Gap Analysts Question Planned Old Navy Spinoff After CEO Change

(Bloomberg) -- Gap Inc. shares sank pre-market Friday as Wall Street questioned whether the planned spinoff of Old Navy will proceed after the company announced that Chief Executive Officer Art Peck would be stepping down and issued disappointing preliminary third-quarter results.

“In our view, the timing [of Peck’s departure] is surprising in light of the pending separation of Old Navy (likely spearheaded by CEO Peck) and following the company’s recent analyst day in September which showcased the two new companies,” MKM Partner’s Roxanne Meyer wrote in a note.

In addition to Peck’s departure, Gap also issued weak preliminary third-quarter results and reduced its full-year adjusted earnings-per-share forecast. Comparable store sales in the quarter fell more than expected at all three brands, including Old Navy, leading analysts to question whether a spin off would actually create the shareholder value they were hoping for. The weak preliminary results, along with Peck’s departure, led Telsey Advisory Group to downgrade the shares.

Gap will hold a board meeting next week, at which the plan for Old Navy may be discussed. Analysts also expect more details on the third-quarter conference call later this month.

Gap’s Old Navy Meeting Did Little to Dispel Doubts About Spinoff

Gap shares fell as much as 9.7% ahead of the bell. Shares were already down 30% this year through Thursday’s close. Other mall-based retailers may also slip today, with analysts cautioning that Gap’s weak quarter performance and forecast don’t bode well for its peers.

Here’s more of what analysts had to say about Gap’s announcements:

Telsey Advisory, Dana Telsey

• Downgrades to market perform from outperform, and reduces price target to $19 from $24
• The primary thesis to Telsey’s outperform rating had been the belief that the planned spinoff of the Old Navy business was a “potential opportunity to unlock value”
• Thursday’s announcements regarding the ongoing weakness at Old Navy and the CEO transition process may “extend the timeline” of a potential spinoff, while weaker results at the Old Navy business “reduce the upside potential to the value of a stand-alone entity”

Jefferies, Randal Konik

• “With the CEO gone, that creates a vacuum of permanent leadership, and a number of questions like ‘does the spin still happen?’”
• The analyst believes market share loss “could be permanent” given that comparable sales results were again negative at all brands, underperforming many other retailers
• “Our sense is the buy-side wasn’t too enamored with Art, so him leaving could improve sentiment,” Konik wrote in a note
• Rates Gap buy given the low valuation, “but we need answers to these questions,” he wrote; price target $37

RBC Capital Markets, Kate Fitzsimons

• Fitzsimons believes the board may be “re-evaluating their options” given the CEO departure, she wrote
• Meanwhile, the updated outlook suggests EBIT margins down about 200 basis points in the third quarter and down 380-400 basis points in the fourth quarter
• The updated year earnings-per-share-forecast implies that fourth-quarter EPS will be down around 50% year-over-year vs the 25% drop in the third quarter; “with all divisions landing below the Street in 3Q, the 4Q update suggests no relief into holiday, particularly out of Old Navy”
• Gap’s expectation for a “tougher holiday” is bad news for the rest of RBC’s mall-based coverage
• Rates Gap shares sector perform, price target to $16 from $19

Here’s What Bloomberg Intelligence Says:

“Gap’s next CEO will need to find a better way to connect with younger shoppers through product, marketing and digital. The sudden appointment of interim CEO Robert J. Fisher to replace Art Peck likely comes from a failure to return the company to growth.”
--Poonam Goyal, click here for note

MKM Partners, Roxanne Meyer

• With Peck out of the picture, Meyer wonders if management will now reconsider the Old Navy spinoff
• A separation won’t create value for shareholders, given the disappointing 3Q and expected 4Q performance, and her assumption that weakness will carry into next year
• She believes the Old Navy separation plan, which was likely spearheaded by Peck, bought him more time, but the “3Q miss/revised 4Q guidance was likely the final straw”
• The analyst disagrees with the board’s plan to search for its “next great operator as CEO;” “in our opinion, simply put, in this late stage for GPS, an operator could be the final ax, unless the goal is to spin-off Athleta or shut the majority of stores”
• Rates neutral, price target $18

B. Riley FBR, Susan Anderson

• Anderson believes the spinoff of Old Navy “could be in question,” given the CEO change and continued lackluster perform across the board
• Rates neutral, price target $20

To contact the reporter on this story: Janet Freund in New York at jfreund11@bloomberg.net

To contact the editors responsible for this story: Catherine Larkin at clarkin4@bloomberg.net, Steven Fromm, Courtney Dentch

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