Nautilus calls Pearl Izumi acquisition "pure-play in fitness"

Stunning investors and the sports community alike, Nautilus on June 17 announced it had acquired high-end cycling and running apparel brand, Pearl Izumi, calling it a "pure-play in fitness" and an addition to the equipment it offers for the fitness enthusiast. Nautilus closed the deal to buy the Broomfield, Colo.-based company for $74 million -- $68 million in cash and about $6 million in assumed debt – drawing on nearly three-quarters of its cash war chest of just over $100 million.
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Stunning investors and the sports community alike, Nautilus on June 17 announced it had acquired high-end cycling and running apparel brand, Pearl Izumi, calling it a "pure-play in fitness" and an addition to the equipment it offers for the fitness enthusiast.

Nautilus closed the deal to buy the Broomfield, Colo.-based, company for $74 million -- $68 million in cash and about $6 million in assumed debt -- drawing on nearly three-quarters of its cash war chest of just over $100 million. That makes it a deal worth an estimated 1.3 to 1.5 times sales, assuming sales as cited in cycling industry publications of $50 million. The $74 million price was called "exorbitant" by insiders.

Nevertheless, Nautilus was quick to point out this was not an attempt to get into sports apparel or compete with the likes of Nike or Russell.

"We view this as a part of the equipment that fitness enthusiasts use, rather than Nautilus entering the apparel business," Ron Arp, Nautilus senior vice president, told SNEWS®.

Extending the Nautilus brand business
The acquisition was called a "natural extension" of the Nautilus strategy in a company statement announcing the deal, saying it also provided the fitness equipment supplier with a "highly complementary entry" into the high-performance fitness apparel market. Vancouver, Wash.-based Nautilus (NYSE: NLS) owns several brands, including: Bowflex, which was its first product and the foundation of its business in the 1980s; Nautilus, acquired in 1999; Schwinn Fitness, bought at the company's bankruptcy auction in 2001; Stairmaster, acquired in 2002 just before the company was to declare bankruptcy; and Trimline, a treadmill manufacturer. It also sells Champion Nutrition products, a partnership begun in 2001 but not sealed with a purchase although formally extended in 2002. The discontinuation of Nautilus Sleep Systems was announced in early 2004.

"The Nautilus management team, which has experience in the apparel and footwear industry, intends to apply expertise in both apparel and fitness to further leverage our brands as fitness enthusiasts pursue technically-superior equipment," CEO Gregg Hammann said in the statement. Hammann, who came to Nautilus in July 2003, has experience at Levi Strauss as do several other members of the current Nautilus management team that joined him at Nautilus in early 2004 after his arrival.

Depending on who's doing the counting and what apparel segments they are considering, sports apparel is said to be worth anywhere from $2 billion to $30 billion. The retail fitness equipment market is said to be worth about $5 billion.

Nautilus has and does now offer apparel but only limited items with, for example, eight-panel Schwinn-branded cycling shorts, Bowflex-branded hats and sweatshirts, and a couple of technical tops for men and women. But, Arp said, company research done on consumer preferences and opinions after Hammann arrived showed that the public, when asked about its equipment needs for workouts, quickly segued a discussion to apparel. Arp called apparel one of "the tools that fitness enthusiasts use."

The deal caught investors, sports insiders and analysts by surprise -- a few had expected a stock buy-back with some of the cash the company had stashed. Initial questions about how the Pearl brand and culture fit into the Nautilus strategy and company caused stock prices to drop the day of the announcement by 0.78 from 28.50 to 27.72 on a volume of 939,000.

On June 20, however, stock prices recovered slightly, closing at 28.00 on volume of just 417,500. According to the company statement, the deal is expected to be neutral to Nautilus' earnings in 2005 and is expected to add about 6 cents to 8 cents to 2006 earnings per share. Board of directors member Jim Weber, president and CEO of running-specialist Brooks Sports, a Pearl Izumi competitor, is said to have not voted on the deal, and when asked about potential conflict of interest, Arp said there were no issues short term. Weber was not available for comment, and Pearl employees and management were not allowed to speak about the deal, referring inquiries to Nautilus.

Established in 1951 in Japan and first distributed in the United States in 1981, Pearl Izumi brand apparel and footwear is distributed through 2,600 independent bike dealers, an unknown but limited number of outdoor specialty shops, 600 running specialty retailers worldwide, as well as nine Pearl Izumi retail outlet stores. It is sold in 14 countries. The brand was commonly known to have been on the blocks since earlier this year despite growth figures.

Minimal disruption to Pearl brand planned
Arp said that Nautilus plans a hands-off management approach to allow Pearl to continue to grow its product line and market share in all its current categories, including cycling, running and trail running. In addition, he said there were no plans for layoffs, any leadership changes, or other changes in the sales force "for the foreseeable future." He did add that some of the core Pearl functions, such as human resources and IT, could be merged with current Nautilus functions in Vancouver, Wash., but that all employees affected will be given an opportunity to stay with the company. The official announcement noted that current Pearl CEO Jerry Edwards would become a part of the Nautilus team.

"The idea is a slow integration and minimal disruption," Arp added.

"We have a high level of fondness and appreciation for what Jerry Edwards has done with Pearl, and we're looking to incrementally improve that" rather than change it.

Although much is still left to decide, the Nautilus strategy includes keeping the current line as it stands, but adding Schwinn- and Nautilus-branded technical apparel for fitness enthusiasts and gym-goers who will appreciate the performance and are willing to spend the money. Bowflex-branded clothing is more of a reach since that consumer exercises less and would be less likely to spend money on highly technical goods.

"We see an opportunity to leverage the Pearl brand," Arp said, who admitted that marketing and promotion will be called for since gym-goers and fitness enthusiasts don't necessarily know the brand as cyclists and runners do.

Finding a fit
Some insiders had less enthusiasm for the meshing of Pearl, as a technical cycling and running brand, with fitness.

"Like everybody else, I don't see the fit," said Bicycle Retailer Publisher Marc Sani. "It's not a natural fit -- at least it doesn't appear to be."

And the worry exists that a niche specialty brand like Pearl with a devout following could lose its cache if it isn't nurtured well.

"Publicly traded companies buying niche specialty brands have not generally performed well," Sani added, "and have often damaged the brand. They'll be swimming upstream on this one."

Insiders pointed out that Nautilus paid a lot of money for a stock gain of 6 to 8 cents. The Motley Fool said in a June 17 story that just because Pearl makes great products for cycling, that doesn't give it "permission" to enter the gym. Writer David Meier noted that brands somehow must "earn the right" and "gain permission" to sell products to different segments of consumers. He added, "I am not sure how well this Pearl is going to fit inside a Nautilus."

And since this is Nautilus' first foray into integrating a non-equipment company, it will have to prove the company can do it, another financial analyst pointed out. But with the Nautilus recent history of collecting brand names like Schwinn and StairMaster, the Pearl move could, if integrated and marketed correctly, work very well, said another.

"More than anything, it gets Nautilus a quality, branded product it can leverage with its other brands," said Mark Rupe, analyst for Adams Harkness, which raised its FY06 EPS estimate to $1.57 from $1.50, and reiterated its "Buy" rating and a price target of $30. "They can do this, as long as it's marketed right."

Sani, of Bicycle Retailer, however, has one warning: "If the folks at Nautilus can keep their cotton-pickin' hands off Pearl and let it run, it'll be fine."

SNEWS® View: An acquisition of Pearl Izumi left us a bit stunned too, especially considering the price of about 1.5 times sales, a heck of a lot to pay for a company like Pearl. Certainly Pearl has shown sales gains of about 15 percent per year in the last four years, but were profits mentioned? Or goals? We know for a fact that its entry into the running shoe market has been a rough-and-tumble one and has dropped profits overall. Not that we don't love Pearl. The apparel is superb and has a devoted following, particularly among cyclists. But cyclists and runners are an odd bunch, if you will. Cross them or act like you are taking away THEIR brand and they will run faster than a cat from a dog. Remember Hind in its older days? A niche brand loved by runners who swore by its offerings. Then it was sold, the product was watered down and changed, and the brand nearly died a slow and painful death. Luckily, it was brought back to life by new owners and management, but not without the management slowly evolving its offerings. Still great stuff, but different – more fitness-y, more lifestyle, more yoga and some running, and -- guess what? -- no more cycling.

Distribution is another key question that Nautilus has not totally answered. The company pointed out that the brand is already in some sporting goods stores, and at least one investor on a Yahoo chat board was nearly salivating: "Imagine Izumi stuff in every Sports Authority...." Nautilus, however, only said that it wants to be wherever enthusiasts shop or exercise. That can mean a lot of things, and that will likely worry the core cycling, outdoor and running specialty shops, especially considering Nautilus' ongoing strategy to increase its penetration with its fitness equipment brands at sporting goods and mass. Take Pearl to, heaven forbid, Costco, and the brand will die a fast death.

The deal has been called by sports insiders and analysts that SNEWS® spoke with, among other things, an attempt to backup the Bowflex bubble before it totally bursts, an effort to cover up the lack of organic growth, or simply a "diversity play" to buy Pearl's expertise. Consider all those thoughts and go in the direction you see fit.

How about the positive? If Pearl is left to do its own thing and retain its current company culture (although we're not sure if Nautilus will like company policy of closing at 11:30 on Fridays), Nautilus could use its management expertise to help continue its growth and get profits back where they should be. AND they could use its technical know-how in clothing to come up with a great line of Schwinn- and Nautilus-branded apparel.

Either way, Nautilus paid a heck of a lot for the ability to do branded apparel -- something it perhaps could have licensed -- so there must be other plans simmering for the Pearl know-how. We do know Nautilus was on the hunt for an acquisition in the last few months and hadn't quite landed a couple of fish. One thing for sure, Jerry Edwards landed in the honey pot since we hear the management is locked up into this deal with all kinds of incentives and stock options. And equity firm co-owners had one big grin on their faces too.

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