Why Are Companies Spinning Off Successful Brands?

Two big retailers are spinning off more successful brands from their struggling parents. That's good for investors because it gives them a better picture of how each company is doing.

In this segment from Industry Focus: Consumer Goods, Fool.com contributor Daniel Kline joins host Dylan Lewis to talk about J. Crew spinning off its Madewell brand. That move will put the company's hip jeans brand on its own and leave the parent as a stand-alone business as well.

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This video was recorded on Oct. 8, 2019.

Dylan Lewis: We're going to be spending a lot of time talking about J.Crew taking its denim brand Madewell public. We're also going to be talking about another retail spin-out, that's Old Navy being spun out of parent Gap.

But before we get into the company-specific discussion, let's talk a little bit about this mini trend that we're noticing with these spin-outs.

Dan Kline: Really, what's happening here is, you have two companies owned under the same umbrella. One is struggling and one is doing well. And if that was happening in your real life, let's say you made really good money and your spouse didn't, it's OK to mix those finances because nobody needs a true picture of what's going on. But in the case of two retail brands, what you don't want to do is have one successful brand propping up the losses for a struggling brand. Obviously, you can report and show what's happening. But if you can't pay your rent at the struggling brand and there's money at the successful one, obviously, if you're the same company, you have to use that money for certain things.

So what's happening is these companies are breaking apart, and investors are getting a share of the sick brand and the healthy brand. And it's putting you in a position where you really understand what's going on, you're probably losing a little bit of back-office synergy in terms of, you need a few more accountants, you need a payroll person, a couple of other assets; but you can really look at the health of each one. And for the one that's not doing as well, you can make some of the tougher choices. You might have more flexibility to do so because, for example, your landlords can't say, "Hey, you have plenty of money. I'm going to charge you more. I don't care if this brand isn't doing that well." So, it's good for investors, and good for anyone that deals with these brands.

Lewis: Yeah. I like to think of it as a chance for the true value of the successful brand to be realized. So often, those very strong results are masked by the parent company. Very often with these press releases, when you see these types of announcements, they'll say, "We want the market to appreciate the full value of what's going on over here."

Kline: Yeah. You don't want your expansion to be constrained by problems of sister companies. If you look at the two companies we're going to talk about, both have very clear, one is struggling, one is growing very fast. You want to be in a position to put all your profits into growth, or a lot of your profits into growth, not into paying off bills for your struggling sister. This is also true in families, where you don't want to have to do that, either.

Lewis: Spoken like someone who has had some exposure to a family business, Dan.

Kline: [laughs] No comment.

Lewis: Why don't we kick things off by talking about the J.Crew spin-off of Madewell? For the uninitiated, Madewell is J.Crew's denim brand. I think that they are what you think of as a very hip, millennial-focused brand in modern retail. They sell T-shirts, hoodies, jeans, tops. If you go by high fashion standards, a lot of their stuff is not particularly expensive. But I think it's far more expensive than what you'd expect to see at a Target or a Walmart or something like that.

Kline: It's a high price point for jeans. You might pay $40 for jeans at Old Navy, you might pay $80 for a nice pair of Levi's, maybe $100 for a pair of Guess jeans. I don't know, I haven't bought them in a long time. This seems like a somewhat high price point that is being pushed up a little bit by the company being trendy and a brand people want to have.

Lewis: Yeah, the numbers that I've seen looking around online, most of their jeans tend to retail between about $100 and $150. A lot of their women's tops come in around $70 or $80. Definitely some premium pricing there. You see that bear out in the financials and some of the margins that they're able to get, at least on the gross margin side. This is a successful brand. It's one that has a lot of mindshare with younger consumers right now currently, in the Chinos Holdings category for J.Crew -- which is a little confusing for folks.

Kline: Yes. Chinos, for those of you who are a little bit younger, is slang for jeans back from like the 70s. When it gets spun off, it's going to be called Madewell, which makes a lot more sense. What's interesting is, everything you can say about Madewell now is how I felt about J.Crew when I was in college. It shows you a little bit about how trendy these things go. You can be a very hot, trendy brand -- which J.Crew was, for a long time -- and when you lose your way, it's very difficult to get back.

Lewis: Yeah. I think that this is a situation where you see exactly why all these retail companies invest in these sub-brands. It is very common for what seemed like the stalwart retail companies to have all of these sub-brands associated because you want to have a little bit of optionality with wherever consumer tastes might go.

Kline: Yeah, it's a major hedge. One of the things you see here is, these are both high price points. They're not getting any hedge against price. But they are getting a little bit of a hedge against trends. With jeans -- we'll bring this up over and over again -- there is also the possibility of becoming a stalwart brand, meaning that this might be red-hot right now -- and at various points, Levi's have been red-hot, Guess has been red-hot, but they don't necessarily fall to the depths that may be J.Crew has fallen to, or some of these other brands have. It is possible that Madewell becomes a standard for jeans. Again, the demand won't be as huge and won't grow as fast, but we've bought Levi's for, what, 40, 50 years? It's a really long time. And it is possible that this happens here -- though perhaps not all that likely.