Falling into The Gap

By Nancy R. Gibbs

The plunge made Wall Street veterans grab for their rip cords. "I've never seen a stock fall that far, that fast," said Barry Bryant, a retail analyst at Drexel Burnham Lambert. "This is a decline that leaves you gasping." Only a month ago Gap Inc., owner of the Gap, GapKids and the Banana Republic clothing chains, had been one of the stock market's highest flyers. But from an August peak of 77 7/8, the stock sank to 37 early last week, down 52%. That included a 10 1/4-point drop last Monday alone.

Even for the wild market of 1987, it was a hair-raising ride. Many of the forces driving Gap stock down affected other retailers as well: sluggish August sales, sharper competition and growing ambivalence among shoppers. But such factors were not enough to account for the rout of Gap stock. Some problems were uniquely its own -- just as its startling success had been over the previous four years.

The Gap, which is based in San Bruno, Calif., has been an innovative leader in the specialty retail business that is siphoning sales away from department stores. Founded in 1969 by Entrepreneur Donald Fisher, the company relied heavily on the blue-jeans craze in the 1970s, but then added bright-colored, practical sports clothes. In 1983 Fisher made two shrewd moves. He bought Banana Republic, a San Francisco retailer with three stores and a catalog operation that sold trendy travel and safari wear, and he hired a new president, Millard Drexler, the marketing whiz from the Bronx who had turned around the faltering Ann Taylor chain.

Drexler worked similar magic at the Gap. Between 1983 and 1986 its sales rose from $480 million to $848 million as the number of stores expanded from 550 to 724. Banana Republic alone grew to 65 stores. The Gap's annual profits ballooned from $21.6 million to $68.1 million. Before its dive, the firm's stock price had risen nearly 2,900% in five years. Said Dean Witter Reynolds Analyst William Tichy before the stock's plunge: "This thing has just defied the law of gravity."

But last week the stock started obeying all physical laws. The trouble began at a Sept. 17 Manhattan conference on the retail industry with Smith Barney as host. Dozens of top Wall Street analysts and institutional investors were assembled to hear reports from the leading companies. Many of the experts suspected that the news was not good. But the Wal-Mart Stores discount chain announced that sales were up sharply in September. The chairman of Toys "R" Us declared that though this was a slow period, he was excited about the Christmas season. True to Gap tradition, Chairman Fisher refused to reveal any projections for third-quarter earnings. In the past, though, company officials had offered at least a hint of whether sales were up or down. This time there was not a word, and the analysts got queasy. "We are a forgiving lot," says Walter Loeb of Morgan Stanley. "Had Gap advised us about what was happening, we would have stayed with it. But we on the Street don't like surprises."

Troubled by the uncertainty, many analysts took the Gap's stock off their list of recommended buys. The company's shares fell by 8 5/8 the next day. Then over the weekend, Chairman Fisher finally announced the firm's projections for third-quarter earnings: 40 cents to 55 cents a share, in contrast to 60 cents last year. It was this news that drove the stock down another 10 1/4 points last Monday. On Tuesday, when the Dow Jones industrial average climbed a record 75.23 points, the Gap managed an anemic 5/8-point rise. It closed on Friday at 36 3/4, down 10 1/2 points for the week.

What could account for such a collapse? Some factors were plaguing the entire retail industry. A hot summer and late Labor Day meant that the normal back-to-school spending sprees never really revved up. Some shoppers, it seems, were just not sure what they wanted to buy. Many were wondering, for example, if the miniskirt was really back. Once inventories piled up, stores had to cut prices to keep their merchandise moving. That depressed earnings. The Limited's stock price dropped 27% over the past month, and the Dress Barn was down 25%.

But the Gap apparently made some mighty miscalculations of its own. Analysts say its fall colors, weighted heavily toward gray, beige and olive, were too drab for many shoppers. The chain's staples -- roomy buffalo-plaid flannel shirts, ten-button Tees and jeans -- did not offer buyers anything fresh. Even Banana Republic's safari look was running out of steam. Meanwhile, copycat stores seemed to be appearing on every corner.

Some industry experts predict that the Gap will regroup in time for Christmas. In San Francisco and two other locations the company is trying out a tony kind of store, new for the Gap, called Hemisphere shops, to cater to an upscale market. "We're going to adapt," vows Drexler. "It's a matter of speeding up our creative process." And despite last week's setback, the Gap remains one of the most profitable chains in the country. "I see some hopeful developments for 1988," says Loeb. "You do sometimes have a season that is wrong, but that doesn't mean the company is going to fold." That should console Chairman Fisher. In the past month the value of the 9.5 million Gap shares that he and his wife own fell by close to $360 million. That is quite a gap to fill.

With reporting by Charles Pelton/San Bruno and Linda Williams/New York