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Shoe stock comes unlaced Fila had soared with Grant Hill line

THE BALTIMORE SUN

Everyone from physicists to blues singers teaches kids that what goes up must come down. But lately the stock market is teaching that harsh lesson to Fila Holding SpA.

Fila has been one of the market's highest nontechnology fliers, and one of Maryland's unqualified business success stories. Sales went from $188 million to $1.3 billion in five years, and one who bought 1,400 shares of Fila in 1994 at $15 could pay cash for the average Baltimore-area house with the profits by September, when Fila reached $106.88.

But Monday, just three months later, Fila shares were back to $58. In the sneaker business, image is everything, and the buzz has turned on Fila. Hard.

After two years in which analysts flocked to the stock, defending its sky-high price with visions of uninterrupted growth, Fila finds itself looking up at the overall stock market, at industry leader Nike Inc. -- and even at shares of oft-derided rival Reebok International Ltd., a company Wall Street thinks is finally getting its act together. And Fila hates it.

"I don't understand how you could be recommending Reebok [stock] at a higher multiple than ours unless you worked there," Fila USA General Manager Robert W. Liewald complains.

But it's happening. And there there are a lot of reasons why.

Fila pins much of the blame on short sellers, on the arrival of more skeptical footwear analysts at a pair of Wall Street firms, and on announcements that fashion companies like Ralph Lauren, Tommy Hilfiger and Donna Karan are pushing into the sneaker business, threatening to chip away at Nike, Reebok, and particularly Fila.

But closer to the bottom line is slow retail sales of the latest Fila shoe endorsed by Detroit Pistons forward Grant Hill. Hill's first shoe sold 1.5 million pairs last year, a performance Fila says made it the biggest new sneaker since the first Air Jordan. The second edition of the Hill sold even more. But the new edition, Fila's first $100 sneaker, is being marked down to $80.

High-flying stocks are always vulnerable to bad news, especially when they're driven as much by a key product as is Fila. When the Hill sneezes, Fila catches cold.

"Markets always bid up stocks that show strong growth rates," said John Horan, editor of the newsletter Sporting Goods Intelligence. "All you need is one little tiny mistake to see the market overreact in the other direction."

Fila hasn't had much opportunity to learn how to accept criticism gracefully. There hasn't been much criticism for the Italian firm, which has U.S. headquarters in Hunt Valley.

Fila labored in near-obscurity through the late 1980s. A licensee controlled the footwear brand in the United States, and hadn't done much with it. But Fila bought out the licensee in 1991, and things took off from there.

Fila had a tiny piece of the 1991 market, but a key edge: it was closely identified with the trend-setting inner-city consumer. As black style went hip-hop, and hip-hop went mainstream, Fila rode the waves skillfully.

By 1993, when Fila went public, it wanted to break into suburban markets ruled by Nike and Reebok. Executives also wanted to make people think of Fila as a shoe to wear to work out, rather than just a fashion item. They saw athletic acceptance as the way to make sure Fila didn't go the way of L. A. Gear, a hot 1980s brand that collapsed when the fashion trends that made it big faded.

So Fila began signing big-name U.S. athletes to endorsement deals. Endorsements sell shoes and build an athletic image, but each endorsed pair is also more profitable than the same shoe without an endorsement because the extra markup more than covers the athlete's fees. In 1994, Fila outdueled Nike for the blessing of Grant Hill.

The first Hill shoe became a staple at suburban YMCAs as well as on city buses, winning Fila previously unavailable amounts of prime display space from chains such as FootLocker. Other winning ideas followed.

"The key driver of Fila's growth has been its ability to create excellent product," Salomon Inc. analyst Brett Barakett wrote earlier this month. "More so than at any other company, the product creation group at Fila is superior to all other departments."

Fila's profits went just about nuts. The company's U.S. market share doubled between 1993 and 1995 and it moved to third place last year from sixth in 1993 in U.S. wholesale athletic-shoe sales, according to Sporting Goods Intelligence. International shoe business also grew fast, and promising clothing lines blossomed.

Even as Fila beat Wall Street's earnings expectations every quarter, the forward-looking news was usually even better. When Fila announces its quarterly results, it also discloses information about its orders for the next quarter or two -- and those reinforced the good news by showing sales rising 30 percent to 50 percent or more in the future as well.

Fila made more than $61 million last year, or $2.42 per American Depositary Share. Analysts expect this year's earnings to be $4.30 a share and next year's to reach $5.37 a share.

By September, Fila's stock was riding a wave of optimism so intense that its American Depositary Shares traded at more than 31 times Fila's recent earnings (the Standard & Poor's 500-stock index is now at about 20 times earnings). Merrill Lynch analyst Brenda Gall defended the price in May, saying using past earnings to value Fila stock was unfair because 1997 earnings figured to be so much stronger than 1995 or even 1996.

But over at Salomon, former Reebok executive Barakett wasn't buying it.

Other analysts thought Fila would keep growing 20 percent to 30 percent a year. They thought Nike would grow 20 percent plus. But industry sales are growing only 7 percent to 10 percent.

"Someone has got to give," Barakett said. So when Salomon started formally covering Fila Dec. 3, Barakett rated the stock as "neutral" -- a kissing-your-sister rating on Wall Street.

"I wasn't bearish. I put a hold on the stock, not a sell on the stock," protests Barakett, whose report predicts that Fila shares will rise to $80 to $83 in a year. But all of a sudden, skeptics about Fila weren't completely alone.

Over at Gruntal & Co., analyst Susan Silverstein had moved on and been replaced by Michael Conn, who cut to $80 Silverstein's estimate that Fila shares would reach $115 in 18 months. He wouldn't talk about it, saying "it is a sensitive situation."

Both Conn and Barakett wrote that Wall Street's expectations for Fila's sales growth are too high. Barakett thinks that sales growth could fall to 10 percent early next year, despite Fila's November announcement that futures orders for the first half of 1997 are up 41 percent from the same time last year.

"One particular concern, in our view, is signs of continued sluggish [retail sales] for the company's marquis [sic] footwear product, The Grant Hill," Conn wrote. He blamed a slow market for basketball shoes and better competition from Reebok and Converse, both of which have struggled recently.

"The Grant Hill came out and didn't sell anywhere near expectations," Liewald admits. But he says all basketball shoes are moving slowly, and that doesn't mean Fila is losing its touch.

Sporting Goods Intelligence's Horan agrees: "Outside of the Air Jordan, nothing is doing much. The Penny [a heavily promoted Nike shoe named for Orlando Magic guard Anfernee "Penny" Hardaway] went out at $140 and went to $99 in a week."

But Barakett is worried about more than just the Hill shoe. Longer-term, he says, the push into sneakers by fashion houses like Donna Karan, Ralph Lauren (which is in a joint venture with Reebok), Nautica and Tommy Hilfiger will claim up to 7 percent of the $8 billion U.S. wholesale sneaker market, an estimate that he bases largely on conversations with retailers.

That share will have to come from somewhere, and he figures the strongest candidate to get hurt is Fila. More than Nike and Reebok, Fila relies on fashionable design -- the newcomers' strength -- to sell its shoes, Barakett said. Fila doesn't have the Air technology that makes people ask for Nikes, or the Feet You Wear concept that is boosting Adidas.

The only Fila shoe Barakett sees selling season after season is the Hill. Other than that, he reasons, Fila has to keep the brand hot by coming up with fresh styles every season. That's easier said than done, especially once big fashion houses get into the game.

"These are serious players" with more money, better reputations and more clout with retailers than eclipsed fashion-sneaker rivals like L. A. Gear, he said.

Fila executives seem puzzled by Barakett's analysis. They say he assumes that Fila will get beaten up by brands that aren't direct competitors -- either because they're likely to be far more expensive or because they don't have any athletic style or function.

Donna Karan sells to women, a market where Fila is already weak, although it has been improving. Prices for Lauren's shoes haven't been announced because they won't come out until 1998, but the brand is at the expensive end of every market it's in -- a marked contrast to Fila, whose most expensive sneaker is $40 cheaper than the top of Nike's line.

"The only one that could make a significant impact is Tommy," said Liewald, a former top executive at FootLocker.

Nonetheless, once the stock started falling little problems began to seem more important. In particular, a scandal that broke in in October involving ex-financial executives of the Italian conglomerate Gemina S.p.A., which owns about half of Fila, forced executives to deny speculation that Fila would revise past earnings reports showing spectacular growth.

Then short selling began rising. The number of Fila's shares sold short -- an aggressive bet that the stock will fall -- rose to 1.5 million inDecember from 72,000 in July. That is still modest, but it's enough to make the company defensive -- especially after Forbes magazine, quoting an anonymous short seller, projected that Fila could fall to $50.

Fila dropped more than $5 a share as news of the piece spread early last week. But in yet another sign of how volatile Fila stock has become, Fila rose more than $5 Thursday after Nike reported that its quarterly earnings rose 81 percent. It closed Friday at $65.125.

"All the rumors are creating nervousness, and it's very misleading," insists Giacomo Del Grande, Fila's investor relations director. "When rumors and other kinds of information start coming into the market, it's very difficult to control it."

There are dents in the facade that shone so brightly a few months ago, Liewald and Del Grande concede. Future sales growth looks slower, and widening profit margins will stagnate next year as Fila spends more on advertising.

But the company sees itself as essentially the growth play it has been since it went public: Del Grande says Fila still expects to boost sales and profits by 28 percent to 30 percent next year.

And Fila has been down this road before. Its stock tanked eight months ago when market commentator Dan Dorfman wrongly predicted that fall sales "just ain't happening," and again at this time last year on rumors the Hill II was selling poorly. In the past, bears always hibernated after the earnings came out. Whether that will happen again remains to be seen.

"After so many quarters where we have proven ourselves, people shouldn't listen so much to short-sellers, which apparently they do," Del Grande grouses. "It's not easy once people get nervous."

Pub Date: 12/22/96

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