Key Takeaways:

Xtep will sell KP Global, the owner of K-Swiss and Palladium, to Xtep’s controlling shareholders for $151 million through a series of transactions
The foreign brands have racked up losses since the athletic apparel and shoe seller acquired them for $260 million in 2019

By Warren Yang

Talk about a misstep. Just five years after acquiring the globally known K-Swiss and Palladium shoe brands, Xtep International Holdings Ltd. (OTC:XTEPY) is preparing to dump the pair to stop the bleeding from what has turned out to be a self-destructive purchase.

Last Friday, the sports apparel maker issued a 100-plus page document detailing a complex series of transactions to divest the two brands, which it acquired in 2019 from Korean group E-Land. The company first announced its plan to sell the assets in May.

The sale is a bitter move for Xtep and shows how Chinese acquisitions of shaky global brands, with plans to reinvigorate them by bringing them to China, can sometimes backfire. Xtep bought K-Swiss and Palladium for $260 million and has racked up more than $100 million in losses from them since then. Last year alone, Xtep booked a loss of about $32 million from the two assets, and says it expects more of the same this year. Xtep blamed slumping consumer demand in China for the brands’ struggle, but that’s not their only challenge.

Palladium is a French brand best known for casual canvas boots, positioning it differently from Xtep’s core focus on sports shoes. But times are rough these days for global sports apparel brands as they lose market share to more innovative startups. At a time when even behemoths like Nike and Adidas are feeling the pinch, it’s not hard to see why older second-tier players like K-Swiss, a former tennis shoe pioneer, is having trouble staying relevant.

Xtep is disposing of K-Swiss and Palladium through a series of transactions that are quite complex, which seems to reflect a certain amount of difficulty the company had in disposing of the brands.

The company will first sell KP Global, the entity that owns K-Swiss and Palladium, to the family of Ding Shuipo, Xtep’s controlling shareholder, via a vehicle named Ding Shun Investment for $151 million. Then, Xtep will distribute all money from the sale to its shareholders as special dividends.

The company says it will pay the dividends “in appreciation of long-term support” from shareholders. But the plan also looks like a way to reimburse the Ding clan for some of the money it is spending to take KP Global off Xtep’s books. The family owns 46.5% of Xtep, so it should get a little less than half of the $151 million back through the special dividends. As the Ding family has “material” interest in the dividends, it abstained when Xtep’s board voted on the matter, the company said.

But the whirlwind of transactions doesn’t end there. KP Global will also redeem $65 million of convertible bonds related to K-Swiss held by a third-party investor. Then, Xtep will issue a roughly matching amount of convertible bonds due in 2030 to the third-party investor. So essentially, Xtep will swap K-Swiss convertible bonds with its own convertible bonds for the third-party investor.

Call Option

The Ding family vehicle buying KP Global will also write a call option that gives the investor the right to own 20% of KP Global for $65 million within five years. To sum things up, KP Global will give $65 million to the investor by redeeming the K-Swiss convertible bonds. Then the investor will channel the same amount of funds back to Xtep by subscribing to Xtep’s own convertible bonds. And the investor may later exercise its call option for 20% of KP Global shares.

Topping things off, KP Global will issue $154 million of convertible bonds to Xtep to raise the $65 million it needs to redeem the K-Swiss convertible bonds and to cover its accumulated losses from operations. If Xtep converts the notes in the future, it will retake some ownership in KP Global, with about 30% of the company.

Through all these transactions, Xtep will be able to stop booking losses from KP Global, without completely cutting ties with the business. That leaves Xtep the option to benefit if K-Swiss and Palladium ever bounce back. Ding’s ultimate goal may be to sell the brands to an unaffiliated company and pocket some profit. But reviving the brands is likely to require significant investment, which seems difficult right now due to KP Global’s cash-strapped situation.

Sales of K-Swiss and Palladium products are actually surging in China right now, though from a low base. Last year, domestic revenue from the two brands more than tripled to 465 million yuan ($65 million). But overseas sales fell nearly 10%, reflecting the brands’ waning popularity in global markets.

For now, Xtep may be better off focusing on augmenting its own brand at home, following in the footsteps of rivals like Li Ning (2331.HK) and Anta (2020.HK), which have grown rapidly in recent years, taking market share from Nike and Adidas. National pride has helped to fuel the Chinese companies’ rise, but improvements in their product quality have played an important role as well. So have endorsement deals from big-name athletes, particularly those in the NBA, which is hugely popular in China.

In 2018, Li Ning scored a lifetime contract with 13-time NBA All-Star Dwane Wade, who defected to the Chinese brand from Nike six years earlier. And NBA players wearing Li Ning shoes include another superstar, Jimmy Butler. Last year Anta signed its own deal with Kyrie Irving, a significant addition to its existing long-running partnership with Klay Thompson.

Xtep is endorsed by Jeremy Lin, the former New York Knicks player who sparked a cultural phenomenon known as “Linsanity” back during the 2011-12 season. And it’s raising its profile with elite Chinese marathoners running in its shoes.

As Xtep focuses on its own core brand, assets that need retooling like K-Swiss can be obstacles. So, the disposal of K-Swiss and Palladium removes an unneeded distraction.

Xtep shares have risen somewhat following the original announcement of its plan to divest those brands in May, but have given back all those gains since then. They now trade at a price-to-earnings (P/E) ratio of about 10.7, slightly higher than 9.9 for Li Ning but far below 17.3 for Anta, the largest of China’s major sporting apparel brands. And Xtep’s market capitalization is much smaller than the other two.

A renewed focus on its core brand, with the disposal of money-losing K-Swiss and Palladium, may help Xtep improve its financials quickly. But with its overseas ambitions now taking a major haircut, the company will be forced to show it can pick up market share from larger domestic and international rivals in its competitive home market.

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.

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