Will New Ownership Breathe Life into this Shoemaker?

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

On Jan. 17, shoemaker K-Swiss (NASDAQ: KSWS) finally caught a break, as South Korean apparel distributor E-Land World offered to buy the company.  Given K-Swiss’ significant net cash holdings and outsourced business model, the acquisition is a fairly low risk bet on E-Land’s ability to engineer a business turnaround at the shoemaker.

Founded by two brothers in 1966, K-Swiss was one of the first companies to introduce leather tennis footwear, and it built a loyal following to its traditional Classic shoe.  Unfortunately, the company's failure to pursue a customer base outside of its core tennis market led to stagnant sales growth over the past decade.  In addition, the greater popularity of contact sports, especially football, basketball, and baseball, have led to much greater success for K-Swiss’s global competitors, including Nike (NYSE: NKE) and Adidas (NASDAQOTH: ADDYY).

In its latest fiscal year, K-Swiss reported a 23.8% increase in revenues, but it also generated its fourth annual operating loss in a row.  While sales volumes and average prices were both positive, up 19.9% and 3.6%, respectively, its gross profit wasn’t large enough to support its global operations.  On the upside, K-Swiss’s sales benefited from its recent diversification into the performance training category, although the segment still only accounts for roughly 23% of total sales.

An uphill climb

For fiscal 2012, K-Swiss reported poor results, with a 16.8% decline in revenues and additional operating losses.  However, its operating margin improved slightly, as the company reduced its overhead and advertising expenses.  While domestic sales have dropped sharply this year, international sales are only down 3%, and the segment has turned a profit through the first nine months of the year. 

E-Land wants to purchase K-Swiss for $4.75 per share in cash, or $170 million.  The offer values K-Swiss at roughly 0.6 times FY2011 sales and 1.2 times book value.  E-Land may see a gem here, but it definitely has work to do.

The footwear giants

The sale of footwear requires significant marketing muscle, so investors need to stick with the diverse global brands.  At the top of the list is Nike, the powerhouse that has built a $24 billion footwear and apparel business out of a mission to create a consistently better product.  It also knows when to refocus its business, including sales of the Umbro and Cole Haan subsidiaries in 2011.

In fiscal 2013, Nike reported mixed results, with an 8.7% increase in revenues and a 4.6% decline in operating income.  While the company generated strong sales in North America, it suffered from weak sales in Europe and China.  Sales growth benefited from rising prices, up 9% for the period, as customers continue to show a strong desire to pay high prices for Nike’s products. 

Like its competitors, though, Nike’s operating efficiency has been hurt by rising marketing expenses and contract manufacturing costs.  While the company is valued at a premium level, it has been a long-term winner for investors.

Meanwhile, Adidas has fought the Nike juggernaut by creating a diverse portfolio of brands that include Reebok, TaylorMade, and Rockport.  It also has a large retail presence, with over 2,400 stores around the world. 

In fiscal 2012, Adidas has reported solid results, with increases in revenues and operating income of 14.2% and 19.1%, respectively, compared to the prior-year period.  Despite economic weakness in its European market, Adidas has been able to generate sales increases in each of its geographic segments.  With the company forecasting a double digit increase in operating income over the next year, Adidas is a relatively cheap way to invest in the global sports apparel business.

A third option

Investors might also want to consider the large distributors of footwear, which offer a diverse assortment of leading brands in men's, women's, and athletic categories.  One of the best-run companies in the retail footwear business is DSW (NYSE: DSW).  Since opening its first store in 1991, the company has built a network of 363 domestic stores, as well as 345 branded departments within other mass retailers. 

In FY2012, DSW has reported increases in revenues and operating income of 10.1% and 71.4%, respectively, versus the prior year period.  Sales growth benefited from a 6% increase in comparable sales and the company continued its domestic expansion, with 37 additional stores in 2012.  In addition, DSW’s overall operating efficiency has improved due to cost savings from its larger base of stores.  The future also looks bright, as the company expects to open 15 to 20 stores annually over the next few years.

The Bottom Line

Due to its inability to market and sell shoes at a profitable margin, K-Swiss is not a good investment, whether the pending deal goes through or not.  While Nike and adidas will likely continue to deliver rising profits, distributors like DSW are a better bet since they provide diversification across the leading brands and aren't tied to the fortunes of one shoemaker.  With only roughly 700 locations across the U.S., this retailer has room to run.

rghanley owns shares of DSW. The Motley Fool recommends Nike. The Motley Fool owns shares of Nike. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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