caused its gross profit margin to sink along with rivals like Under Armour (NYSE:UA) (NYSE:UAA). Both companies have seen their growth forecasts slow to a crawl over the past year as consumers move to new, lower-priced brands.
Nike has some big guns it can bring to this fight, beginning with a marketing budget that, at over $3 billion annually, is more than half of Under Armour's entire sales base. It is much better established in markets outside of the United States, too, which is why management believes Nike can still grow at a healthy clip over the next few years even as its biggest market flatlines.
What's next for Converse?
As for the Converse brand, CEO Mark Parker and his executive team believe it will keep shrinking in the U.S. while growing at a much faster clip in areas like China. After all, a rising middle class will make that country's addressable market 10 times the size of Nike's U.S. segment over time, management estimates.
The long-term success of the brand will depend on the company executing on the right designs, styling, marketing, and pricing to make the footwear products stand out in a crowded market. Investors haven't seen much evidence of those challenges being met lately.
But the Converse franchise isn't going anywhere. In fact, it should feature more prominently in Nike's portfolio as the company leans on international markets to deliver most of its growth between now and 2021.
Demitrios Kalogeropoulos owns shares of Nike, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool owns shares of and recommends Nike, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool has a disclosure policy.