Kanye West took to Twitter on Wednesday to proclaim that his shoe and apparel brand Yeezy would “hit a billion dollars” this year and is on its way to being worth ten times that much.
“It is the 2nd fastest growing company in history,” West wrote. “It is a unicorn on its way to becoming a decacorn.”
A “unicorn” is Silicon Valley jargon for a privately held company valued at over $1 billion. A “decacorn” would be worth $10 billion or more.
West’s claims were greeted with a lot of skepticism. Could his weirdly named brand of ugly shoes really be a unicorn? Priced like some genius tech start-up? Come on!
But some rough back of the enelope math and a deep dive into Adidas annual report suggest that West is correctly reporting the value. West’s shoes are a billion business. And they may be much bigger than that.
To figure out how much Yeezy is worth takes some work. There’s no financial disclosure that directly reports the valuation Yeezy, which is a “brand partnership” between West and Adidas. Instead we have to turn to Adidas financial disclosures to sniff out a valuation. This is not easy because Adidas tells us next to nothing about Yeezy. No sales figures. No expenses. No profit margins. No growth figures. Nothing except that it exists.
Oh. There’s one other thing. Adidas executives are really excited about Yeezy. Almost as excited as West himself.
“The strategic partnership with Kanye West is likely to be the most significant one ever created between an athletic brand and a non-athlete,” the normally sober German executives told their investors in last year’s annual report.
So what else can we learn about Yeezy from the 2017 report?
Last year, German-based Adidas reported that its footwear division had 12.4 billion euros in sales, 24 percent higher than the prior year. That accounts for about 58 percent of the company’s 21.8 billion euros of total sales, which was an increase of 16 percent. This tells us that footwear is becoming more important to Adidas and is the biggest source of the company’s sales growth. In fact, footwear sales accounted for 82 percent of the growth from 2016 to 2017.
Profits at Adidas grew to 10.7 billion euros from 9.2 billion, a growth of 18 percent. Profits growing faster than revenues indicates that the company’s margins, the profitability of each sale, are expanding. As well, the money it spent producing its shoes grew by just 12 percent, from around 9.4 billion euros to 10.5 billion, far less than the growth of sales. As a result, the company says its gross margin, which is the difference between the direct costs of making its shoes and its sales, rose to 50.4 percent from 49.2 percent.
Combine the footwear driven sales growth with the margin improvement and you get a strong indication that the footwear business is higher margin than the other products Adidas sells. Or perhaps that it is improving the margin on its footwear business by a lot. There appears to be what financial analysts call operating leverage in the shoe business. The reason we have to do some guesswork here is that Adidas does not give more granular numbers because it does not want to give its competitors to clear of a view of its internal operations.
Unfortunately for investors, the shoe business has very high overhead. Think of how expensive all those shoe advertisements you see everywhere must be. So while the gross margin is 50 percent, the operating margin–which is sales minus not only the cost of making shoes but all of the overhead, including marketing, paying executives, and administrative costs–is far lower. Last year, Adidas had a operating margin of 9.8 percent, which was an improvement from the prior year but still quite a bit lower than its competitors. The company says it expects this to rise to between 10.3 percent and 10.5 percent next year.
This paints Yeezy in a very favorable light. It is in the fastest growing part of the company, which likely has superior gross margins. Its very likely that the operating margins that could fairly be assigned to Yeezy are very, very good. Yeezy branded shoes sell themselves in a matter of hours. You’ve got Kanye West marketing them for you on Twitter and everywhere else in the known universe. No need for expensive ad campaigns, bringing marketing costs down to close to nothing. The shoes are sold directly via the internet, which also reduces sales overhead. There’s some overhead associated with executives working on the brand. Most likely the biggest piece of overhead are the commissions or royalties that get paid to West.
But Kanye West is basically a machine for improving operating margins.
A conservative estimate would be that Yeezy has operating margins of something closer to 20 percent–twice that of the company as a whole. It may be even better than that, since a lot of the administrative costs would have to be absorbed by Adidas if Yeezy didn’t exist. A very good operating margin at Yeezy, combined with expected growth, would explain part of how Adidas plans on cutting its overall operating margin.
There are other hints in Adidas annual report that Yeezy is very valuable. The partnership with West was part of Adidas push to grow in the U.S., so it makes sense to look to U.S. sales for clues about Yeezy. Sales of Adidas branded gear–which includes the Yeezy brands–hit 3.8 billion euros in North America sales, 33 percent higher than the year before. That is the highest growing business of the company.
In another tweet, Kanye said that his Yeezy 350s sold 400,000 pairs in 4 hours. These had a sticker price of $220. So that single “drop” would represent $88 million of sales. How much could Yeezy be selling in a year? That 400,000 is likely a high water mark not an average sales number. Let’s make the conservative assumption that a typical drop is one-third of that massive 350 sale, or around 132,000 pairs. At eight drops a year, Yeezy would see sales of $232.3 million. Subtract out the overhead and operating profits are around $46.5 million.
To do a quick gut check on that, let’s see how that compares with the overall numbers. If our sales or profits figures are impossibly large compared with the overall size of Adidas, we’ll have to revise them. But even at $232 million in sales, Yeezy would amount to just 5 percent of Adidas North American sales last year. That is high but it hardly sounds unreasonable given that he is central to their U.S. growth strategy. In terms of worldwide footwear sales, Yeezy would amount to around 1.5 percent, which is still not unreasonable. Measured against all Adidas sales, Yeezy comes in at less than 1 percent.
Can $46.5 million of annual operating profits make Yeezy worth $1 billion? Pretty clearly, the answer is yes. The market values shares of Adidas at around 16 times operating profits. At that valuation, Yeezy would be worth $744 million. But the higher-margin, faster-growing Yeezy would call for a higher valuation than the company as a whole. At Nike’s 20 times operating profit valuation, Yeezy would be worth $929 million. But, again, Yeezy is young, growing, and higher margin. So its multiple should be even greater than Nike’s. Tick up the valuation to 22 times, and Yeezy clears the billion dollars easily.
And remember, to reach this $1 billion or so valuation, we estimated sales at just one-third of the number West tweeted. Sales could be much higher. Or operating margins could be better than 20 percent. This is a conservative valuation.
The stock market says Adidas is currently worth 43.75 billion euros. If Yeezy is a $1 billion company, it would be worth around 1.8 percent of the total company. That’s about twice what its sales would imply. But remember, Yeezy almost certainly has much better margins. So this fits.
Can Yeezy grow to be a $10 billion company? Using the metrics above, it would have to have operating profits of $465 million. Sales would have to be around $2.3 billion. While that number sounds incredible, keep in mind that on the secondary market, Yeezy shoes often sell for between 150 percent and 500 percent of their sticker price. That implies that there is a lot of unmet demand for the shoes. So there is likely a lot of room for growth in the brand.
Perhaps, however, West is thinking of something else. Nike’s Jordan brand has sales in the neighborhood of $3 billion. If Kanye gets anywhere near that number–and there’s no reason to think he can not–Yeezy will be worth at least $10 billion.
Let’s just hope his next video doesn’t feature him riding on a ten-horned horse. He’s already got one potential decacorn. He doesn’t need to make us see another.