As March Madness descends upon the country, Industry Focus dives into the multimillion-dollar deals that apparel manufacturers like Nike (NYSE:NKE), Adidas (OTC:ADDYY) and Under Armour (NYSE:UA) sign with major colleges. Learn why college sports, and especially basketball, are so important to global athletic wear manufacturers, and why Nike and Adidas must increasingly look over their shoulders at Under Armour.
A full transcript follows the video.
This video was recorded on March 19, 2019.
Jason Moser: Now, let's get into talking a little bit more about NCAA, sports in general. Basketball in particular, though, is really big business. I know football tends to get a lot of the spotlight. Maybe that's just due to the nature of the sport itself. But I feel like basketball gives a little bit more of a level playing field for a lot of teams out there. That's probably why you see a school like Wofford that can hang on the basketball court. Maybe not so much on the football field. Basketball really is big business. We talk about the major players in this space, the obvious suspects there. Nike, Adidas, even Under Armour. I saw something where Under Armour tweeted out, they've got 17 squads representing in the Men's Tournament this year. They've got 12 squads representing in the Women's Tournament this year. Asit, we've seen lately here, as Under Armour has been in the process of a little bit of damage control, Nike and Adidas have been duking it out lately. It seems like Nike might be gaining the upper hand there.
Asit Sharma: Yeah, it seems like that. Nike was once the undisputed leader of program partnerships and really evolved this whole mechanism where a major sports apparel company will team up with a school, give the school athletic gear and cash and marketing support, and then get their product placed within these schools, which is really great for their brand. But, we've seen in recent years, Adidas really tried to take some of this share from Nike, and Under Armour get into the game as well.
It's really interesting to me. I was doing a bit of research for this program. I'm surprised, it's estimated that these three companies jointly pour in about $300 million a year in college program contracts. One of the ones that stands out is Under Armour's mega-contract with UCLA, which they inked in 2017. This is a 16-year partnership. Each year, UCLA will get an annual cash allotment of $9 million. They will get product worth $3.76 million. You have to pause there and think: How many stickers does $4 million buy? [laughs] Of course, this is going to all their teams. I'm sure there's new lacrosse jerseys, etc. There's all types of departments that prosper in a big deal like this. It's a $200 million deal over that life span. So, Under Armour has come in and pushed up or escalated the bidding process.
Adidas, as you mentioned, Jason, had really come out in front of Nike in the past few years on a couple of fronts. It really stole some nice partnerships upon contract renewals, but also, in financial terms, as Adidas decided to focus on the college market, that was simultaneous with margin expansion for the company and revenue expansion. I looked this morning, Nike still has about $36 billion in annual revenue a year. Adidas now has $26 billion. So it's slowly catching up.
The really interesting thing is, as Adidas has decided to challenge Nike on everything from shoes to jersey apparel, their margins have improved. They used to range around 6% three years ago, their operating margin is what I'm referring to. Adidas' operating margin has now almost doubled to 11%. In that same time frame, Nike, which used to have an operating margin of 14% to 15%, has seen its operating margin decline to about 12%. The inferences in the marketplace is Adidas, with these new contract deals and a lot of innovation on the sneaker front and other apparel fronts, is forcing Nike into some bigger promotions and more discounts.
But again, just as it seemed that Adidas was going to take over, they've run into some problems. In a recent earnings report, which you shared with me, Jason, it looks like they're stumbling with some supply chain issues. That's going to knock a few hundred million dollars off of that $26 billion top line in this current year. It's a never-ending battle between these companies. Every time you think one of them is getting this decisive edge, there's a stumble or a new contract deal, which is so important for both of their brands to extend out into the apparel universe.
What are your thoughts about this whole dynamic between Adidas, Under Armour, Nike?
Moser: In our Foolish universe here, certainly Nike is a popular holding. Under Armour has been a popular holding for a long time. Adidas has always been sort of that company that maybe didn't get as much of the limelight. You referred to the fact that they're making a considerable amount in regard to top-line revenue annually as well. You think about it, Adidas has been around for a long time. That's a brand I remember very well as a child growing up many, many years ago. [laughs] I guess my point there, between Nike and Adidas, it's important to remember that those companies have been around for a long time doing what they've been doing, whereas Under Armour is still, relatively speaking, the new kid on the block.
With Under Armour, we've been very excited about the opportunity, the possibilities there, the potential. There was a little bit, I think, maybe it was an overreach on Kevin Plank's part, the founder and CEO of Under Armour. He's talked about wanting to supplant Nike as the world's No. 1 brand. That's not a bad goal to have. But it's worth remembering how long it took Nike to get where they are today in. I think that time spent doing what they're doing, that's a very important variable in the equation for Under Armour. It's not to say they can't do it one day, but really, it's going to take them some time to get there.
Now, to their credit, it does seem like they've gotten the business right-sized. They've corrected some of the errors. But, yeah, this retail business, the nature of it is very difficult. Supply chain management, making sure you don't overload yourself with inventory that you then have to basically liquidate, thereby affecting the margin, the profitability. It's a difficult space to operate on a consistent basis. But when you're looking at the brands that really are ruling the space there, those are three very big ones.
We recently were talking -- I don't want to go too much into this -- about Zion Williamson's shoe malfunction. The big story there was, how much is Nike going to feel this impact on their stock price from that? And we all kind of looked at that and said: "You know what, that's kind of silly. Let's take a step back and recognize the fact that it's one isolated incident." It'd be different if that was happening to shoes all over the place. To be sure, if you see one or two shoes blow out here during the NCAA, we probably will see a little bit more of an impact. But again, those are very temporary in nature for a company that still has done a lot of great stuff over a long period of time.
Sharma: Yeah. We'll chat in a bit about the impact that Zion Williamson -- for those of you who don't know the incredible 285-pound player for Duke University, who will almost certainly go pro next year, he's having a phenomenal year. We'll talk about his impact maybe on a smaller company than Nike in just a bit here.
I wanted to second you on Under Armour. I think their focus last year on getting back to basics, and Kevin Plank's ability to hand over the mechanics of operating this company to his operations people is paying off. I think that was wise of him, to back off and focus on innovation, let the operational people get back to brass tacks. It's certainly paying off; their stock has recovered. It's still down over a three- to five-year period. But, over the past 12 months, shareholders have seen some appreciation. That's pretty good for them.
One thing we should mention before moving on about Adidas is this ongoing scandal in college basketball, which was a big story in 2017, 2018. Loyal Motley Fool Industry Focus: Consumer Goods listeners will remember that we had a whole show on this Adidas scandal. We talked about the executive James Gatto, who was arrested for charges of bribery and fraud, basically steering money to players in order to get them to go to schools that had deals with Adidas. We should just mention here in passing -- I don't want to spend a lot of time on this -- this scandal is yet to be resolved. Only a couple of weeks ago, Louisiana's basketball coach, Will Wade, was suspended after some reports that he may be implicated in this whole ball of wax. It's amazing, because Louisiana is having a great year. They're in the tournament. It just goes to show that the competition for these school endorsements is intense for a reason. It leads to unethical behavior, in my opinion, for a reason -- because the ultimate impact on the bottom line of companies like Nike and Adidas, it's hard to measure. It's really easy to measure and throw out figures like $300 million that these three companies will spend annually. But the reverse impact, what Nike gets out of kids wearing its products after they see a marquee player on a basketball team, that kind of effect is hard to measure but contributes to their top-line growth, margins, and the rest.