Sports Retail Market Sees a Changing Landscape…

Well, the size and frequency of the deals certainly slowed in 2007 and will undoubtedly see more challenges in 2008 as the sub-prime mortgage market continues to impact the broader credit markets.  Throw in a slowing job market in the U.S., oil over $100 a barrel, a weak U.S. Dollar and the largest first week dive on Wall Street in eight years, and there are few reasons to raise a glass of cheer as we move into 2008.

For 2007, the market saw a bit of a shift from the recent trend to consolidation of like or similar businesses to a new, and most likely, enduring, trend to the blurring of the lines between retail and vendor.

Consolidation still continued through 2007, albeit at a slower pace, but the combination of fewer retailers and exclusive brands made the prospect of new brands or concepts getting a foothold even more remote. The market also started to see more divestures of acquired businesses by the consolidators that in previous years had focused on collecting new brands like baseball cards.  Instead, the realities of the limits of some business synergies and the difficulties of managing multiple brand messages and divergent categories caused a number of companies to reduce their focus or get out of the business altogether.

The other major issue for 2007 centered around the collapse of at least one major business driver for many in the sporting goods industry over the last two years and the seeming lack of any must-have items coming out of the sporting goods business for the holidays. Even the lifestyle fashion athletic trend in footwear, the hottest trend aside from Heelys and Crocs the last few years, started to show some challenges at year-end.  At the end of it all, there was little to excite the consumer into the mall retailers, a trend that helped create one of the biggest stories of the year – the non-merger of two major mall entities.  The lack of continued excitement resulted in just one IPO for the year and the sporting goods public company market failed to keep pace with the growth elsewhere.  As if to signal a tougher year ahead, the sporting goods industry last week took a bigger beating than the broader S&P 500 index.

 

Lines Between Retail and Vendor Start to Blur…

The sporting goods world tilted slightly more vertical in 2007. In a game of role reversal, stores moved into the brand building business, while several brands moved more aggressively into store operations.  Dick's Sporting Goods reached exclusive deals for a number of private brands, including Nike ACG, Reebok's RBK brand, adidas for baseball hardgoods, Slazenger, Umbro and Field & Stream.  Private label/brands have helped DKS meet and exceed its plan for the exclusive business to represent 15% and has now decided to stop reporting the size of the private label/brands business in its quarterly and annual reports filed with the SEC.  Not to be completely outdone, The Sports Authority reached an agreement with Hilco TAG, LLC to became the exclusive U.S. retail licensee for the Tommy Armour, Ram, TearDrop, and Zebra golf brands and picked up an exclusive deal for the Sims brand in snowboard from Collective Licensing International.

After acquiring Collective Licensing and Stride Rite Corporation, Collective Brands, Inc. now has ten brands under its umbrella in addition to the  Payless ShoeSource chain.  At the same time, a few of the industry's legendary sports brands went down market in exclusive deals with retailers: Fila Sport for Kohl's, Converse One Star for Target, and Ocean Pacific for Wal-Mart.

For stores, gaining an established brand on an exclusive basis is much easier than building a private label brand from scratch.  Much like private label, private brands provide better gross margins and greater differentiation, but provide the consumer with a more recognizable brand that can still be sold at a premium.  Rusty Saunders, a veteran industry consultant, says consumers are looking for legitimate brands from retailers.  “I think the consumer is too smart now,” augurs Saunders.  “A private label doesn’t do it anymore.”

On the other side, both Nike, Inc. and adidas Group announced plans to aggressively grow their store base. NKE predicted its direct-to-retail business would increase to 15% of sales within five years from 12% today.  adidas suggested that their business from “controlled space” retail (owned-retail stores, shop-in-shop and franchises) would exceed 30% of sales by 2010.  Although retailers have long dealt with store expansion from vendors such as Sketchers and Vans, it came as a shock to some merchants coming from these two core resources.

Learning from its Vans acquisition, VF Corp. also announced plans to open stores for brands such as The North Face and Reef.  VFC also acquired lucy, its first direct-to-consumer acquisition, in an effort to establish a vertical foothold in the growing women’s sport lifestyle market.  Even Under Armour opened its first store in a lead up to the holidays.

For brands, opening stores helps establish their own image in the marketplace, while also providing a location to showcase their whole collection and test product.  If done right, going direct can also provide better margins than selling through wholesale channels.

One industry analyst predicted that, at the minimum, 25% of the sales for brands will come from their own stores in the not-to-distant future. At the same time, proprietary brands will represent the same percentage for retailers in the future.  “Anyone who does not get on this bus will be left behind forever,” he said.

 
But a top exec at a sporting goods chain said both retailers and vendors are going against their core competencies in moving into each other's businesses. Vendors have to understand the grind of operating a store profitability. Stores face the double task of making their brands as well as their store nameplate known to the public.  “You're suddenly in a business you don't know too much about,” the executive said. “The missteps could be great.”

Nike insisted that its plan to open 100 stores over the next three years – half in the U.S. – shouldn't be looked at as a competitive threat to retailers.

New Retail Partnerships to Ensure Brand Penetration…

Instead, Nike said the move would only help it partner with its retail customers to find the best ways to serve today's consumer in the spirit of collaboration. “Our primary job is to be a better partner. This is not about Nike versus the retailers,” said Gary DeStefano, president of the Nike Brand. “This is a partnership. We believe this could be a growth strategy for our industry.”

Nike also announced plans to work more closely with its top retail partners to improve the way they differentiate their stores and promote their products. Part of that strategy evolved into a partnership with Foot Locker to open 50 stores in the next three years that sell only Nike, Jordan and Converse basketball products.

The stores, called House of Hoops by Foot Locker, will primarily be converted from existing Foot Locker stores and are touted as a “hub for all things basketball.” The first store opened in Harlem in late November.
For its part, Dick's Sporting Goods chairman and CEO Ed Stack pointed out after Q3 that the floor space the chain dedicates to its private brands is coming at the expense of the second-tier brands – not the top brands.

“We have made a very concentrated effort not to impede on the market share of our main partners,” says Stack. “So we are not impeding on the market share of Nike. We are not impeding on the market share of    Titleist or TaylorMade or The North Face. We are really trying to grow those businesses, and we have identified a number of brands that we want to grow their business with, and we make sure that from a private-label standpoint we do not impede upon those brands.”

 

Joe Amoruso, VP of sales at Jack Schwartz Shoes, the owner of Lugz and Sneaux footwear, believes gaining greater differentiation through exclusive brands is becoming more critical for stores, because business has become tougher.

 

“It seems you have a smaller amount of consumers shopping so you want to try to capture them by having something different than the next guy does,” says Amoruso. “When the business slows down like it has, it's all basic and commodity oriented product so everybody has the same thing. It used to be if one store had the red stripe on the shoe and the other one down the mall had a black stripe, that would work.  Now they want an exclusive they can build on.”

Lack of Must-Haves Leads to Less-than-Exciting Holiday Season…

Indeed, while sales slowed across retail as a consumer faced rising gas prices and a housing crisis, a lack of strong trends also particularly hurt demand in the sporting goods space.

One big casualty for the industry in 2007 was Heelys, which failed to maintain its meteoric growth seen in 2006. Ken Meehan, vice president and GMM for Dunham's Sports, said that Heelys “rose like a rocket and then fell like a rocket.”  Stores were forced to heavily discount the product in the back half of 2007 to liquidate heavy inventories planned for increasing sales that never came.  The brand moved into the family footwear channel in November and the full line sporting goods guys were selling the wheeled footwear product for half what they were getting in the prior year.

Crocs, the other hot ticket for 2006, was a bit more fortunate in 2007, but the brand found it difficult to maintain its growth curve from previous years.  Unlike Heelys, the Crocs brand was able to diversify its portfolio of product a bit and found itself with at least one strong product going in the holidays. The Mammoth  became a hot commodity as temperatures fell and sandals became tougher to retail outside of college towns.

An even more disturbing trend is the ongoing weakness in white athletic footwear and the overall urban category.  Some feel that while a lack of key fashion ideas is contributing to the weakness, some retail models just aren't connecting with today's customer anymore.  The year ended with some retailers signaling the beginning of the end of the low-profile fashion athletic trend. 

“Mall based athletic specialists are too athletic for the fashion customer and not athletic enough for the true athlete,” explained one market analyst.  “They need to lose the striped shirts and basketball hoops and face the fact that the world has changed.” 

He notes that a major part of the problem across the channel is that non-sport specific footwear now leads the industry, and new business models or new styles are desperately needed to adjust to this shift. Also weighing down the channel is that basketball is showing little life, and he suspects efforts by Under Armour and Nike around crosstraining and fitness will only be moderately successful.

“If 15% of the customer actually uses athletic shoes for the intended purpose, it's not an $18 billion industry; it's a $2.5 billion marginal game,” he said.

Many other retail execs also feel core offerings of sneakers and licensed apparel are struggling to compete against the pizzazz behind gadgets such as iPods, cell phones and video game consoles.

“They'd rather have a Wii than anything we're selling,” said Dunham’s Meehan.

“Jordan and Nike Air Force One footwear have been good. So if you have the right product, it's going to sell,” adds Mickey Newsome, chairman and CEO of Hibbett Sporting Goods. “But a lot of youngsters are into technology now. That's got to run its course.”

M&A Continues, But Slows…

M&A activity was noticeably less prevalent in 2007 as the market settled into consolidating – or divesting – the brands already acquired, and that should slow even more in 2008 as private equity money dries up due to pressures from the sub-prime mortgage mess.

One drawback to the recent market consolidation is that vendors as well as retailers in the middle seem to be getting squeezed out.  “It seems more and more like it's beginning to be an industry of the very large and the very small,” said Hibbett’s Newsome.

Indeed, one surprise for some is that smaller companies seem to be carving niches in the market against the giants. Shawn Neville, president of Keds, sees an increasing number of niche brands – whether specializing in categories such as performance running or lifestyle athletic footwear or a number of apparel categories – finding a spot in the marketplace, because they're more agile and innovative. 

“Historically, you had the power athletic brands that would cross over many categories and would dominate all segments and there would be few niche players that had any relevance,” said Neville. “But now you see niche vendors across categories entering the market. The barriers to entry seem to have gone down.”

For a vendor, the “scary trend” of continued consolidation on the retail side is that vendors have fewer and fewer retailers to sell to at day’s end, according to Jim Hoff, VP of sales at Asics America. 

“It makes your wins bigger and your losses bigger, because you have fewer chances to win and lose,” said Hoff.  “It's like facing the same pitcher in baseball. If you strike out 80% of time against him, what are your chances?”

Outside of the many mergers driven by moves around vertical integration, there were a host of traditional mergers around finding new platforms for growth and gaining economies of scale. With an abundance of private equity money seeking deals, valuation remained high and some are likely to pay the price for over-valuation in 2008.

Nike sought a coup de grâce on adidas in the fight that had raged between the two over who would be the dominant force in the soccer kit market by reaching an agreement to acquire Umbro. 

Before it could complete the deal, however, Mike Ashley and his Sports Direct chain made things interesting by purchasing a 29.9% stake in Umbro, which i off a little more than he could chew as the sporting goods industry’s largest company eventually closed the deal with Nike acquiring 67% of Sports Direct’s stake in Umbro, representing 19.9% of the company’s stock for £56.1 million ($115 mm).

Sports Direct International also gave Nike an irrevocable undertaking to vote its remaining 10% stake in Umbro in favor of Nike’s acquisition of the soccer company, even if a competing offer for Umbro is announced.

Puma was effectively acquired by French luxury goods company Pinault-Printemps-Redoute, parent to Gucci Group and other brands.  The firm first acquired the 27.1% ownership stake held by Mayfair GmbH, an asset management company that manages the investments of Günter and Daniela Herz and their families. PPR eventually came to hold a total of 62.1% of all PUMA votes after extending an offer to the remaining shareholders.

As Nike looked on-field with its Umbro acquisition, adidas looked off to the fashion world of retro-cool, adding Mitchel & Ness Nostalgia Company to its Sports Licensed Division, which currently houses both the adidas and Reebok licensed apparel businesses.

A unique business model, Collective Brands, Inc., was formed after Payless Corporation in August acquired The Stride Rite Corp. and its iconic brands Stride Rite, Keds, Sperry Top-Sider, Saucony and Tommy Hilfiger Footwear. The two companies were then merged into the new entity that also includes Collective Licensing International, which Payless acquired earlier this year and oprates the Airwalk, Vision Street Wear and Sims footwear brands. The partnership has already helped build private label sales at Payless to over 40%, but management is certainly looking at other channels to feed growth for its roster of ten brands.

New Balance used 2007 to continue its expansion into both the apparel and hockey markets. In a push to jumpstart its apparel business, New Balance acquired Vital Apparel Group. The acquisition was the first by New Balance since Rob DeMartini became CEO in April and was charged with making the $1.55 billion company a $3 billion entity by 2012.  Also in 2007, New Balance’s Warrior Sports division increased its hockey presence by acquiring Made In America Sports, a manufacturer of hockey gloves, sports bags, pant covers and accessories.

After spending the majority of 2006 focusing on integration, VF Corp. got back on the warhorse in 2007. The company shook things up by acquiring Eagle Creek, which was announced the last week of 2006, followed by Majestic Athletic. The Majestic deal gave VF its first   entrée into on-field athletic apparel through that company’s MLB deal. In addition to adding Majestic to its Imagewear coalition, VF created a new coalition, VF Contemporary Brands, through the acquisitions of Lucy Activewear and Seven For All Mankind. The Lucy acquisition brought VF into the vertically-integrated business model in a bigger way, while the Seven for All Mankind deal brought Mike Egeck, formerly the president of the company’s Outdoor Coalition America back in-house. Finally, VF Corp. sold off its intimate apparel business to Fruit of the Loom, a sign that the outdoor and activewear businesses will likely be a focus of the company for at least the near future.

Rethinking its strategy around conquering mass retail, Nike moved to divest its Starter brand sold at Wal-Mart and hinted at scrapping its Tailwind project sold through Payless.  Instead, it brought a stronger name to a more upscale discounter with its move to license the Converse One Star footwear and apparel collection exclusively to Target stores beginning in February 2008. Nike agreed to sell Starter to Iconix Brand Group for $60 million in cash. It had acquired the broader Starter business, which included the Starter, Team Starter and Asphalt brand names, as well as a master license of the Shaq and Dunkman brands, for $43 million in 2004.  Nike also announced plans to sell its Nike Bauer Hockey business, which did about $160 million in revenues in 2006. While the hockey business was doing well, it did “not align with the company’s long-term growth priorities.”

While Some Consolidators Start to Divest…

At the tail-end of the year, Global Brand Marketing, Inc. (GBMI) was acquired for a mere $6 million by Titan Global Holdings, a holding company with interests in telecommunications and the electronics/homeland security business. The footwear company – which owns Dry-shoD, No Mass, Mehandi and Funflopps brands and also licenses Nautica, Sean John and Seven For All Mankind labels for footwear – had fallen into disarray after Diesel, its primary licensee, announced plans in October to take the line in-house, ending a 10-year relationship with GBMI.  GBMI was also reportedly hurt by its efforts to resurrect Pony, which it sold in 2006.  GBMI founder Killick Datta joined Titan's management.

One of the surprise acquisitions of the year came on the hardgoods side when Jarden Corp. acquired K2 Inc. for approximately $1.2 billion. Prior to the acquisition, Jarden owned the Coleman brand of outdoor equipment, which created good synergies with K2’s outdoor and snow sports brands. However, a major question mark in the deal surrounded what JAH would eventually do with K2’s team sports business, which includes the Rawlings, Worth and Miken brands. Rumors on the floor at several of the team sports buying group shows held JAH creating a separate Team Sports Solutions group to mirror its Outdoor Solutions platform, where Coleman and the overall K2 business are currently held. However, at the end of the calendar year, those rumors had yet to come to life.

Nearly as surprising in the hardgoods space were old enemies becoming apparent friends as the Luxottica Group acquired Oakley, Inc. for roughly $2.1 billion.  LUX management was quick to point out that this was a deal to better both companies, creating one uber-behemoth out of two already strong entities. Without the fighting between the two over distribution and retail space of one of the categories largest brands in Luxottica’s large retail presence, the combined entity should see better margins and increased sales.

Finally, in the “not at all surprising” category, was Quiksilver’s divestiture of the Cleveland Golf business. SRI Sports Limited, the parent company of Srixon, acquired Cleveland for $132.5 million, with hopes of increasing the Japanese company’s presence in the U.S. golf market. Quik, meanwhile, will dial back its hardgoods efforts to just the Rossignol brand.

On the very last day of the year, Nautilus, Inc. conceded defeat in its hostile takeover battle with Sherborne Investors LP. After winning a special proxy vote, the New York investment firm consequently replaced four of seven board members. Sherborne partner Edward Bramson was elected chairman, replacing Robert Falcone, who stayed on as president and CEO. Sherborne's proposed turnaround plan revolves around returning Nautilus to its roots in direct marketing. Falcone, who became CEO in August, has made several significant moves in his short tenure, including laying off 9% of the company's work force and looking for a buyer for the Pearl Izumi apparel business.

And Some Deals Just Couldn’t Get Done…

To close the year, Genesco, Inc. won the first battle of what many believe will be a long, drawn out war in its legal fight with The Finish Line, Inc. to complete the merger first announced in June of last year.  The judge in the Chancery Court in Nashville, the venue where Genesco filed its suit to force The Finish Line and financial backer UBS to complete their $1.5 billion buy-out of Genesco, issued a ruling that The Finish Line, Inc. must complete the merger deal.

Chancellor Ellen Hobbs Lyle dismissed Finish Line's claims that Genesco executives withheld key financial information that could have forewarned FINL and UBS of impending sales and earnings issues after the deal closed. Her ruling effectively holds that GCO executives did not commit fraud during merger negotiations.  Lyle said The Finish Line and Swiss investment bank UBS AG were sophisticated enough to know what they were getting into with the $54.50-per-share purchase.  The deal was conducted by “teams of lawyers, advisers and handlers being paid enormous sums to orchestrate the procedure for obtaining information” she wrote in her ruling.

“This milieu is UBS' home territory,” she said.  

The Finish Line, Inc. said it was disappointed with the ruling issued by the Court, and issued a release saying it was studying the Court's decision. FINL said it was considering its options, including the possibility of filing an appeal.

During a quarterly conference call with analysts, Alan Cohen, chairman and CEO of The Finish Line, Inc., suggested that they are starting to see a change in the attitude of the consumer in the mall that may favor the Finish Line format.  That consumer shift may reflect a move back to performance athletic footwear and away from the strength of the low-profile business that has haunted the mall specialty retailers for the last year or two, depending on region.  If that assessment is correct, then there may be one other reason why the jewel in the Genesco crown, Journeys, may not be as attractive as it once was.

When the Genesco deal was first announced, FINL looked at the acquisition as an opportunity to diversify its footprint and broaden its appeal in the mall.  Many analysts saw the move as an avenue to tap into the stronger consumer trends that favor retailers capable of capitalizing on the trend to lifestyle fashion athletic footwear, including the sharp gains seen in low-profile silhouettes, as well as the trends to Crocs, sandals, and Heelys.  Journeys has been the focal point in the mall for all of those trends.

This decision is just round one of this fight.  The litigation concerning the commitment made by UBS Securities LLC and UBS Loan Finance LLC to finance the Genesco transaction is still pending in the U.S. District Court for the Southern District of New York.  The Finish Line’s take on the Nashville ruling is that the Court “expressly reserved for determination by the New York Court whether the merged entity would be insolvent. If the New York Court so holds, the merger will be halted.”  UBS also issued a statement , saying it disagreed with the court and believes “there are material issues in our client's and UBS' favor in this matter.”  The New York case has yet to go to court, but Lyle disagreed that the combined company would be doomed.

“The merger has a reasonable chance of succeeding,” she said.

She has directed The Finish Line to “use its reasonable best efforts” to find the money to buy Genesco and close on the merger.  Now the market awaits the New York decision.

While Other Retailers Expanded Their Reach…

Aside from the FINL/GCO fiasco, the retail M&A landscape was dotted with opportunity buys, PE money and a desire for quicker expansion. Of the latter, Dick’s Sporting Goods definitely was the torchbearer, first closing on its acquisition of Golf Galaxy early in the year, then announcing its first foray into California through Chick’s Sporting Goods late in 2007. Dick’s Sporting Goods has suggested recently that they see an opportunity for 90 stores in the state of California and the Chick’s deal gives them a solid foothold of 14 stores in the SoCal market from which to grow.

While DKS looked westward, The Walking Company headed south to Florida, acquiring Natural Comfort Footwear, a chain of eight retail stores.

Private equity firms definitely made the biggest splash at retail in 2006, excluding Dick’s moves, acquiring several independent retail chains. The biggest amongst the PE acquisitions was