For manufacturers of luxury sporting goods, developing and maintaining an image is crucial. Teenagers and young adults make up the bulk of their consumers, and this consumer group is willing to pay a premium for these brands, says Charles Burbeck, head of global equities at HSBC Halbis Partners in London, England.

“It’s all about creating an image, marketing very well, innovating and charging relatively high prices for goods,” Burbeck says. And unlike other luxury sectors, flooding the market is not a problem. This demographic isn’t interested in exclusivity, he says; it just wants to have whatever is “in.”

Emerging markets present an opportunity to grow those sales even more. “In emerging markets, young people like to buy American values,” says Burbeck, and luxury sporting goods are attractive to them.

Of the three big luxury sporting-goods companies, only one — Oregon-based Nike Inc. — is U.S.-based. Both Adidas AG (formerly Adidas-Salomon AG) and Puma AG Rudolf Dassler Sport are based in Germany. Adidas, however, acquired Massachusetts-based Reebok International Ltd. at the end of January, so it now owns the Reebok brand, which it plans to maintain.

Big sporting events and professional endorsements are critical for sales of these luxury sporting goods, so all three companies are tying many of this year’s marketing dollars to the FIFA World Cup of Soccer in Germany.

Marketing at such events takes two forms: broad-based advertising, which can include being an official sponsor; and team/individual sponsorships. The latter can pay big dividends if the teams and individuals do well.

Adidas is spending the most — more than US$200 million — on the event. This includes the cost of official event sponsorship. Adidas is also sponsoring six teams, four of which — Germany, Argentina, France and Spain — are among the strongest and most popular. Adidas also has a marketing relationship with British star David Beckham.

Nike is believed to be spending about US$100 million for the event, and two of the eight teams it is sponsoring — including defending champion Brazil — are both strong and popular.

Puma is sponsoring the largest number of teams with 12, but only Italy and the Czech Republic are among the strongest and most popular.

While soccer is getting the lion’s share of the attention now, the three companies are active in virtually all sports. In the race for stars, Nike has golfer Tiger Woods and retiring cyclist Lance Armstrong, and still sells a Michael Jordan line of footwear and apparel. Puma recently added Ferrari Formula One driver Michael Schumacher. And although Adidas has several other big names besides Beckham in soccer, it also has some well-known basketball players, including Tracy McGrady, Tim Duncan and Kevin Garnett.

However, these companies can’t get stars if they don’t have good products; so style is also important and a lot of effort goes into design. Puma, particularly, has been successful, says Burbeck, selling “high-margin fashion wear with a sporting edge.” Richard Nield, a portfolio manager at AIM Funds Management Inc. in Texas, agrees, adding that the company targets teenagers, while Nike and Adidas appeal to a somewhat older crowd.

All three companies are targeting emerging markets, especially Asia, where a lot of the goods are made. Adidas expects sales in Asia of two billion euros by 2008; its 2005 sales were 1.5 billion euros. Nike sees big growth opportunities coming from developing markets — India, Thailand, Indonesia, Brazil, China and Russia. And Puma believes regional expansion, particularly in emerging markets, combined with product expansion, can push it significantly closer to its sales potential of 3.5 billion euros in the next five years. The company’s sales in 2005 totalled 1.8 billion euros.

Of the three companies, Puma is the most profitable. It had an operating profit margin of 22% and return on equity of 40% in its fiscal year ended Dec. 31, 3005. Nike had a 13.8% operating margin and 23% ROE in its fiscal year ended May 31, 2005, and Adidas’ operating margin was 10.6% and ROE was 18% for the fiscal year ended Dec. 31. Burbeck expects Adidas’ Reebok purchase to produce additional sales and cost savings, moving its profit margin and ROE closer to Nike’s over the next three years.

Adidas is the cheapest of the stocks. Widely held, it recently traded at 37 euros a share on the Frankfurt Stock Exchange, or 12 times Burbeck’s estimate of 2007 earnings. Puma’s stock recently traded around 270 euros on the Frankfurt Stock Exchange, or 14 times 2007 earnings. Nike recently traded at US$81 a share on the New York Stock Exchange, or 14.5 times 2007 earnings.

@page_break@Burbeck says both Nike and Puma are good companies with strong management teams and clear strategies. But from an investment perspective, Adidas is not only less expensive but also has greater potential for restructuring and margin gains. Adidas has become much more focused, Nield adds, selling its ski apparel subsidiary, Salomon, last October.

Here’s a closer look at the three companies:

> Adidas. The Reebok purchase is important for Adidas because it provides what Burbeck calls “critical mass” in the U.S. In the first quarter of 2006, with two months of Reebok revenue included, U.S. sales increased to 31% of total sales of 2.5 billion euros, vs 24% of 2005 sales of 1.8 billion euros.

But, first, the company has to turn around the struggling Reebok brand. It plans to do that by using more disciplined product distribution, more focused brand communication and new products, which will be launched in the second half of 2006. The impact of these initiatives will be felt mainly in 2007; percentage decreases this year are expected in the single digits.

Adidas is looking for significant synergies from Reebok: by 2009, it expects 500 million euros in additional revenue and 175 million euros in cost savings. Some of the additional sales will come from buyouts of Reebok distributors and joint ventures in fast-growing markets such as Russia and China.

A major benefit of the Reebok deal is an 11-year strategic global merchandising partnership with the National Basketball Association. Reebok has been the official uniform and apparel provider for the NBA, Women’s NBA and the NBA Development League. Adidas chairman and CEO Herbert Hainer expects this to be a springboard for basketball product expansion internationally because almost 30% of NBA players come from outside the U.S.

Adidas reported net income of 150 million euros in the first quarter, vs 108 million euros in the same period a year earlier. Operating cash flow after the net change in non-cash working balances, however, was a negative 281 million euros, vs a negative 11 million euros the same quarter in 2005. Its long-term debt was 3.2 billion euros at March 31.

> Nike. In a March report, Credit Suisse First Boston Corp. had an “outperform” on the stock following the release of Nike’s nine month results. “We believe Nike can continue generating mid- to high single-digit sales growth as well as margin expansion” once current pressures abate, the report said. Inventories are up and high oil prices and discounts in Europe and Asia have pushed down gross margins.

Nike had net income of US$1.1 billion in the nine months ended Feb. 28, up from US$862 million in the same period a year earlier; revenue was up 9% to US$10.9 billion. Operating cash flow after net change in non-cash working balances was US$1 billion, vs US$1.1 billion the year before. Long-term debt was US$411 million as of Feb. 28.

The Nike brand dominates, accounting for 88% of sales in the first nine months. However, the share for subsidiaries, such as Converse (athletic and casual footwear, apparel and accessories) and Starter (discount athletic footwear and apparel), is rising, and is now 12% of total revenue, vs 5% in 1999. As well, says new president Bill Perez, the company has barely scratched the surface in women’s fitness.

Nike directors and management own 43% of the two classes of shares outstanding.

> Puma. This company is small but growing. Burbeck says annual sales increases of 12% over the next five years are reasonable. Like Nike, it is looking toward emerging markets, but it also plans to expand its product lineup.

Most of the expected growth will be organic. CEO Jochen Zeitz says future acquisitions will be smaller, accounting for 10% of revenue, at most. The company will also look at expanding by selectively adding other brands, which could contribute up to 10% of total sales.

Puma’s mission is to become the most desirable sports lifestyle company. Its current expansion is the fourth stage of a long-term business plan that was launched in 1993.

Puma reported net income of 93.1 million euros for the first quarter of fiscal 2006, up from 90.9 million euros in the same period a year earlier — despite net sales growth of 29% to 642.8 million euros. IE