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Gap’s controlling Fisher family made a good first headcount reduction by getting rid of Pressler back in January, but much more is needed.  This opened up rampant speculation that the company was dressing itself up for sale and the hiring of Goldman to “review strategic initiatives” didn’t hurt either.  Much has been written about whether private equity would step in and purchase Gap; probably the biggest reason nothing has happened is because the smart money knew the sticker price could fall quite a bit.   So far the smart money has been smiling, as the current stock price of $17.50 is at least 10% lower than the $20.00 range at the time the rumors peaked and Pressler was sacked.

It was almost bankable that Gap’s operating performance would continue to suffer, from a take-your-pick combo of market saturation, brand deterioration (especially at Old Navy and Gap-branded stores).  The company doesn’t need to fire for the sake of firing; it needs store closures and select pink-slipping.  It can take its own Draconian measures now, or it can suffer more later.  This won’t make the company a instant success, but it can look itself in the mirror and figure out that it isn’t exactly a winner right now.   Gap properties (data as of 2/3/07): Gap Brand Stores – 1338 (1199 US); Old Navy – 1008 (949 US); Banana Republic – 527 (495 US); Forth & Towne- 19. 

F&T has already been flushed down the toilet, but that was a newconcept and not even a drop in the bucket for what needs to come.Banana Republic is doing ok, with comps in the low single digits forthe past few months, and is positioned within favorable fashion anddemographic trends.  But Gap stores are still bad and Old Navy appealsonly to people who don’t know better; the most recent quarter’s compswere -8% and -9%, respectively.

The company already plans to close about 200 stores during the currentfiscal year, although some of that number is eaten up by the F&Tclosings and some Old Navy Outlet re-brandings.   The company is alsoplanning to open “about 230 stores” during the year, most of them…..OldNavy.  Why it is under-funding the one growing brand is beyond us andover-funding the garbage is baffling.

When the company was seeing explosive growth 7-8 years ago, they wereable to negotiate very favorable lease terms – rates that will go upsubstantially when those leases need to be renewed.  While we don’thave exact figures on the schedule for this, it’s not unreasonable tothink that 200-300 of these stores could just be scheduled to be closedinstead of being renewed in the next 12-24 months.  It isn’t animmediate fix, but it would help quantify things today.  It couldlikely even get out of some leases earlier in hot locations where itunderperforms that its landlords could lease at current rates.Management doesn’t seem to be looking to that as a strategy, as theystated on their last conference call that their hurdle rates haven’tchanged when reviewing leases.  The company has no real estate assetsof note that would make a sizeable difference, which takes away asource of potential luster for private equity shoppers, especially whenthe long-term operating margins of many of the stores are in doubt.

Even if the company pares down more opportunistically, this might notbe swift enough to satisfy shareholders.  But that is at least a start,and many (including Jim Cramer) think this one just needs to position itself to be a moreattractive buyout.  Realistically the company should attack on bothfronts and announce an immediate “review for closure” of domestic Gapstores and Old Navy stores, particularly Old Navy. Simultaneouslystating they will only keep top-performing stores when their leasescome up for renewal over the next 5-years would send a bottom-linewatching message. 

Paul Charron, former CEO of Liz Claiborne, has said that the badpublicity that would result from closing this many stores could hammershares and cloud management’s ability to send clear business results -an argument in favor of going private, where the demolition could takeplace without the image concerns.  The company can start selectively writing pinkslips and lease non-renewals now, or they can do it when they are in aworse spot later.

The important roles of Marketing VP and CEO are still vacant without anheir apparent, but announcing these closures and slashing some deadweight might make the task more manageable and attractive to outsidetalent.  We still don’t know if its organic tee-shirt initiative isgoing to work out yet, particularly at $16.50 retail and since theyaren’t in the food business.

It seems that the company could trim 5,000 to 10,000 via somenear-future closures and it could keep a similar amount “underreview.”  It counts more than 150,000 employees, but many of these arepart time workers that are students and young adults that don’t exactly keep the same job for years.  So it has a shotof cutting headcount without the negative social ramifications offorcing workers out on the street.

Written by Ryan Barnes, edited by Jon Ogg
March 28, 2007