Gap Cancels Plan to Spin Old Navy
We view the termination of the spin as favorable to shareholders and think shares of the no-moat firm are undervalued.
Citing complexity and cost, no-moat Gap (GPS) reversed course and announced that it was no longer planning to spin Old Navy. We had anticipated this decision for months, as Old Navy’s results deteriorated in 2019 and Art Peck, the architect of the spin, was fired as CEO in November. We had previously argued that the separation of Old Navy (which we believe generates about 80% of Gap’s operating income) from the rest of Gap provided little strategic sense and would destroy value through expected direct costs, capital expenditures, and gross dissynergies of as much as $1 billion. Thus, we view the termination of the spin as favorable to shareholders.
Gap also announced that its holiday sales were not as bad as expected (although still not good), leading the firm to raise its 2019 EPS guidance to “moderately above” its previous range of $1.70-$1.75. The firm now expects 2019 comparable and net sales to be “at the higher end” of its previous outlook of down mid-single digits and low-single digits, respectively. Gap provided few details apart from better-than-anticipated results at Old Navy. As we had forecast 2019 EPS of $1.71 and total company and comparable and sales declines of 4% and 2.6%, respectively, we now expect that Gap will modestly exceed our prior fourth-quarter EPS forecast of $0.36 when it reports earnings on Feb. 27.
The cancelation of the Old Navy spin does not change our view that Gap lacks a sustainable competitive advantage. However, we think the decision will allow Gap’s management to refocus on the stronger parts of its business, Old Navy and Athleta. We do not expect that the latest news, which caused shares to move up about 4% in post-market trading, will have any significant impact on our fair value estimate of $25.50 per share. We view shares as undervalued.
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