Why Gap’s Decision To Scrap The Proposed Old Navy Separation Is A Good Move

Gap Inc. (NYSE: GPS) is no longer pursuing the separation of its largest brand, Old Navy. The company has called off its proposed spin-off, and Gap will continue to operate as a single entity. The management indicated that the cost and complexity of splitting into two companies combined with softer business performance limited the company’s ability to derive sufficient value from the separation. In other words, the cost of the separation was likely to outweigh the benefits.

We believe that the primary reason behind Gap’s decision has been the company’s poor performance since the announcement of the spin-off. Soft quarterly results and the burden on the organization to deliver adequate returns to shareholders understandably forced the board to rethink the spin-off. Trefis analyzes the reasons behind Gap’s decision to reverse the Old Navy spinoff in an interactive dashboard and concludes that poor performance over recent quarters is the primary reason for the move.

How Has Gap Performed Since Announcing The Separation In Early 2019?

#1 Gap’s Revenue Has Been On A Decline Since The Proposed Spin-off

• Gap’s performance over the first three quarters of 2019 has been slightly soft, with the company reporting a decline in revenues each quarter.
• The company’s iconic brand, Gap Global, has been hit the worst.
• The brand’s revenue declined by more than 11% in YTD 2019 – losing $415 million in total revenue.

#2 Comparable Sales Have Slumped Due To Gap Global’s Poor Showing

• The poor performance of the Gap global brand has been one of the primary reasons for Gap canceling the separation.
• Gap global’s year-to-date comparable sales declined by 8%, resulting in a 4% decline for the key metric at the consolidated company level.
• Additionally, Old Navy’s comparable sales are also on a declining trend, with the brand’s comparable sales falling by 3% in year-to-date 2019.

#3 Gap’s Gross Margin Is Also Shrinking

• Gap’s gross profit has shrunk steadily, with the gross profit margin shrinking (y-o-y) in each of the last three quarters.
• Gap’s year-to-date gross profit has declined by 4.4% primarily driven by higher promotional activity at Old Navy Global as well as higher inventory shortage costs at all global brands.
• Further, lower revenues have also aided in the decline in gross profits, resulting in a 100 basis point erosion of the gross margin in YTD 2019.

#4 Finally, Gap’s Declining Profits Were Hurt Further By Separation-related Costs

• Gap’s year-to-date operating profit has shrunk by more than 17%.
• A key factor behind the decline besides falling revenues is separation-related costs incurred for Old Navy spin-off as well as higher expenses related to specialty fleet restructuring costs.
• Separation-related costs were weighing on the profits of the company at a time where gross profits were already trending lower –  resulting in the management shelving its plans for the separation.

To sum things up, Gap’s decision to cancel the separation looks like a smart move by the company. Given Gap Global’s soft showing in the extremely competitive apparel industry, Gap was not in a position to run two separate companies. Moreover, the expenses related to the separation would have outweighed the potential value unlocked from the separation – especially given the soft outlook for global economic growth. Additionally, given Gap Global’s poor showing, the separate entity would have failed to achieve the desired revenue growth needed to justify it being a separate entity.

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