Is Old Navy Really Worth So Much More Undocked From The Gap?

The business of selling clothes in malls is not what it used to be -- to put it mildly. The rise of e-commerce and the movement toward fast-fashion brands has knocked the legs out from under a number of retailers, to one degree or another. Case in point: The Gap (GPS -3.83%), which for quite a few years had a solidly winning model with multiple chains catering to various demographics. Now, of course, only one is really thriving: Old Navy. So the news that Gap was spinning that one out into a separate public company got Wall Street's attention last Friday.

In this segment from MarketFoolery, host Chris Hill and Motley Fool Asset Management's Bill Barker discuss the problems the retail company has been enduring, Gap's strategy, and its lack of overall growth. They also explain why the impending split might actually make the parts worth significantly more than the whole.

A full transcript follows the video.

This video was recorded on March 4, 2019.

Chris Hill: Shares of Gap are down a bit this morning, but on Friday, shares popped 20% when Gap announced that it is going to spin off Old Navy into a separate public company. Gap, Banana Republic, and Athleta are going to be a separate company, yet to be named.

You think this makes sense, both in terms of the spin-off and the reason that shares popped 20%. I'm assuming people said, "I'd like shares of Old Navy if it's a separate company, and I guess the way to get that is to buy shares of Gap today."

Bill Barker: Yeah, I guess it makes sense in this respect: You've got Gap also announcing it's going to close 230 stores in the next two years. What do they do in that case right now? At times they're going to look at their other brands, including Athleta, Banana Republic, Old Navy, Intermix. "Can we slot one of these things in here? Will it do a little bit better than Gap?" Because Gap is heavily mall-based. So, at times, it may make sense for the company to put Old Navy into a place where it doesn't really want to be, if it were making its own decisions, but it's better than leading a second or third Gap in the same mall, which has occurred. So, making its own capital allocation decisions is good for Old Navy.

But the reason why it is potentially more valuable separate and apart aside from that is, the valuation for companies that look like Old Navy are higher, that are discount brands and are not locked into malls. There are Old Navy stores in malls, but they're not as weighted down by that as Gap is. So, you've got Old Navy joining a comp group where, at least according to one of the analyst reports that I read, they're putting a two times higher multiple on Old Navy alone as on the remaining stores in the Gap umbrella.

Hill: That's pretty impressive. For a good stretch of time -- and you have to go back a ways for this -- the case for owning Gap was not just that it was a different time, there was a lot less online shopping. It was also that Gap had these three brands in Old Navy, Gap, and Banana Republic that appeal to different life stages. You've got Old Navy, which is much more geared toward kids; Gap, more toward older kids, young adult; and then Banana Republic was more for young professionals, and then presumably, young professionals, if they're having children, they're going back to Old Navy. It was this wonderful cycle.

But really, the story for this company for at least the last five years has been, quarter after quarter, "Well, Old Navy did well to make up for the rest of the business."

Barker: That's one of the stories. The other story is, "When is this thing finally going to grow again?" You can go back to 2004, and it was doing $15 billion, almost $16 billion in revenues. It's 2019, it's doing $16.5 billion in revenues. It has bounced up a little bit, down a little bit, but it's never had more in sales than $16.5 billion. It was at $15 billion 10 or 15 years ago. That's just not a growth story. It doesn't look like, when you take the whole package together, despite having added a couple of brands in Athleta and Intermix, that it's growing today. You've got the comps from the most recent quarterly report, Gap down 5%. No surprise there. That's not necessarily worse than what you're seeing from L Brands. Gymboree is going bankrupt. It's just, clothing in malls, not what you thought it was 10 years ago.

Hill: Does Old Navy as a stand-alone company interest you as an investor?

Barker: I don't know. I'd have to see the numbers. It's better-positioned. I'd want to know how many stores are in malls. I'd want to know what management is projecting the growth as. I'd like to see the margins broken out. I don't know. It has to have more going for it than just, "We're not part of Gap now." Positive as that is.

Hill: Although it wouldn't be the worst tag line right out of the gate.

Barker: No. I was flashing back today after looking at this graph of the sales over the last 15 years, to the 2005 Spike Jones commercial.

Hill: You email this to me right before we started. I'll tweet this out on the MarketFoolery Twitter feed. I was unfamiliar with this, or, if I watched it in 2005, I don't remember it.

Barker: Well, you're getting old.

Hill: I am.

Barker: Unlike some of us. [laughs]

Hill: Well, today, my friend, you're getting older.

Barker: [laughs] Well, it got a lot of headlines at the time, because Spike Jones, great director of both commercials and music videos. You know some of his best work there.

Hill: Yeah, Christopher Walken.

Barker: Christopher Walken. You should tweet that one out, for people that don't know Christopher Walken's work with Fatboy Slim. You've got a whole bunch of tweets coming today.

Hill: I think I do, yeah.

Barker: You're promoting YouTube, basically, today. Anyway, the commercial, just to ruin it -- for anybody who desperately wants to watch it, spoiler alert -- they just trash the Gap store. It's about, "We're doing some remodeling." That's the news and the punchline. But it's done in an entertaining way. But I find it oddly prophetic. They've just been destroying the company for about 15 years now.

Hill; Yeah. It was meant to be, "Hey, customers and eventually employees in this commercial are just trashing this one Gap store." And eventually, it turns to the "pardon our dust, we're remodeling, a whole new Gap is coming." But as you said, really, it was just the beginning of the business being trashed.

Barker: I think they should have just had Christopher Walken dancing around the store. That would have been better. Looking back on it.

Hill: That could be something for Old Navy, for their new marketing campaign.

Barker: Exactly. It wouldn't be as weird as some of their old marketing campaigns.

Hill: That's true.

Check out the latest earnings call transcript for Gap.