E HH The Gap - Inside The Landmark West Deal

In our initiation coverage report (June 10), we ascribed a Neutral rating for Gap Inc (GPS) citing the legacy challenges and the strong rally in the retailer's stocks which is in line with most of the other retailers. The stock had dropped down to $10 levels from its one month high of about $14 before shooting upwards yesterday post the announcement of its milestone deal with Kanye West amidst an otherwise weak market. Is the deal so monumental as to race past all the challenges that the company is facing? What led to the euphoria for the stock to rise about 40% intraday and close about 18% higher?

The Gap-Yeezy Deal plans for the launch of a new clothing line called Yeezy Gap, which will be introduced in the first half of 2021. Yeezy’s design studio, under Kanye West's creative direction, plans to create “modern, elevated basics for men, women, and kids at accessible price points.” Under the terms, West would retain full ownership and creative control of the Yeezy brand while Gap Inc would manufacture and distribute the apparel internationally and pay West a fee based on sales, a similar plan to West's earlier collaboration with Adidas. The plan is looked at as highly lucrative for both sides as Gap has struggled with a host of financial problems stemming from a lack of creative designs, flagging consumer interest, and online competition as well as an overabundance of stores. The footwear collaboration of Adidas and Yeezy has been highly successful generating about $1.3bn in sales last year, of which West made ~11% of it. Gap is expecting sales of ~$1bn from Yeezy Gap after the five-year point in the 10-year arrangement, which can be further extended for 5 years. For the context, Gap Brands generated ~$4.6bn in sales last year.

But does that justify the meteoric rise for the stock price? Would this be able to solve the legacy issues faced by the brand and lead to more shoppers turning to their stores? The sneaker side of the Yeezy brands has been doing extremely well, valued at $3bn last year. But would the apparel side of the business change the fortunes of the Gap Brands? Gap added over $700 mn in market cap yesterday. With an easy back of the envelope calculation, assuming a $1bn in incremental sales during year 5, discounting it to the current year and applying a much higher EV/Sales of 1.0x (in context Gap Inc long term EV/Sales median is at 0.6x), the incremental effect is just ~$550 mn which would question the sustainability of the rally based on this news.

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William K. 1 week ago Member's comment

The fast rise on the first day can certainly be explained in part by the market being driven by emotions. Certainly that drive is obvious to many, and just because it is not rational does not mean it is not real. Probably there does exist a reason for some benefit from the partnership based on the instances referenced, so some optimism is reasonable. And some folks are over emotional.