• Revenues for NIKE, Inc. increased 5 percent to $8.4 billion, up 7 percent on a currency-neutral basis.

• Revenues for the NIKE Brand were $7.9 billion, up 7 percent on a currency-neutral basis, driven by double-digit growth in Western Europe, Greater China and the Emerging Markets as well as the Sportswear and Jordan Brand categories.

 

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Lebron James: Lifetime Deal with Nike

With new competition from rivals like Adidas and Puma, these endorsement deals continue to get larger and riskier for companies like Nike. These are a risk to all companies in the space and will hurt growth, margins, and earnings.

This precedent increases the likelihood of other competitors offering longer-term deals or lifetime deals perhaps as loss leaders that will significantly hurt the industry.

I see many coming instances of the “winner’s curse” in future endorsement deals.

The winner’s curse is a tendency for the winning bid in an auction to exceed the intrinsic value of the item purchased. Because of incomplete information, emotions or any other number of factors regarding the item being auctioned, bidders can have a difficult time determining the item’s intrinsic value. (via Investopia)

This lifetime contract sought to prevent a bidding war but it still presents significant risk for Nike. In addition, a huge drop in TV ratings for the NBA presents another level of risk here.

 

“We can confirm that we have agreed to a lifetime relationship with LeBron that provides significant value to our business, brand and shareholders,”

Nike said in a statement.

“We have already built a strong LeBron business over the past 12 years, and we see the potential for this to continue to grow throughout his playing career and beyond.”

When the news of the deal first broke back in December, estimates on James’ payout ranged from $400 million to $500 million for the most part, though some outlets did throw out a $1 billion high (ESPN)

 

 

Nike Strategy:

The Nike strategy is for Lebron to be selling shoes for the next 20 years like Michael Jordan has done. The problem is that LeBron James is not Michael Jordan and there is no evidence he can ever attain that level of sales success.

In fact, there are significant risks that his sales could drop significantly heading into the end of his career and stop once his career ends. As a financial risk, Lebron James is not Michael Jordan.

 

Michael Jordan is still the king:

Michael Jordan produced their best-seller for Nike in the latest quarter.

Now, in order to replace those sales in the future, Nike needs Lebron to be selling $150 sneakers 25 years from now.

 

Medium/Longer Term Risks for Nike Stock:

NBA TV Ratings are down:

NBA’s RSN ratings down 15 percent this season.

• Sports TV’s ratings doldrums are hitting local NBA games hard this season. So far, at least 20 teams are posting lower or flat ratings compared with the same point last season.
• The top three teams in the East are down double digits: The Cavaliers (down 28 percent), Celtics (down 15 percent) and the Wizards (down 12 percent). In Chicago, Bulls’ ratings so far are down 35 percent, following a season when they dropped 37 percent.

 

The Jordan Brand is now 32 Years old.

LeBron James: 32 years old – (est NBA retirement in 6-8 years.)

Estimate of Jordan brand U.S. sneaker sales in 2015 ~$3 billion:  via SportsOneSource.

Percentage of Nike’s $30.6 billion 2015 revenue that Jordan accounted for is 8% (via Forbes).

 

 

Brand and Likeability:

Michael Jordan is still loved 14 years after his basketball career ended.

Michael Jordan is second on the list, also for the second year in a row. Jordan was the most popular athlete in the country as recently as 2013. (via Harris)

For the second year in a row, LeBron James is the most loved athlete among people in the United States.

He is also the most hated.

 

Risks of a scandal (Tiger Woods):

The best-case scenario assumes no public relations disasters like Tiger Woods experienced or Lebron James’ infamous “the decision” p.r. disaster.

The higher the athlete endorsement deal, the more risk of a financial loss in the event of a scandal. Sure, you can void a contract due to a morals clause, but the costs are still catastrophic.

When the Tiger Woods scandal broke in 2009 researchers at the University of California, Davis estimated that his sponsors lost a collective $5-$12 billion.

Nike Earnings Trends:

These are some very difficult trends for a large company like Nike. The bright spot is that their business is incredibly profitable (margins in the 40% range.

It’s hard to justify a P/E of 27 with growth in the mid-single digits and slowing.

Margins:

Again, a very profitable business, but trends in growth and valuation make it unattractive. With more competition from Under Armour and Adidas in endorsements, the best attribute of the company is under threat. As the competition for endorsement talent creates much more risk to margins over the near and medium term.

 

 

Competition:

And more competition from both Under Armour and Adidas.

As far as sales, Nike had nine of the top ten best-selling shoes in the U.S. by dollar volume last year, but failed to secure the top spot which went to Adidas for the first time in a decade.

 

Consumer Debt:

Nike Demographic:

Nike’s customer base for sneakers is typically a late teen who spends 20% more on shoes than an adult counterpart; – this happens to be a large segment of LeBron fans. (via percolate)

 

Millennials: (as published by Washington Post)

Millennials have become a key driver for this market.

Americans aged between 18 and 34 spent $21 billion on footwear last year, a 6 percent increase over the previous year – and three times as much as the total American footwear sales growth over the same time, data from market researcher NPD Group show.

“The entire millennial generation grew up wearing nothing but sneakers.

Given their druthers, they’d probably only wanna wear sneakers today,” said Matt Powell, a sports industry analyst with the NPD Group.

“Conspicuous consumption really comes into play here. There’s this prestige factor. If I can buy a pair of LeBrons, it means I’ve got $175 – and you don’t.”

 

Consumer Risk:

I think this chart speaks for itself. The larger issue is whether 8 years of easy credit policies encouraged by the Fed will eventually reverse. Discretionary spending like a $175 pair of Lebron sneakers could easily be scaled back and Nike is priced at a premium valuation (27X earnings).

The US economy has had a 9-year span without a recession. At some point, the economy and consumer spending will contract. Higher interest rates could be the impetus.

Uneconomic long-term endorsement contracts and longer-term issues for both the Jordan Brand and the ability of Lebron James to fill the sales void present greater questions for investors. However, since the shares are already overpriced, it is not a risk worth taking for the investor.

 

 

Conclusions:

In the short term, I am concerned by Nike’s exposure to consumer credit trends and a high valuation. However, in the medium and longer term, I find significant risk as to how the company will evolve with a slowing Jordan Brand being replaced by LeBron James and his ability to fill that role seems incredibly risky, for many reasons.

Even in a positive scenario, a recession risk and re-evaluation of the company valuation to a slower growth P/E presents risks.

The stock is simply too expensive.

Buyer beware.