Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.
It will save money by not going ahead, but has now added to the list of problems it needs to fix.
*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.
Motley Fool Returns
Market-beating stocks from our flagship service.
Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 2025-08-29 11:36:42.916291.
Discounted offers are only available to new members. Stock Advisor list price is $199 per year.
Calculated by Time-Weighted Return since 2002. Volatility profiles based on trailing-three-year calculations of the standard deviation of service investment returns.
Gap (GPS 0.03%) was caught between the proverbial rock and a hard place. Having agreed to spinoff the Old Navy chain to help it raise cash to pay down its heavy debt load, the jeans and khaki retailer was forced to call off the transaction as the discount store's business spiraled downward.
If Gap had stayed the course, the spinoff would likely have been a failure as stumbling businesses don't excite investors, and it wouldn't have raised enough money to pay the underwriters and its debt. But canceling it means it still has its debt load, and it's stuck with an ailing retailer it must now rehabilitate.
Image source: Gap.
There were no good options available, but the one Gap chose is probably the best. However, because the retailer itself is not in the best of shape and still has many problems to confront, investors should stay clear of its stock.
The spinoff of Old Navy made a lot of sense when Gap first proposed it. The discount retailer was the workhorse of Gap's family of stores, reliably posting higher sales quarter after quarter while Gap's namesake brand and the Banana Republic brand routinely saw comparable store sales spiral downward.
But soon after the spinoff announcement was made, Old Navy's business, which was already starting to weaken, quickly turned negative too. Now all three businesses are regularly reporting negative comps.
Data source: Gap SEC filings. Chart by author.
Although Gap maintained it was committed to the separation, the third quarter earnings report saw it oust its CEO, and from then on it seemed only a matter of time.
Art Peck had led Gap for five years, but over that time the retailer's stock had lost over half its value. While he had turned Old Navy around by transforming it into a fast fashion retailer that was able to quickly swap out styles as consumer whims changed, he could not engineer a similar reinvention with the other two brands, and subsequently abandoned the quest.
Yet the separation of Old Navy from Gap was also an idea he backed, and with Peck no longer in the captain's seat the plan was somewhat leaderless.
Add in the chain's declining fortunes and it was almost a foregone conclusion the idea would be scrapped. Gap, however, now has more problems heaped on it that make it questionable how long it can survive.
Gap reported $1.25 billion in long-term debt in the third quarter, and a successful split would have helped decrease that considerably, even though technically it was the company being spun off (Old Navy was the remaining business and it would have changed the corporate name).
J. Crew, which is similarly indebted, is planning to IPO its Madewell denim chain to help it pay down $1.7 billion worth of debt and keep it from going bankrupt. But unlike Old Navy, the Madewell business continues to post strong results, though it will be going public in an increasingly competitive jeans market.
Gap doesn't have the luxury of a strong business, and with an estimated cost of $700 million to $800 million to finance the spinoff, it needed a healthy Old Navy to attract sufficient investors to make it work. The whole fast fashion wave may have run its course as well, and worse, Gap is in turmoil with no executive at the helm. It also doesn't have a clear turnaround plan in place.
Giving it some breathing space, however, was a better than expected holiday season, even at Old Navy. In the statement saying Gap was pulling the spinoff, it raised its full-year guidance: "As a result of better than anticipated promotional levels over the holiday period, particularly at Old Navy, the company now expects its adjusted fiscal year 2019 earnings per share to be moderately above its previous guidance of $1.70-$1.75."
Even so, comps are still expected to be negative, despite Gap saying they will be at the higher end of its prior guidance which called for mid- to low-single-digit declines. This is not a healthy business.
Although the markets buoyed Gap's stock on the news, all the problems the retailer had before remain, and it is now stuck with the Old Navy brand too. Because their businesses are so similar, albeit one a discount chain, it serves to cannibalize sales at the other. That's still going to be the case now, and investors would do well to steer a wide berth around it.