LULU = Activist Candy

Takeaway: Things are getting so bad that it’s good. If no one goes activist, we might. Shareholders deserve it. Still solid acquisition candidate.

Conclusion: We think that things are getting so bad, that it’s almost good. This company is in worse shape than the quarter suggests. The good news is that every problem we see can be fixed with the right talent steering the ship. The bad news is that such talent is nowhere to be found in Vancouver. The reality is that someone will have to step up and go all activist on LULU. Valuation is at a point where we could see that happening, which could be facilitated by recent tension at the Board level.  And if it doesn’t happen, we might just lead the charge ourselves. Value needs to be unlocked. This is an amazing brand with solid global growth prospects. Management is too focused on recapturing Gross Margin that is a) lost forever, and b) something that investors won’t pay for without meaningful top line growth. If all else fails, there are no fewer than five public companies eyeing LULU, not to mention financial buyers.  

 

DETAILS

We said that the risk/reward for LULU would really shape up on a miss. We’re standing behind that statement. If we had to be long or short at this point, we’d be long. Fortunately, we don’t have to be either. But let’s make one thing abundantly clear. Our view that it is a more favorable risk/reward is not because we have confidence in management executing a sound growth strategy. Quite the opposite, actually. This is as close to a ‘no confidence’ vote as we’ve come across with a management team in a long time. If this was a weak brand with questionable growth prospects, then it’d be game over. But the fact is, this is what we’d consider one of only a small handful of truly defendable brands in retail. When there’s a great brand with bad management, it is a situation that can be easily fixed. When even the greatest of managers are in charge of marginal brands, they’re usually terminal. This is definitely the former.

 

If the play here is for a rebound in the business under the current regime, then it is an absolute coin toss as to whether they succeed. We don’t like flipping coins. Process = Good. Coin Flip = Bad.

 

That means we need major change inside the company.  John Currie (CFO) getting pushed out is a start. He was terrific for LULU in its early years (when Chip was still relevant), and sales were sub $500mm. But so many of us forget just how fast LULU grew, as sales were a mere $275mm in 2007. The skill sets throughout this company today are broadly consistent with those of an entrepreneurial early-cycle company. The problem is that LULU is going through puberty. It is sitting at $1.6bn in sales, and is in need of a completely different range of skills. Unfortunately, we’re not convinced that CEO Laurent Potdevin has them either.

 

WINNING VS LOSING: (LULU should look 948 miles South to see how it’s done)

We think it’s so ironic that LULU reported earnings within 14 hours of Restoration Hardware (RH – our top long idea). Some similarities are striking. Both are $1.6bn in revenue, both serve a very high end consumer in a fragmented and hyper-growth piece of the retail space, and both can conceivably achieve $4-$5bn in revenue over a 5-year time period. The big difference is that the CEO of RH (who many people hate) got on the call, played offense, took control and set the investment narrative. He conveyed top to bottom what his vision is for the company, what it will mean for long-term revenue growth, what the margin implications are, and what kind of capital is needed to achieve those goals and maximize ROI. Laurent said…well…not that.

 

LULU, instead, was extraordinarily defensive. Granted, weak trends will put anyone on defense. But we did not listen to the call and think “hey, these guys really understand their business.” There was no talk about long term growth targets, no crisp delineation of key growth initiatives, with the only real numbers given around share repurchase and gross margin goals.

 

Let’s address the gross margin issue for a minute. The fact that this company leads in with recovery of gross margins to a mid-50s level is preposterous. If the company can recapture a few points in margin over time, then great. But there’s no way we (or most others) will pay up for that now. This is a mid-cycle growth company that is growing outside of an extremely profitable core (dresses, denim, men’s – fine, but not Gross Margin Accretive). There is one thing and one thing only that most investors will pay for with LULU – top line growth.  Yet the only top line growth drivers they really address on the calls are little near-term tactical patches that are irrelevant in the context of investing in Retailers.  

 

THE ULTIMATE PROBLEM

What this means for us, is that the problem is still…you guessed it…Chip (Wilson, Founder). As much as everyone likes to say that Chip stepped away last year, the fact is that the guy still controls 27% of the voting stock. Voting stock aside, his influence inside the hallways of Lululemon trumps that of the CEO that he hand-picked and pushed through the Board approval process. John Currie was Chip’s CFO, and when the Board decided to push him out over the past week, we think that’s what prompted Wilson to vote against the re-election of the two Board members who caused it (one of whom replaced Chip as Chairman).

 

What’s nice about this is that the Board is no longer uniformly ‘Chipped’.  The more the Boardmembers band together and show Chip that he’s no longer the boss, the better chance this company has of succeeding.

 

The reality with all of this is that someone will have to step up and go all activist on LULU. Valuation is at a point where we could see that happening. And if it doesn’t happen, we might just lead the charge ourselves. Value needs to be unlocked.

 

THE ULTIMATE CHANGE: AN OUTRIGHT SALE

One consideration is whether the company’s troubles put it in play. The answer there, we think , is Yes.

  1. Nike is a perennial possibility. Though its strategy is to build instead of buy (and it passed when LULU was at $8) the fact is that it has been chasing LULU for years, and LULU still is far more authentic for Yoga than Nike is. Low probability. But something to consider.
  2. Kering is in print saying that it wants to broaden its portfolio of sports brands (the owner of Gucci also owns Puma, Tretorn and Volcom). Does not hurt that it is a French company and LULU has a French speaking CEO.
  3. VFC is possible. But VFC is rumored to be buying everything. It has Lucy, which is a poor-man’s version of LULU. It’d be interested at the right price.
  4. PVH is an interesting thought. It’s business is in trouble, and what does PVH do when its core weakens? It does a HUGE acquisition. Enter LULU.
  5. Here’s a dark horse…but GPS is not completely out of the realm of possibility. Granted, it’s eating LULU’s lunch with Athleta in markets where the brands overlap. But GPS could handle it financially, and it would give the company some organic growth.

LULU = Activist Candy - LULU financials

 


Did the US Economy Just “Collapse”? "Worst Personal Spending Since 2009"?

This is a brief note written by Hedgeye U.S. Macro analyst Christian Drake on 4/28 dispelling media reporting that “US GDP collapses to 0.7%, the lowest number in three years with the worst personal spending since 2009.”

read more

7 Tweets Summing Up What You Need to Know About Today's GDP Report

"There's a tremendous opportunity to educate people in our profession on how GDP is stated and projected," Hedgeye CEO Keith McCullough wrote today. Here's everything you need to know about today's GDP report.

read more

Cartoon of the Day: Crash Test Bear

In the past six months, U.S. stock indices are up between +12% and +18%.

read more

GOLD: A Deep Dive on What’s Next with a Top Commodities Strategist

“If you saved in gold over the past 20 to 25 years rather than any currency anywhere in the world, gold has outperformed all these currencies,” says Stefan Wieler, Vice President of Goldmoney in this edition of Real Conversations.

read more

Exact Sciences Up +24% This Week... What's Next? | $EXAS

We remain long Exact Sciences in the Hedgeye Healthcare Position Monitor.

read more

Inside the Atlanta Fed's Flawed GDP Tracker

"The Atlanta Fed’s GDPNowcast model, while useful at amalgamating investor consensus on one singular GDP estimate for any given quarter, is certainly not the end-all-be-all of forecasting U.S. GDP," writes Hedgeye Senior Macro analyst Darius Dale.

read more

Cartoon of the Day: Acrophobia

"Most people who are making a ton of money right now are focused on growth companies seeing accelerations," Hedgeye CEO Keith McCullough wrote in today's Early Look. "That’s what happens in Quad 1."

read more

People's Bank of China Spins China’s Bad-Loan Data

PBoC Deputy Governor Yi says China's non-performing loan problem has “pretty much stabilized." "Yi is spinning. China’s bad-debt problem remains serious," write Benn Steil and Emma Smith, Council on Foreign Relations.

read more

UnderArmour: 'I Am Much More Bearish Than I Was 3 Hours Ago'

“The consumer has a short memory.” Yes, Plank actually said this," writes Hedgeye Retail analyst Brian McGough. "Last time I heard such arrogance was Ron Johnson."

read more

Buffalo Wild Wings: Complacency & Lack of Leadership (by Howard Penney)

"Buffalo Wild Wings has been plagued by complacency and a continued lack of adequate leadership," writes Hedgeye Restaurants analyst Howard Penney.

read more

Todd Jordan on Las Vegas Sands Earnings

"The quarter actually beat lowered expectations. Overall, the mass segment performed well although base mass lagging is a concern," writes Hedgeye Gaming, Lodging & Leisure analyst Todd Jordan on Las Vegas Sands.

read more

An Update on Defense Spending by Lt. Gen Emo Gardner

"Congress' FY17 omnibus appropriation will fully fund the Pentagon's original budget request plus $15B of its $30B supplemental request," writes Hedgeye Potomac Defense Policy analyst Lt. Gen Emerson "Emo" Gardner USMC Ret.

read more