5/1/18 08:51 Overview of Adidas Company Description (Euros in millions, except per share data) Company Description Financial Summary and Valuation Exchange: DB: ADS Founded: 1924 Headquarters: Herzogenaurach, Germany Employees: 53,731 n Adidas AG Designs, manufactures, and sells sports apparel and accessories n Operates several brands including Adidas, Reebok, and TaylorMade n As of Q3 2015, Adidas operated a total of 2,679 stores, of which 850 were factory outlets Relative 5-Year Stock Price Performance Revenue Breakdown By Geography By Brand 250 200 +95.6% 150 100 50 0 11/29/10 11/29/11 11/29/12 11/29/13 11/29/14 ADS.DE S&P 500 2014A Revenue: €14.5bn Source: Capital IQ, Company reports, own estimates Ben Hoban 1 [email protected] 5/1/18 08:51 Overview of Adidas Adidas Relative 10-Year Share Price Performance Over the past three years, despite performing on par with S&P, ADS has underperformed sports apparel leaders UA and NKE, which are up more than 250% and 150% Source: Capital IQ Ben Hoban 2 [email protected] 5/1/18 08:51 Investment Thesis Bridge Over Troubled Water Where has Adidas gone wrong, and what can it do to right the ship? Wall Street Consensus 2015E to 2018E Contribution to EPS Growth 5.50 € Overhead operating margin € 0.23 lag compared to peers provides opportunity € 0.05 € 0.03 5.00 € € 0.73 4.50 € € 0.08 € 0.01 € 0.75 Golf is currently distracting 4.00 € from overall Adidas Group growth A&P spend will allow for continued improvement in core brands 3.50 € Net Revenues 3.00 € EPS Before Adidas Reebok TaylorMade EBIT Margin Other Items Tax Rate Shares Outstanding EPS After Source: Capital IQ, Wall Street research, own estimates Ben Hoban 3 [email protected] 5/1/18 08:51 Investment Thesis I recommend investors establish a long in Adidas (ADS) with a 3 year price target of 145.50 Euros, representing a 18.5% IRR from today’s price 1 2 3 Margin Improvement A&P Turnaround Golf = Solvable Adidas has fumbled versus Possible to spend more in Choices for golf include Nike and others, sending marketing while maintaining sale or sit and wait – similar gross margins margin improvement story; learning from past mistakes through a bloated overhead NA to show returns in next can make brand valuable structure couple years; strong brand and accretive again to return Adidas Before Adidas After • Bloated • Golf a ‘drag’ • Market wanting to look away • Lean, mean, NKE/UA fighting machine • North American turnaround • Steady European base Ben Hoban 4 [email protected] TBU Revisit old work 5/1/18 08:51 Do new work Thesis One Margin Improvement Potential Operating margins (or lack thereof) have become a main story behind Adidas, driving stock price • Currently, Adidas severely underperforms the market in terms of Overhead Operating Expenses as % of Net Sales operating margins 35.0% • While marketing in line with peers as % of revenues, 30.0% overhead is providing a drag on company's profitability 25.0% • Over the past four years Adidas has traded in line with operating ADS margins and operating margin expectations 20.0% NKE • General bull thesis that if Adidas is able to improve margins 15.0% UA closer to that of the golden standard in the industry, Nike, then PUMA profits and stock price will increase substantially 10.0% • Potential added ancillary benefit of a multiples rerating to 5.0% higher growth TEV/EBIT 0.0% 2013 2014 2015 12.0% € 120.00 11.0% € 100.00 10.0% 9.0% € 80.00 8.0% 7.0% € 60.00 6.0% € 40.00 5.0% 4.0% Operating Margin Adj Close € 20.00 3.0% EBIT Margin EBITDA Margin 2.0% € - 1/1/2011 7/1/2011 1/1/2012 7/1/2012 1/1/2013 7/1/2013 1/1/2014 7/1/2014 1/1/2015 7/1/2015 Source: Company filings, Capital IQ Ben Hoban 5 [email protected] 5/1/18 08:51 Thesis One Margin Improvement Potential Large gap to other players like Nike, but possible to fill some of it, especially 2-3 years out Where Is the Improvement Coming From? Op Margin Bridge to Nike • Gross margins (2017 out) 18.00% • Product, Brand, Geographic mix • China, Ecomm 16.00% • Overhead 1.9% • R&D in line with street @ 1% of revenues; but 14.00% logistics costs much higher (double smaller UA) 4.4% a year of 4.6% true overhead lag • CEO Herbert Hainer’s contract expires early 2017 12.00% • to NKE, when Possibility of outside perspective coming in and removing R&D looking at the company with fresh eyes 10.00% • union heavy board unlikely to push for cost cutters 2.6% • Win/win scenario (margins not improving by 2017 will increase chance of outside mgmt vs. mgmt 8.00% 0.5% 1.4% following through) 13.6% 6.00% “The guidance is that we're going to grow our bottom line every year…I think that this 4.00% is a big statement that we're going to average 15% per year. And, yes, over this period, 6.4% we will definitely outperform the top-line growth” - CFO Robin Stalker @ Investor Day 2015 2.00% “Where we have failed is on the operating margin. There have been some external 0.00% ADS Op Gross Margin Marketing Logistics & Marketing Other NKE Op factors…(b)ut we definitely learned from these mistakes…(We)e have put even more Margin Difference R&D OH, Central Margin KPIs into our targets…North America” ` Admin, SF, - CEO Herbert Hainer @ Investor Day 2015 SWB Source: Company filings, Company web site Ben Hoban 6 [email protected] 5/1/18 08:51 Thesis Two A&P Spend to Turn Brand Around Adidas has experienced a brand dilution in past four years, especially in North America § Management has admitted to ‘diluted brand desirability’ as Relative Market Share & Revenues Over Time well as underperformance in North America § Comeback story $60,000 60% § At lowest EBIT margin, North America is interesting case § Were considering abandoning NA business § Realized they needed the US ‘cool’ factor in order to $50,000 50% maintain China levels, which is ~40% of EBIT § Therefore, they are in the beginning of § EBIT margins for NA skewed in that other 40% 40% 40% 39% 40% 39% 38% countries rely on NA investment $40,000 37% 40% § New marketing plan focused on more cost efficient 34% sponsorships, getting gear on floor vs. big contracts § Strong start with new initiatives $30,000 30% Revenues UA PUMA ShareMarket NKE $20,000 ADS 20% ADS $10,000 $18,535 $19,128 $18,858 $19,288 10% $15,806 $15,888 $14,096 $14,439 $12,656 $- 0% 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Company website, Capital IQ, Company reports, Wall Street research, Google Trends Ben Hoban 7 [email protected] 5/1/18 08:51 Thesis Two A&P Spend to Turn Brand Around Adidas is positioned well to have an impact with their marketing spend; much more to put to work Potential Regressed Marketing Spend v. Market Share • Adidas has lagged competitors in marketing working 54% budget spend on a % of revenue basis 53% • Set to increase spending over the next couple years y = 0.1394x + 0.429 R² = 0.07174 • Regressing Adidas market share spend vs 52% competition, they have power to take market share from Nike, UA, and Puma when they increase their 51% marketing spend 50% • Can increase marketing working budget spend while still increasing operating margin, sticking with Thesis 1 ShareMarket (of top 4) 49% • Strong forecasted topline growth will allow them to put a much larger amount of absolute $ to work in marketing 48% 45% 46% 47% 48% 49% 50% 51% 52% 53% 54% 55% Marketing Spend Share (of top 4) Marketing Working Budget as % of Net Sales 30.0% 41% 25.0% ADS NKE 40% 20.0% UA 39% 15.0% PUMA 38% 10.0% 5.0% 37% y = 0.2256x + 0.3215 0.0% 36% R² = 0.18553 2013 2014 2015 ShareMarket (of top 4) 35% Adidas consistently lagging competitors on Marketing Working Budget spend; brand has relatively deteriorated compared to competitors as a result 34% 20% 25% 30% 35% 40% Source: Company website Marketing Spend Share (of top 4) Ben Hoban 8 [email protected] 5/1/18 08:51 Thesis Three Golf A Solvable Problem Golf has been dragging Adidas down lately as the entire golf industry has experienced severe contraction Option 1: Sale Sell TaylorMade? § Given golf ’s drag on Adidas overall, a sale might be the best path forward § Quick calculations comparing against recent sales of Callaway and Titleist show that TaylorMade could fetch slighly below $1bn § Selling golf in my and Wall Street revenue estimates produces an overall Adidas with a higher growth rate, possibly leading to a multiples expansion Regressing ADS + competitor Revenue Growth vs. TEV/ EBITDA, 2016 Revenue Growth 6.6% -> 7.2% = ~45bps multiple expansion, equating to 592mm Euros of TEV expansion 20.0% 15.6% Growth w/ Golf 15.0% Growth without 11.0% 10.3% 14.6% Golf 10.0% 11.1% 11.7% 7.2% 7.3% 6.7% 5.4% 4.9% 3.9% 5.0% 6.6% 7.1% 6.6% 2.3% 4.9% 4.0% 0.0% -4.6% -5.0% -2.5% Source: Company website Ben Hoban 9 [email protected] 5/1/18 08:51 Thesis Three Golf A Solvable Problem Adidas can alternatively wait to see if golf turns around as restructuring, inventory, new launches set to benefit Option 2: Wait It Out On/Off Sales - Golf TaylorMade Revenues Equipment § The other option for Adidas is to wait to see if: 1500 § The cycle improves 3000 § New products that show some promise take hold 2800 1000 § Past mistakes can be made up for 2600 2400 § Restructuring improves profitability 500 2200 § Over the past few years, Adidas flooded Dick’s with 2000 inventory, likely other golf stores as well 0 2008 2009 2010 2011 2012 2013 2014 § Leads to deflation + perception from customers they can wait for deflation to happen § May need a year or so before effect wears off Learning From Mistakes “There is definitely going forward, in my opinion, a much better situation in the golf market in terms of inventory levels on the “Industry insiders point to last year’s double bogey by sports retail giant Dick’s that crimped revenue and margins industry-wide.