Old Navy, meanwhile, brings in about $8 billion in annual sales by itself. This brand has notably been the strongest within the company as Gap's namesake label has struggled to grow sales of late. Old Navy has been successful in targeting shoppers on a budget, rivaling off-price channels like T.J. Maxx and Ross Stores.
Gap's current CEO, Art Peck, will remain at the company and become chief executive of "NewCo," Gap said. Sonia Syngal, currently president and CEO of Old Navy, will lead the new public, stand-alone Old Navy company.
The spinoff should help both companies operate with "a sharpened strategic focus and tailored operating structure," Peck said in a statement. The transaction is expected to be completed in 2020, subject to final approval by Gap's board of directors.
One analyst who covers the company welcomed the news.
"Separating Old Navy to a standalone company is what we have argued for over the past few years," Jefferies' Randal Konik said in a research note. "Doing so allows the market to properly value Old Navy for its high margins and strong cash flows."
At Gap, which is more troubled, Konik said there's still value in the brand's outlet stores and e-commerce business, "so distorting business here makes a lot of sense to us."
Gap also on Thursday announced it plans to shut 230 of the namesake brand's locations over the next two years, as it works to restructure its business. The retailer posted mixed results for the holiday quarter. To revive the Gap brand, it said it's working on multiple initiatives to fix the fit of its products and "modernize its marketing."
Gap shares have fallen roughly 20 percent over the past 12 months, bringing its market cap to about $9.7 billion.