Nike Bull's Pen
by Dale Wettlaufer ([email protected])

Whoosh. That's the sound of Deion Sanders blowing by Washington Redskins quarterback Gus Frerotte, who, lying on the ground in a stupor, can only process the thought, "Man, I thought my guy had three steps on Sanders." Fans outside the Washington, D.C., area aren't sharing that thought. They're marveling at the pure athletic talent of a superstar athlete who can chase down a 4.2-40 track star receiver, snatch his lunch out of the air at an altitude of 11 feet, spin, and take it back 80 yards.

Goooooooallll! Goooooaaaaallll! Goooooooooooaaaaaaaaaaalllllll!, the announcer screams. Young Jesus thrilled at the sound of the announcer's now world famous lyric cry. Having grown up in Belo Horizonte, Jesus loved soccer. When not playing soccer, he was thinking about it. And when he wasn't thinking about it, he was dreaming about it. Yes, he had heard all about Pel� and had seen the old games on television, but Jesus couldn't imagine how anyone could really be as good Ronaldo. Maybe someday...

Jean-Marie knew exactly why he liked the big man. Soaring through the air, number 23 looked like a big cat -- powerful and graceful. After the game, the player flashed a huge grin as he talked to a reporter, and Jean-Marie knew this wasn't a fake man or a false hero. Since that day, when he first saw Michael at Barcelona, Jean-Marie had escaped what could only be understated as an unhappy home and worked on his jump shot and dribbling for hours in the school gym. On the flight home from Sydney, Jean-Marie felt the medal in his pocket and thought about Barcelona and Jordan.

This is what Nike is about. At its roots, this company is about sports. Too often, we get bogged down in the (admittedly important) details of inventory turn and what's hot and we forget about the heartfelt mission of this awesome company. Nike didn't start out fake and it hasn't yet gone fake, though the nabobs who retreat to their comfortable American dens after their hard days of social criticism might not agree. The enduring appeal of this company's mission to support sports and athletes will continue to attract people to Nike. Further, the evolving structure of the company's design and technology, product marketing, and logistics functions will continue to turn out products that people will demand.

This isn't a cotton candy factory that tries to figure out what will be sweetest tomorrow, so I think the arguments that can be composed based on fashion appeal miss the mark. It's not about fashion. In fact, Chairman Phil Knight was really ticked off when Andre Agassi, a Nike athlete, appeared on TV saying, "Image is everything." To Knight, this was the antithesis of the Nike philosophy. It's about the ageless pursuit of competition, self-improvement, and heroism. A company that focuses on that isn't going to go bust like L.A. Gear. In fact, if the company controls its overhead and capital, it's going to do all right over the years, and its shareholders will benefit from the company delivering value to consumers.

That's considering worldwide happenings, too. Business coverage is way too caught up in what is happening in Asia this quarter or Europe next quarter. A company's value is derived from the net present value of all future cash flow. If cash flow tanks this year and is bad for the next two years, that shaves the value of the business, but it doesn't sink the 15 years of good results in a 20-year cash flow model.

So what kind of value do we have at Nike, then? For 1998 have revenues of $9.6 billion, up slightly from 1997 revenues of $9.2 billion. Pre-tax income was down, however, to $653 million, nearly half the prior year's $1.3 billion and 1996's $900 million. That works out to a return on assets (ROA) of 7.4%, down from 17.1% in 1997 and 15.6% in 1996. ROA in 1995 was 14.4%.

Even in a down year, this is the sort of company that can generate a return on equity (ROE) of 15% with mild leverage. In good years, we're talking about 35% ROE with leverage equal to the rest of the consumer goods world. Finally, the company generated return on invested capital (ROIC) of approximately 13% last year, well in excess of the company's cost of capital. This is down from world-class levels, but let's talk about the value of a business that can meet its cost of capital in a down year and that has proven itself over and over again, even while a large part of the globe still doesn't know the "Swoosh" or other Nike brands.

As Scottie said in Star Trek IV, "Now what would that be worth to ye?" Is that worth $10.9 billion? That's the value of its current equity market capitalization and long-term debt. What sort of return could we make on this going forward? Well, let's see. The company currently has invested capital of $4.2 billion. At an enterprise value to invested capital ratio of 2.6 times, we're pretty near fair value based on down results. But down results are more the exception than the norm for this company. Is there economic goodwill here? Yeah. And rather than running a fancy discounted cash flow model or EVA model, I'll go straight to my test of asking myself, "Would I pay cash of $12 billion (to purchase all equity at a control premium) to purchase Nike?" My answer would be yes.

Off the top of my head, I think the company will grow invested capital at 10% per year for 10 years. So, in 10 years, invested capital will be around $11 billion and shareholders' equity will be about $8.4 billion. Say the company can generate ROIC of 20%, getting us to EPS around $7 and ROE of 25%. At 12 to 16 times EPS, that's $84 to $112 in value. That's present value of $30 to $39.50. I'm not getting gypped if I buy this company now, and I'm getting upside on top of the numbers above. The company won't stop growing at year 10, and the entire Asia/Pacific part of the globe isn't going to implode like a cheap TV set tomorrow. We've got Nigeria, Brazil, Russia and Ukraine, Bosnia, China, and lots of other regions to think about. While the valuation doesn't set me on fire, the company is fairly priced. Am I bullish on the long-term? You bet, Yi-Hsin.

Next: The Bear Argument