A big part of success in the sports apparel industry lies with endorsements. A company like Nike Inc (NKE) or Under Armour Inc (UA) need high-profile athletes and celebrities to promote their brands.
While Nike has been in a league of its own for the last 20 years with endorsements, it could actually learn a lot from UA.
NKE and Big Spending
Last year Nike shocked investors when it reported that financial obligations to sports teams, leagues, colleges and athletes was nearly $6.2 billion for the fiscal year ended May 31, 2015. That represented a 32% increase year-over-year, and was on top of a fiscal 2014 where commitments had also jumped more than 30%.
Prior to 2007, Nike’s commitments never topped $2 billion annually, but looking forward, it won’t be long before commitments top $10 billion.
After all, Nike signed that big $1 billion NBA jersey deal after its fiscal report last year, and also signed a lifetime deal with Lebron James that could reach $1 billion in value. Thus, financial obligations for fiscal 2016 and 2017 are both likely to be significantly higher than the $6.2 billion it spent last year.
Meanwhile, Under Armour is spending well under $500 million annually for sports teams, leagues, colleges and athletes. That’s about 10% of its revenue. NKE is spending more than 20% of its annual revenue on these commitments.
NKE Consistently Strikes Out
With that said, if all these deals are lucrative for Nike, then it makes no difference what it spends. Unfortunately, that is just not the case.
In the last week, NKE cut ties with Manny Pacquiao after his homophobic remarks. This follows a number of other high-profile investments gone wrong for Nike in recent years.
While NKE has some great deals, like Michael Jordan, Lebron James and Kevin Durant, it has also has many duds. Last year, Nike grabbed Karl-Anthony Towns, but it also signed D’Angelo Russell and Kevin Love, and lost James Harden. None of these are good.
Historically, Nike has been very aggressive at signing young basketball players in the NBA draft, hoping that some will be a star. A good example was in the 2013 NBA draft.
Nike signed the first pick Anthony Bennett, the second pick Victor Oladipo and the third pick Otto Porter, as well as Cody Zeller, Alex Len, Trey Burke, Kentavious Caldwell-Pope, CJ McCollum, Michael Carter-Williams, Kelly Olynyk, Giannis Antetokounmpo, Dennis Schroeder and Phil Pressey. Sure, a couple of these worked out, but for the most part, these are role players who are undeserving of a major endorsement deal.
Furthermore, Nike missed on Nerlens Noel and Ben McLemore, who are arguably two of the better players from that draft.
Given this illustration of signings, it is no wonder that annual commitments have skyrocketed for Nike, growing much faster than revenue growth. This is a company that has thrown money at schools, professional teams and athletes over the last few years, with a big chunk of those signings amounting to little or nothing for the footwear giant.
In other words, NKE favors quantity over quality.
UA Embracing Quality, Not Quantity
Meanwhile, Under Armour does not have the same large lineup of endorsers as Nike, but almost all have been home runs. These include Tom Brady, Gisele Bundchen, Jordan Spieth, Cam Newton, Lindsey Vonn, Bryce Harper and of course, Steph Curry. During UA’s last quarter, its footwear revenue nearly doubled to $167 million, thanks to strong performance from the Curry line.
While UA does not have a large lineup, what it does have is an incredible lineup of endorsers. UA has the reigning NBA and NFL MVP, along with the most famous supermodel of the last decade, the world’s best baseball player, a next big star in golf and perhaps the best quarterback to ever play football. It does not get much better than that.
Given the rate at which Nike’s obligations are growing, and the overall percentage that these costs are of revenue, it is inevitable that sooner or later, Nike’s emphasis on quantity is going to cut into margins. When that happens, Nike stock is sure to suffer.
After all, Nike stock may have fallen considerably during the last few months, but it is still pricey at 24x fiscal year 2017 earnings per share, which means it has quite a ways to fall.
What NKE needs is to embrace UA’s approach, doing more research into the character of athletes, and only signing athletes who truly deserve such endorsements, rather than half of the NBA draft. That way Nike’s revenue will grow faster than its obligations, and its margins will go higher, like UA.
At the end of the day, this approach bodes well for the business and Nike stock.
As of this writing, Brian Nichols did not own any of the aforementioned securities.
