Armchair Archaeologist

FRANKFURT (Reuters) - Germany's sporting goods maker Adidas-Salomon has agreed to buy U.S. rival Reebok for $3.8 billion, closing the gap on Nike and promising a profit jump by expanding in the United States and entering new markets.

The world's second- and third-biggest sports goods companies said on Wednesday Adidas would buy the outstanding shares of Reebok for $59 per share in cash, a 34 percent premium to Reebok's closing share price on Tuesday.

The combination will create a more formidable competitor to battle Nike's dominance of the market for athletic gear, particularly in the United States, which accounts for 50 percent of the sports footwear market alone.

Reebok, based in the Boston suburb of Canton, Massachussets, brings along key equipment licensing contracts with major North American professional sports leagues, including the National Football League, National Basketball Association, National Hockey League and Major League Baseball.

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Reebok shares surged 32 percent to $58 on Instinet ahead of the 1330 GMT New York open, while Adidas was up 5.7 percent at 156 euros in much higher volumes than usual by 1153 GMT after it painted a bright outlook for the merged firm in a conference call.

Shares in Adidas had initially dropped 4 percent on the news, as some analysts questioned the deal's benefits and cost.

The takeover complements Adidas's strengths in Europe with Reebok's strong position in the United States.

"The deal makes sense. In one go, both brands are expanding significantly in Asia, North America and Europe," said HVB analyst Uwe Weinreich.

Puma, the world's fourth-biggest sporting goods company, last week also unveiled aggressive expansion plans through acquisitions and entry of new sportswear markets.

Adidas said it was confident Reebok's shareholders would approve the deal, which includes Reebok's net cash position of $84 million.

Adidas said the deal with Reebok, which it expects to close in the first half of next year pending antitrust and shareholder approval, would boost net income of the new Adidas Group by more than 10 percent per year in the medium term.


Sales are seen growing at a mid- to high-single-digit rate, and cost savings are expected to reach $150 million annually by the third year after the deal closes.

Adidas said it expected no significant restructuring costs and that they would quickly be outweighed by synergies.

Dresdner Kleinwort Wasserstein raised its investment view to "buy" from "add," saying Adidas' margins would grow.

In the key U.S. market -- where Adidas has repeatedly changed strategy to attack market leader Nike -- Adidas and Reebok said sales would double as Adidas gets access to Reebok's popular basketball, American football, hockey and womenswear products.

"North America is the market where you have to be," Adidas Chief Executive Herbert Hainer told a conference call.

In the second quarter, Adidas's sales grew in all regions except Europe, meeting expectations by rising 8.2 percent to 1.52 billion euros.

Net income rose 33 percent to 94 million euros ($116 million), when adjusted for the sale of Salomon -- beating the average estimate of 86 million euros forecast in a Reuters poll of 18 analysts.

For 2005, the Bavarian firm reiterated net income from continuing and discontinued operations would rise 20 percent.

LIFESTYLE VS SPORTS

Analysts said Adidas would also benefit from Reebok's strong lifestyle fashion business. Reebok Chairman and CEO Paul Fireman will continue to run the Reebok brand.

Adidas, best known for its trademark three-striped running shoes, has been trying to imitate the success of German rival Puma, whose trendy sportswear has spread far beyond the gym or running track.

But some investors were cautious about how successfully Adidas would integrate Reebok, and questioned the deal's timing ahead of next year's World Cup soccer tournament in Germany, of which Adidas is a major sponsor.

"I would watch the execution of the integration very carefully because it won't be easy to integrate the businesses -- Adidas's focus is on sport but Reebok's is on lifestyle," said Volker Riehm, fund manager at Activest.

"Apart from that, Adidas is creating a load of work for itself when the World Cup mega-event is just around the corner." (Additional reporting by Georgina Prodhan and Natalia Matter)

The deal, which was being negotiated late last night and could be announced today, would give Nike its first formidable competitor in more than a decade. A combined Adidas-Reebok would control about 20 percent of the market, but would still remain behind Nike, which has about a third of the $145 billion worldwide market.

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Driving the deal, analysts said, is Adidas-Salomon's chief executive, Erich Stamminger, who has been vocal about the German company's effort to build market share in the United States. John Horan, publisher of Sporting Goods Intelligence magazine, sees the $9 billion branded-shoe market in the United States rising 8 percent this year.

The combined company would likely have increased clout among retailers and an ability to command shelf space. The company would also be better positioned to bid on endorsement contracts and to wring discounts from the multitude of media outlets from which it buys advertising.

"The remaining entity clearly is strengthened in terms of competitive position versus Nike," said Stephen A. Greyser, a professor of sports marketing at Harvard Business School. "The combined company will have more globally than either of the two alone, not just because of size but because of geographic strength. The same goes for distribution, too."

Still, the transaction may raise questions among some investors because it comes at a time when consumers are moving toward fashion-related footwear. Indeed, Nike demonstrated that trend last year when it acquired Converse sneakers for its Chuck Taylors, which have become a retro-fashion staple.

Under the terms of the deal being negotiated, Adidas would pay about $59 a share for Reebok, the executives said. That represents about a one-third premium over Reebok's shares yesterday, which closed at $43.95, up $1.19. Adidas would also assume about $550 million in debt from Reebok, which is based in Canton, Mass. Adidas is based in northern Bavaria in the town of Herzogenaurach.

While the deal is expected to face some scrutiny by regulators in the United States and Europe, antitrust lawyers suggested that it would likely be approved because the marketplace would probably be defined very widely.

The deal's biggest beneficiary would be Paul Fireman, who brought Reebok to the United States from Britain in 1979. Reebok, which is credited with inventing track spikes, capitalized more than any other company on the fitness boom of the mid-1980's, particularly by catering to women, and its fortunes soared in that period.

It moved ahead of Nike as the athletic shoe industry leader in 1987 for a brief time. In 1987, the Reebok board decided it was time to let somebody else run the company and Mr. Fireman was elevated to the new position of chairman, with no responsibility for the day-to-day running of Reebok. He came back as chief executive in 1999, with the stock hovering around $7.

Adidas has made China a particular focus for its expansion, signing on as a sponsor of the 2008 Olympic games in Beijing. Acquiring Reebok would bring Yao Ming, the popular Houston Rockets center from Shanghai, into Adidas's stable of high-profile athletes. According to a recent survey Nike released to analysts, 52 percent of Chinese currently rate Nike as the "coolest" athletic brand compared with 38 percent for Adidas and 15 percent for Reebok.

Adidas is offering $59 for each share of Canton, Massachusetts- based Reebok, 34 percent more than yesterday's closing price. The combined company will have about $11.1 billion in sales compared with Nike's $13.7 billion. Adidas's stock rose to the highest in more than seven years, while Reebok's jumped 23 percent in Europe.

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``It propels them up,'' said Mark Hargraves, who helps manage $7.1 billion, including Adidas Salomon shares, at Framlington Group Plc in London. ``The U.S. market is historically where they've been under represented and it's been difficult to gain share. So in one jump, it moves them up.''

Adidas shares rose 6.18 euros, or 4.2 percent, to 153.70 euros at 2:33 p.m. in Frankfurt, the highest since July 17, 1998. Shares of Reebok, whose endorsers include basketball player Yao Ming and rapper 50 Cent, climbed $13.46 to $57.41 in Germany.

The acquisition will boost earnings in the first year and save 120 million to 125 million euros the first three, Hainer, 51, said.

Second-quarter profit rose 34 percent to 94 million euros from 70 million euros a year earlier, Adidas said today in a statement. Analysts were expecting 82 million euros, according to the median of five estimates gathered by Bloomberg. Sales gained 8 percent to 1.52 billion euros.

Reebok traces its roots back to the 1890s, when English runner Joseph Foster invented a spiked running shoe and then started his own company, according to the Reebok Web site. Reebok remained a British business until 1979, when Paul Fireman noticed the shoes at a Chicago trade fair and bought the license to sell them in North America. Fireman is now the company's chief executive.

Adidas's U.S. market share will double with the purchase, according to Christian Schindler, an analyst at Landesbank Rheinland Pfalz in Mainz, Germany, who rates the company ``outperform.''

The company had an 8.9 percent share of the $8.9 billion wholesale U.S. athletic-shoe market last year, according to the industry newsletter Sporting Goods Intelligence. Reebok controlled 12 percent, and Beaverton, Oregon-based Nike had 36 percent.

Adidas has been expanding in the U.S. amid a slowdown in Western Europe. It signed tennis champion Andre Agassi to an endorsement contract last month after his 10-year, $120 million agreement with Nike expired this year.

The transaction will give Adidas 28 percent of the global $11.5 billion athletic-shoe market, rivaling Nike's 31 percent and widening the lead over its cross-town rival Puma AG.

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``Adidas on its own will probably never have a chance to pass Nike, but with Reebok now they can be a strong No. 2,'' said Andreas Inderst, an analyst with ABN Amro in London.

Adidas and Nike also are becoming fiercer rivals in soccer in the run-up 2006 World Cup, to be held in Germany. Adidas, which sold 6 million Roteiro soccer balls and 1 million pairs of PredatorPulse shoes last year, has formed a 100-member team to plan for the event. The company will unveil the tournament ball in September and roll out merchandise including World Cup jerseys later this year.

The company expects to complete the acquisition in the first half. Adidas plans to finance the transaction through capital increases and debt. Hainer said on a conference call that negotiations to buy Reebok began after he first met Fireman at last summer's Athens Olympics.

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Adidas is paying about 10.7 times Reebok's earnings before interest, taxes, depreciation and amortization and about 0.9 times revenue, according to Bloomberg data. It paid about 8.92 Ebidta and 1.1 times revenue for the ski-equipment business Salomon.

The company agreed to buy Salomon in 1997 for as much as 8 billion French francs, or $1.34 billion at the time. In May, it agreed to sell the business to Helsinki-based Amer Sports Oyj for 485 million euros to focus on more profitable lines such as T-Mac and ClimaCool sneakers and TaylorMade golf clubs.

``At first glance, the price looked demanding, but taking into account the potential synergies and benefits the deal looks more attractive,'' ABN Amro's Inderst said of the Reebok transaction.

Reebok, whose shares had risen 30 percent the past year, said last month that second-quarter profit rose 71 percent, helped by gains in countries such as India and China and new Pump basketball shoes.

Adidas expects the acquisition to get Reebok investor approval and doesn't foresee any regulatory obstacles, Chief Financial Officer Robin Stalker said on a conference call with analysts. Hainer said on the call that Fireman will continue as Reebok chief executive.

Merrill Lynch advised Adidas-Salomon and CSFB advised Reebok on the transaction, according to today's statement.

Reebok is based in Canton, Mass., and would continue to operate under that name with Fireman at the helm after the deal closes during the first half of 2006, the companies said. Adidas is headquartered in Herzogenaurach, Germany.

Recent Reebok ads from independent New York agency mcgarrybowen have generated some controversy, most notably a commercial featuring rapper 50 Cent, who discusses being shot. The company spent slightly more than $40 million on U.S. ads last year, per Nielsen Monitor-Plus.

Adidas' marketing has focused somewhat more on performance, and its endorsers include soccer icon David Beckham. Omnicom Group's TBWA\Chiat\Day in San Francisco and 180 in Amsterdam, the Netherlands, are Adidas' principal creative agencies. Adidas spent $80 million on domestic ads last year, according to Nielsen.

"Adidas just doesn't have the traction to go it alone in the US," said Gavin Finlayson, an analyst at Commerzbank Corporate and Markets in Frankfurt.

"It has been stuck on the sidelines in the US over the past few years as it doesn't have the clout of Nike."

Joining forces with Reebok will give Adidas more power to negotiate with retailers in the US and push for better positioning and promotion.

Outside of North America and picture is rosier, with analysts saying that the deal complements Adidas's strengths in Europe and Asia.

It would allow the company to develop Reebok's Asian business - the company also has been making inroads into India and China - and strike better deals with producers.

Following the takeover, Adidas will have a 28% share of the world's sporting goods market, not far off Nike's 31% slice.

In the tight-margin world of shoe retailing these can prove to be valuable weapons, analysts said.

However, they are not enough to top the tree and question marks have been raised over the amount of cost-cutting that can be achieved and plans to finance the bid by taking on large amounts of debt and issuing new shares.

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Key to any challenge on Nike - and just as important as pricing power and distribution networks - will be image.

Gonzalo Basilico is a 12-year-old who loves his trainers.

He has six pairs - one Reebok and the rest Nike - and uses them for football, basketball and going out.

Gonzalo has a very clear idea about which shoe brands he likes and why.

Adidas is seen as being good quality and comfortable, while Reebok is "cool".

Nike, however, manages to have a foot in both camps.

"I like Adidas, but I still prefer Nike for the fashion, colours, combinations," he said. "It's all Nike at school.

"Everyone talks about Nike, no one talks about the others."

Nick Liddell, a director of brand valuation at consultancy Interbrand, warned that merging with Reebok may only exacerbate Adidas's problems.

While Adidas has a strong performance sportswear brand - under the motto "Impossible is Nothing" - this is not carried through as powerfully into its Originals clothing range despite endorsements from stars such as Missy Elliot.

Reebok seems to have concentrated more on positioning itself as a hip clothing maker, Mr Liddell explained.

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Nike, on the other hand, has a very focused brand, which is based on sporting excellence and product innovation, Mr Liddell said.

That has a trickle down, or halo, effect on Nike's other sporting goods and helps it to sell products as lifestyle choices by linking up with people such as Lance Armstrong and tackling issues such as testicular cancer.

"Sportswear and urban life wear are closely linked," Mr Liddell said, adding that Adidas and Reebok are more "schizophrenic" in their approach.

"Focus will be absolutely crucial" in determining how Adidas and Reebok do in coming years, he explained.

"As long as they can take the two brands and drive them into two separate areas where they don't cannibalise each other, but compliment each other, then it could be a successful strategy," Mr Liddell said.

According to Interbrand's most recent report on the value of global brands, Nike was ranked at number 30, up one place from the year earlier.

Adidas came in at number 71, while Reebok did not feature in the top 100.

Should the Adidas bid get shareholder and regulatory approval, then the two firms will have to work hard to change many people's preconceptions.

Adidas boss Herbert Hainer said that the deal "represents a major strategic milestone for our group".

The takeover still needs to be approved by Reebok shareholders and competition authorities. If cleared, the deal should be completed in early 2006.

Reebok's shares had risen 16% in after-hours New York trade on Tuesday - reaching $51 - as reports of takeover talks appeared on the websites of financial papers.

Adidas' offer is worth $59 per share in cash.

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"This is a once in a lifetime opportunity to combine two of the most respected and well-known companies in the worldwide sporting goods industry", said Mr Hainer.

The combined group will have worldwide athletic footwear sales of 9bn euros, Adidas said.

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It would have about 20% of the US sports shoe market, while Nike has 36%.