FTC to Skechers: You'd Better Shape Up

It was a sketchy claim to begin with: Just wearing Skechers (NYS: SKX) toning sneakers would let you lose weight; firm up your legs, behind, and abdomen; and close the national debt faster than you could say "the Buffett Rule." Now the FTC has ruled the claims were deceptive and settled with the footwear company to the tune of $40 million over its misleading ads.

Fit or fad?
The Fool's Alyce Lomax was immediately skeptical, comparing the toning-shoe fad to similar ones launched by Crocs (NAS: CROX) , though they had a big difference: They didn't claim any medical benefits. And that's what really brought the heavy hand of the FTC down on Skechers. In its release announcing the settlement, the FTC declaimed:

Skechers' unfounded claims went beyond stronger and more toned muscles. The company even made claims about weight loss and cardiovascular health. The FTC's message, for Skechers and other national advertisers, is to shape up your substantiation or tone down your claims.

From an investment standpoint, there were even bigger problems. While Skechers has always been known for producing trendy footwear, which usually resonated well with consumers, Shape-Ups gave the company no moat to ward off competitors. As Crocs discovered when knockoffs of its plastic shoe quickly hit the market, you end up with a pile of inventory that becomes difficult to unload and you have to write down its value.

Skechers' rivals, including Reebok, Collective Brands' (NYS: PSS) Keds division, and Puma, quickly brought to market their own competing versions of shoes, but if that wasn't enough to convince you this was all going to end badly, Crocs got in on the act, too, introducing its own plastic toning clog. Skechers' stock got trampled when inventories soared 70% after it couldn't move product.

Notably absent from the rush to join the latest trend was Nike (NYS: NKE) , which looked askance at the fad and noted that its footwear worked "if you do."

Throwing a curveball
Of course, if you find yourself considering making a purchase that a Kardashian is endorsing, you may want to rethink the decision. Kim Kardashian was a prominent spokeswoman for Shape-Ups, but she's had more than a few sketchy deals of her own, including the Kardashian Kard debit-card debacle and QuickTrim weight-loss products, among numerous others.

While undoubtedly there are those who will view this as a victory for consumer protection, I see it as the essence of exactly what's wrong with such regulation. Like the SEC, the FTC is something of a clean-up crew coming in after the fact and wagging its finger. Not that I think a business should have to run its ad copy past some bureaucrat first, but the market meted out a harsher sentence more swiftly: Skechers lost about three-quarters of its market value as it tripped over its Shape-Ups laces.

Caught flat-footed
Whatever fraud there was, if indeed it was fraudulent what the company claimed, Skechers denies that the settlement means it's guilty; it's just cheaper to deal with the allegations this way. Anyone who's read some of my screeds against trial lawyers knows I'm not their biggest fan when they try to win in the courtroom what an investor couldn't get in the marketplace, but prosecuting cases of fraud against unscrupulous marketers is certainly a legitimate function. And Skechers faces a boatload of class action lawsuits over the shoes.

Yet the footwear fashionista might have a point here. Last year, Reebok also settled with the FTC for $25 million over its EasyTone toning shoes, but at least it had the endorsement of the American Podiatric Medical Association, which found the shoes "beneficial to foot health and of significant value." Skechers shoes didn't have that imprimatur -- though apparently it didn't matter anyway -- but it did have its own studies to back up its claims.

Listen, I'm as skeptical as anyone when it comes to companies that claim health benefits without having to do rigorous exercise and employ a proper diet. But I'm just as wary of government regulators who claim to be able to divine which claims are spurious or not. In the end, it probably was easier -- and, indeed, cheaper -- for Skechers to get this episode behind it.

Laced up and ready to run
Though the stock is down 8.5% since the settlement was announced and there will be further fallout from the lawsuits that have been filed against it, it seems the worst of the toning-shoe issue is behind it. Shares trades at almost half of its sales and slightly less than book value. Admittedly at over 24 times five-year average earnings estimates, it carries a premium, but with so much negativity still priced into the company -- even after the recent rise in its value -- I think Skechers can still kick it higher from here.

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At the time thisarticle was published Fool contributorRich Dupreyowns shares of Skechers and Nike, but he holds no other position in any company mentioned. Check out hisholdings and a short bio.Motley Fool newsletter serviceshave recommended buying shares of Skechers and Nike and creating a diagonal call position in Nike. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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