Is Nike In Trouble & HSBC Shakes Up Its IBD Division

Welcome back to The Deal Room, and I've been reading a lot of press recently that's been very negative about Nike. And Nike is a company I somewhat have an affinity to, very fond of. Uh, small fact, I was once sponsored by Nike, Stephen. Can you believe that? Wow.

Uh, that's a story in itself.

Let's get into that. Well, yeah, but, uh, many moons ago. Um, but yeah, Nike's been getting a bad rap. Their business strategy's been questioned. Their share price has been hit. Really hard recently. So I just wanted to get what's gone wrong at Nike and cover that a bit more. And I know you're an expert in all things strategy. And then HSBC restructuring, I read news articles this recent few sessions about them looking to streamline some of their sector coverage. So any of those interested in investment banking, that would be a good segment to listen to. And then also in the tech world, can't go an episode without at least mentioning AI. A few times. Microsoft are leaving the OpenAI board. Why are they doing that? What does that mean? Are the regulators coming? I'm sure Stephen will explain. And then a little bit of private equity at the end. So stay tuned. But Stephen, how are you doing?

Yeah, good. That was a bombshell. Sponsor— I actually had at the beginning of my notes, note to self, ask Ant how many pairs of Nikes does he own. So I'm going to start with that question, then we're going to get onto this sponsorship. This is, this is interesting.

I, I used to resell them, the Nike shoes they used to send me at school. Yeah. So I was in my final year of high school at this point. So we had gone on a European tour playing for England and we had all been sponsored as a team. And so we used to get sent like packages, like big sports bags full of gear fairly frequently. Um, would be great. Yeah. And I, I just coin it all off for school, make little side hustle cuz we used to get like running shoes as well as basketball shoes and kit and then everything.

That is unbelievable. What a, what a, what a side hustle to have at that age as well. Fantastic. How many— so how many pairs do you own now though? You know, back in the day I can imagine you were, you were all over Nike, but what about now?

It's a good question because, uh, I have, I have, let's say, several, um, all of which are predominantly trainers I never wear and wanted to buy when I was a kid but couldn't afford it. They're all Jordan-related, if I'm honest. So I'm a bit of a sneaker fiend at heart, but actual day-to-day shoes, I'm going to have to say I wear Adidas most of the time.

Well, this is it, and this is part of the problem. You are part of the problem, and we're going to talk about Nike's strategy and why it's fallen out of love, or Gen Z might have fallen out of love to an extent with Nike. The millennials are still into Nike. And I still, you know, look, my running trainers are Nike. I've got a couple of pairs of casual Nike trainers, but the only reason is because they fit me really well. I don't really care about the style, as you can probably tell. But let's get back into, let's get to, let's get to this story. So I think most people that are listening would have some idea of Nike's backstory. If you haven't read Shoe Dog, by Phil Knight, the founder of Nike. Please do. It is required reading for anyone that's interested in business and strategy. Brilliantly written and a fascinating story. So the founding story is that Nike started by Phil Knight importing Onitsuka Tigers, now ASICS, from Japan because there were no good running trainers and Phil Knight ran track in the US. So it's got quality and athleticism right in its DNA. One of the coolest facts that I was reading about was the cost of the iconic swoosh logo. How much do you reckon it costs for the brand agents to come up with that logo and for that to become probably the second most iconic logo after the Apple logo?

Originally, or what?

Originally, back in the '90s. Yeah, nowadays a lot, but back in the 1970s, what do you reckon?

Oh, it's going to be something ridiculous. Maybe he didn't even pay anything.

$35. Oh yeah, $35 for the swoosh. And that's not, that's pretty good value for money. It's such an iconic thing. And it was part of Nike's almost unparalleled rise to where it's at today from the 1960s when it started all the way through to the 2010s. It was a bit of a juggernaut. The bad news was limited largely to working conditions and supply chain, and there were a lot of issues there that have subsequently been somewhat cleaned up, but never were the issues financial. And it just seemed like Nike was going from strength to strength to strength, signing the right athletes, whether it was Jordan or Tiger Woods or whoever it might have been, and getting that right level of innovation. To feel like it was still the main player in town, certainly from a sneaker perspective. So fast forward to today and what has happened. So this was a, a news story that broke a couple of weeks ago, but it's been rumbling on. Q1 earnings from Nike, absolutely disastrous. So for the first time in its history, well, for the first time in its history, sneaker sales are down 4% year on year. Revenue is down 2% year on year. This is unheard of for a company like Nike. And as a result, the investment community that were already slightly jittery just sold 20% down on the day. In fact, this year alone, they're down about 32%. S&P 500's up 18%, by the way. So if you are an active fund manager and you've got Nike as a significant part of your portfolio and you are benchmarked against the S&P 500, You're in for a really, really rough H1. So share price are being depressed and its financials are stuttering. And I'm just looking at some of the financials from their Q1 before we get into maybe some of the strategy. And obviously the most interesting part as we come on and talk about strategy is that pivot that Nike has made away from wholesale customers and towards Nike Direct. So this is moving away from selling in stores like Foot Locker or Sports Direct or whatever it might be, and, and only selling through its own channels, its high street stores, which are great, are great places to visit, but also through its app and through its website. So between 2018 and 2023, The wholesale customer revenue only increased from about $24 billion to about $27 billion. That's 5 years and barely any movement on the grand scheme of things. Yet sales through Nike Direct doubled from about $10 billion to $20 billion. And the Q1 earnings report has just compounded that because Nike sales through Nike Direct have stopped growing. So it's okay when you pivot and the thing that you pivot into is showing double-digit growth and you're like, well, look, this is a bit of a success. But when that thing that you pivot to stops growing and you realize that you no longer have that presence with your Sports Directs and your Foot Lockers and your Macys, then you're left with a massive hole in your growth strategy. So it's not a particularly good time to be a Nike investor. And I thought I would, I thought I'd summarize the strategy with 4 strategic missteps. So should we go for it?

Yeah, hit me.

All right. So what's gone wrong? Firstly, wrong leader. So Nike has been known for having very, very stable leadership. I think the previous CEO before John Donahoe came in in 2020 was there for 16 years. Phil Knight was obviously there for a long time. I think they've only had 4 CEOs in their history. But in early 2020, Mark Parker resigned and John Donahoe came in. Now, John Donahoe is not a sneakerhead. He's not an athlete. He was an ex-executive at eBay and PayPal, and he was there kind of to shake things up a little bit, right? To go, look, early 2020, we need to think about our technology strategy. By the way, we've seen this play out before Disney. We've spoken about previously on the pod. It's a bricks and mortar plus media company that's trying to become a tech company. Nike took that same approach by hiring John Donahoe, who is not an athlete, which is a very, very big departure from their base. So although in the first couple of years, '21, '22, during the coronavirus pandemic, John Donahoe was seen as a really good choice. Everything's going to be bought and sold online. You've got deep experience. We're going to start measuring key performance indicators such as daily active users and launching the Night Run Club. And this is all going to be very exciting. So right place, right time. But as shoppers have returned to the high street, and by the way, they have done, there was expectations that they might not return. They very much have returned to buying things physically. In particular trainers. As shoppers have returned to the high street, this strategy is starting to feel like an apparel and sneaker company trying to be a tech company. And one of my constant refrains from a, from a strategic perspective is that not everything needs to be tech. You can have brilliant companies, whether it's Costco or Walmart or whatever it might be, that are just great companies. They don't have recurring revenue, but that's fine. They're still good companies growing at double digits. So first strategic issue, definitely there is a sense that the leadership is wrong for this stage in Nike's growth. By the way, the leader still got the backing of Phil Knight. So he is the kind of overarching Archbishop of Nike. So that's good.

Secondly, I wonder then on that point, I wonder how far that backing from Phil Knight goes, because if the share price is down, not 30%, but in context of the benchmark, 50%, I mean, it's been hammered. And so surely by backing, you're sticking to the strategy there.

Yes. Phil Knight is backing the strategy. So he's saying, look, this will come good. Give it time. It's still a great product. We're still innovating. I'm still excited about the company. Well, I don't think that although the share price has had a bit of a battering, I don't think that this is, you know, they're not pivoting away from trainers or away from sports, you know. So there, so there's still a direct line, a direct lineage back to the founding story. But there's definitely been calls for the reason why it's gone wrong. Number two, wrong strategy. So I've spoken previously about this move to direct-to-consumer, D2C. And this happened really, really quickly and quite shockingly in 2020 and 2021. There are a lot of headlines saying, look, Nike's just pulled out of another wholesaler, whether it was Macy's, Urban Outfitters, Zappos, Big Five Sporting Goods. They were exiting these relationships and focusing on D2C. Now, in theory, that's a good thing. If you're D2C, direct to consumer, you take more of the margin. You don't have to pay the seller fee, the wholesale fee. But what started off as a good strategy has turned on its head because as consumers have come back to the high street, these stores, Macy's, Urban Outfitters, Zappos, et cetera, haven't just sat around with empty shelf space waiting for Nike to come back. They filled it with a bunch of upstarts, right? So HOKA, or HOKA, the thick-soled running trainers. On Running, which we'll talk about a little bit later. Obviously Adidas with the Sambas and New Balance with the 990s. There's a lot of trainers that are filling that shelf space. So by 2023, 2024, when Nike realized, hey, wait a minute, we've got slightly busted strategy here. Let's knock back on the door of Macy's. Well, Macy's will say yes because it's Nike, but there might be a slightly smaller amount of shelf space to stock those trainers. So this is a, this is a really important piece of strategic advice. When you are making a decision, you've got to think about the magnitude of that decision and the reversibility of that decision. If it is reversible and small, then make that decision very quickly. If it is not reversible and big, that is, you know, that's a transformational decision. And this is one of those transformational decisions that's starting really, really to hurt Nike.

Okay. So leadership, wrong leadership, wrong strategy.

And then thirdly, macro conditions. And you can't necessarily blame Nike for macroeconomic conditions, but it is obviously extremely reliant on a well-functioning globalized supply chain. And what ended up happening during the post-corona world as supply chain issues started flowing through the system is that Nike stockpiled its trainers in order to get over these supply chain issues, which ended up resulting in, I think it was $9.7 billion of inventory needing to be sold in Nike's warehouses. So they kind of did the right thing, by stockpiling, but then they had to get rid of $10 billion worth of inventory and they just cut off all of their major wholesale relationships. So then they started discounting, maybe flooding the apps a little bit more. It started becoming not that exciting, slightly premium product that we all, that we all love, but actually a little bit of a discount product. So macroeconomics certainly haven't helped. Although again, other companies will have had exactly the same and managed to increase their market share. So macroeconomic conditions, number 3. And then finally, upstart competitors. And again, I don't necessarily think that this is wholly a Nike issue. When you are that synonymous with a market, when you have effectively made the market and your market share has hovered around 35 to 37% of the trainer market worldwide, it is so much easier to be an upstart than it is to be the incumbent. And yes, there are, there are some analysts saying that Nike looks a little bit tired. It's not really reinventing itself. It's just adding new colors to existing sneakers. There are more innovative athletic shoes out and about. That's true. All of that might be true, but it's just really, really hard to stay on top when you've got the likes of On Running, Lululemon, ASICS, Brooks, Hoka, all coming into the mixture and picking up some market share because they're new. And a little bit different. I think the derivative point of that is its collaborations. And we spoke about this at the top of the podcast. Do Gen Z know who Jordan is? I know it would pain you to think this, but Jordans that are so exciting for people of our generation and Tiger Woods, how exciting. These aren't the people, right? And they're now working hard to try and find those next superstars. In order to collaborate with, to create the next Jordan. They haven't really found it yet. They're paying big bucks for a lot of endorsement rights, but they haven't quite hit that Gen Z nail on the head.

Yeah, there's, there's definitely like, even Tiger Woods left, right? So when I think Nike, I think Serena, Tiger, and Jordan in terms of, but they're all Yeah, aging.

They're all aging and leaving, and there's definitely a space to be filled that hasn't quite got filled yet with the global superstars of our age. I just want to finish this last strategic point, which is a little bit of analysis on On Running. So in the time where Nike is flatlining and actually slightly decreasing its revenue, On Running released its annual report a couple of months ago. 55% year-on-year revenue increase. EBITDA, earnings before interest, tax, depreciation, amortization margin of 15.5%. Its direct-to-consumer revenue is up at 38%. And year to date, remember Nike share price is down 32%, On Running share price up 37%. So what a time to be. It's so much more fun being an upstart that's trying to claw market share than being the big beast on top that's just trying to preserve. And I And I think that's kind of what we're seeing here. So yes, strategic missteps. Yes, this move to tech B2C hasn't really worked, but there are some bigger forces, both macroeconomic and market-based forces that are probably limiting the double-digit growth that we might expect to see from Nike.

So the Nike CEO calls you up, Steven, what are you doing in response to this?

Well, they've already done the right thing, so they're cutting some costs, which is good. They have hired a 30-year Nike exec back out of retirement to reestablish the relationship with wholesalers, and they are really, really going hard at the endorsements. So they gave, I don't know if you've heard of Caitlin Clark, who's the number one pick, number one pick in the women's NBA draft, massive $28 million endorsement contract. Obviously they've won the Nike endorsement, the Nike sponsorship from the German football team for the first time in 70 years. Adidas being a strong German brand. So it's not all doom and gloom. I think they're doing the right things. I think they need to pull back from thinking that this could be a tech company and definitely focus on going back to, all right, what are the best trainers that you can possibly make endorsed by the people that really, really matter? Culturally at the moment.

Okay, so we've got 3 more kind of areas to cover, about 5 minutes apiece. So let's go straight into the HSBC story.

Yeah, so this one's a quick one, and I think it's just building on our collective knowledge. Anyone that's been listening to the pod over the last few months, building on our collective knowledge of what the investment bank looks like. So kind of take your strategy Nike hat off and then put yourself in an investment bank. So the headline is that HSBC has reshaped its investment bank to look a little bit more like its rivals. So this, we've spoken a decent amount about different divisions within the investment bank, and one of the main areas of an investment bank are its sector coverage teams. Now, if you type in list of sector coverage teams on Google, you are probably going to get 16 or 17 different coverage teams, everything from metals and mining to transportation to shipping as a separate, as a separate area to healthcare to consumer to retail to tech. Now what HSBC is doing is it's winnowing its sector teams down to 5 larger groups. Now these 5 larger groups are kind of monoliths, right? So they've got the technology, digital, and financial services group that captures a pretty large swathe of the world of companies, consumer healthcare and retail. It's a mega group, resources, industrials, and energy transition, real, real assets and services. And then the private capital group, which is an interesting fifth limb to those 5 groups. And what HSBC is doing essentially is, is A, streamlining. It's quite a good opportunity for there to be some selective redundancies or nice see you later retirements. So slightly focusing on costs, but also they're just copying their rivals. And that's no bad thing, by the way. So Citi did something very similar and has these super sector groups, technology and communications, another which covers healthcare, consumer, and retail. So this is a trend that's going on across investment banks. And I, in some industries, it's really good to be different, right? In some industries, you want to be an outlier. You want to be innovative. You want to offer something that your competitors don't. In the world of investment banking, it's not bad thing to look quite similar to other organizations because you're offering a relatively standardized service. You want a potential client to meet two similar looking teams and decide which one of those two banks you're going to go for. So in this case, I don't think it's a bad move. And by the way, I think HSBC in this kind of cost-cutting rationalizing exercise is probably preparing for a world of falling interest rates, i.e., lower profits as it goes into this hopefully interest-cutting environment.

Well, and then I know you mentioned to me offline about BNP, the French bank. Are they some way tied into this narrative?

Yeah, I just wanted to tag BNP to the HSBC story because they're similar banks actually, you know, big global banks, probably more on the commercial side than on the investment banking side. But the headline I don't know if you saw this, that BNP Paribas has signed a strategic deal with Mistral, the company that I reckon we probably referenced 4 or 5 times on this podcast. It's not bad for a company that's got about 100 employees or whatever the number is that we referenced last week. So this is a partnership and it's super, super interesting. So BNP Paribas, big global bank, universal bank, high street lending, high street banking, wealth management, investment banking, et cetera. They're now using Mistral and its large language models to develop a number of use cases across custom customer support, sales, IT, and other areas, including algorithmic quantitative trading, creating new strategies out of Mistral's large language model. And just to take a very quick step back, if we, a few months ago, we spoke about the different strategies of these AI starts. And Mistral's strategy was to build large language models that were suitable for heavily regulated business cases. So it wasn't the free, maybe the freewheeling, you know, let's get everything in there of, of, of, and let everyone use it of OpenAI. They were saying, look, all right, we, we've got this capability and we want to deliver it to governments, defense, and banks. So from my perspective, this is one of the first examples of Mistral putting its strategy and putting its business model into action. And I'm absolutely fascinated to see where this goes. Really interesting to see whether BNP Paribas, as maybe one of the first banks that has aligned so closely with one of these startups, I don't think I've heard another one. Announcing such a big strategic engagement.

Yeah, and it's interesting because BNP is someone I don't think you'd think of immediately when it comes to technology and finance. But you know, there's a post I put out earlier this week about, on the, in the FX department, in the market side, they are the gold standard in algo trading on the sell-side institutions, and it was talking about this REX platform they have and how they are improving efficiency, the cost base, client interactions becoming low touch, being that they've got these sophisticated individual— they're so cool. Viper is one of them, Iguana and Chameleon, and they're a toolbox. And depending on your trade that you want to execute, you just go to— and the algo immediately calculates the most optimal solution, and then you can trade via the algo, which is unusual because you're putting it in the client's hands to execute the trade. So you have zero touch, it's all technology-led, so it's highly efficient. It comes with certain downsides, but yeah, it's interesting because BNP seem to be— and on the algo space, they're running fifth-generation algo models now, and they're award-winning, they're the gold standard on the sell side. Which is something you probably might not think of when you hear their name against others.

Yeah, that, I mean, that's really, really interesting and definitely want to cover on your Friday podcast because my, the limits of my knowledge will quickly be reached. But again, just to go back to the Nike points. So Nike's trying to be a tech company. It works to an extent, but people still need physical shoes. BNP trying to be a tech company, Well, none of this stuff is physical anyway. So if we can do that better, cheaper, and at a higher quality, then this sounds strategically really, really interesting and very exciting.

Okay, so Microsoft and Apple as well, and OpenAI were in the news. Why was that last week?

Yeah, just to build on from our Mistral, we're going to drop OpenAI again, as we tend to do most episodes at the moment. I wonder whether, by the way, we'll look back at this run of episodes in a few years' time and go, well, that was obvious that we were speaking about these two companies or these three companies, or will we go, gosh, what a storm in a teacup. I can't believe we all bought into that.

Yeah.

Yeah. Maybe someone could be tracking the podcast to track bubble tops. But anyway, so this is a continuation story from some of the stuff that we've discussed over the last few months. Now remember, these big tech companies are so large that if they were to make significant acquisitions, Competition and Markets Authority in the UK and the FTC in the US would definitely have something to say. And when a company buys another company, they have a right to opine on that transaction and block it. So very cleverly, the likes of Microsoft and Google and Amazon and Apple trying to figure out how to get around this control point by, instead of acquiring, investing. Instead of acquiring, effectively buying or effectively employing all of the staff of a particular company, as we discussed a few weeks ago. So they're trying to create all of these different scenarios where the FTC is not going to come looking, not going to come sniffing. And obviously we know the value that has been added to Microsoft as a result of its tie-up with OpenAI. $12 billion, $13 billion of investment resulting in well over a trillion dollars worth of market cap gains, albeit not directly. So in response to increased regulatory scrutiny, both sides of the pond, Microsoft has dropped its board observer seat. On the OpenAI board, and Apple has chosen not to take up a board observer seat whatsoever. By the way, just stepping back, a board observer, it's someone that gets to sit at, gets to attend board meetings, but they are not officially a director of a company, uh, of the company. So a board observer doesn't have the liability, doesn't have the legal recourse that a director would have, but gets the strategic input of sitting in on the board meetings. It's quite a nice place to be. But anyway, Microsoft and Apple have pulled back, and this is because in the words of the law firm Foxgloves, Cory Kreider, big tech know that they're in a cat and mouse game with antitrust enforcers over artificial intelligence. So this really is very, very interesting. And the EU's weighing in and looking at the $13 billion of investments, specifically looking at the exclusivity clauses. Between Microsoft and OpenAI. OpenAI has to host its models on Azure, for example. Is that anti-competitive? Is that closing off the market? Yeah, this is going to be rumbling on for years and years and years. And quite frankly, the stronger the regulators get across all parts of big tech, I think the better, the better for startups, the better for consumers, The better for the marketplace. Bring on the regulation. That's what I say.

Oh, Trump will say to that, don't you worry, Steven.

Yeah, I'm a bit worried about that. A little bit worried about that. But I do think it will release creative energy. I think if you think about it, you know, 30, 40 years ago, if you were a technology company, or maybe even 10 or 15 years ago, if you're a technology company, your ambition was to IPO and become a big technology company in your own right. Nowadays, if you're any technology-adjacent company, your ambition is to get bought or to partner with a big tech firm in order to maximize your value. I don't think that that's right. All right.

Well, look, private equity one to finish. What do you have?

Yeah, we'll stand me down from my regulatory hobby horse and we'll talk about clear, Clearlake Capital Group. Now, the reason why I want to talk about this is because in part we like putting a little private equity bit onto most episodes, but this is a really interesting article. So this is the article that's titled The End of Cheap Money Era Catches Up to Chelsea FC's Owner. So Clearlake Capital Group, the owner of Chelsea Football Club, who spent billions of dollars buying and then wasting money on football players. They have about $80 billion of assets under management. So think about that in the context of KKR, it's, you know, well over $500 billion and Blackstone, it's top to trillion, but it's been growing extremely rapidly. And what is important about this story is they grew their funds. So they've got 6 funds. They're about to raise their 7th fund, Fund 7. Below the overall firm. The first fund was raised in 2009. It was a $415 million fund, but in 2020, they raised a $7.1 billion fund. A year later, they raised a $14.1 billion fund. So suddenly within 18 months, they've got $21 billion that they need to deploy. They need to start investing. It's not, You're not a good private equity firm if you just raise money and then don't call on that capital ever. So they've got to go out and invest it. What was going on in 2021, '22, '23, or early parts of '23? Huge, huge valuation bubble. Therefore, and I really, really like the way one analyst puts this, the vintage, the vintage of buying, of buyouts in '21 and '22. Is going to turn out to be a terrible vintage, like to wine growers in France. It's going to be a terrible vintage because you bought at too high a price. And what's happening is that there's a lot of debt that's in these companies that is looking pretty close to distressed levels. I sent you a little chart of some of the price cents on the dollar of some of these companies that are owned through these different fund structures of Clearlake. So again, could Clearlake be the canary in the coal mine of the excesses, raising too much money too quickly, deploying it too fast at bad valuations? And now as they're looking in '24, '25, '26 to start to sell on some of the '21, '22 vintage, They're now going, oof, all right, this isn't as good as we thought it was. These are potentially distressed companies or certainly distressed debt within companies. And are we going to be able to offload these? The sneaky point, by the way, as we finish this piece, the sneaky point of a lot of these private equity firms is that they've started creating continuation vehicles, effectively a new fund owned by Clearlake that acquire businesses that are held by a previous fund in order to provide liquidity and exit the original fund's limited partners. But it's still held, it's still held by the company. So eventually, I like, you know, the pass the parcel analogy works very well. Eventually the music's going to stop and someone's going to get, someone's going to get their, you know, someone's going to get very burnt.

My daughter wants to come in with her Jenga blocks, so we should play a little game here. Should we pull a few out, see how we go?

Yeah. Well, look, all the analogies end with the music stopping or the tower falling over or something like that. So again, let's, let's, we're going to stay on this story. There's a lot of these stories that are coming up again and again, which is really good from a, from a student's perspective that is trying to keep hold of the 4 or 5 bits of information, the 4 or 5 stories that they need to have a decent view on as they go into an interview. Going to their job. All right.

Good point. And on that note, we will wrap it up and we will see everyone next week. Thank you, Stephen.

Thank you, man.