Valuentum Exclusive Analysis for the Discerning Investor

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Image Source: Lululemon Athletica Inc – First Quarter Fiscal 2020 Quarterly Financial Supplements

By Callum Turcan

On June 29, Lululemon Athletica Inc (LULU) announced it was acquiring home fitness company MIRROR for $500 million in cash. MIRROR sells ~$1,500 (before taxes and installation fees) screens that come with a camera and speaker system that allow users to participate in at-home workouts assisted by trainers/videos. That offering comes with a $39 per month digital subscription which allows the user (or users, up to six people per household) to access on-demand and live workout sessions, and additionally, personal training sessions cost up to $40 each.

Overview

Lululemon first invested in MIRROR back in mid-2019 and will run the firm as a standalone entity after the deal closes, which is expected in the second quarter of fiscal 2020. For reference, Lululemon’s first quarter of fiscal 2020 ended on May 3, 2020. In the press release announcing the deal, Lululemon noted that:

MIRROR offers weekly live classes and thousands of on-demand workouts as well as immersive one-on-one personal training. MIRROR has seen rapid growth and strong engagement since it launched in 2018 as demand for in-home fitness offerings continue to increase significantly.

This transaction builds on a successful partnership between the two companies, which began in mid-2019 with an initial investment in MIRROR by lululemon, and also includes a content partnership which brought sweat and meditation classes to the MIRROR platform by lululemon’s Global Ambassadors. This acquisition will further expand the content creation partnership between the two brands and will help lululemon, MIRROR and lululemon Ambassadors reach new guests…

The purchase price is expected to be paid from the company’s primary sources of liquidity, which include over $800 million in cash, its existing $400 million revolving credit facility, and a new one-year, $300 million revolving credit facility.

We wrote a note covering Lululemon’s latest earnings report back in mid-June (link here) and highlighted that the firm exited the fiscal first quarter with no debt on the books and over $0.8 billion in cash and cash equivalents on hand. Lululemon’s pristine balance sheet combined with its access to liquidity via its revolving credit facilities put the firm in a position in make such a bold acquisition.

Peloton Interactive Inc (PTON) has experienced strong growth during the coronavirus (‘COVID-19’) pandemic as households were forced to stay in and gyms were forced to temporarily shut down. In Peloton Interactive’s third quarter of fiscal 2020 (period ended March 31, 2020), its paid digital subscriber base rose by 64% year-over-year. Lululemon likely is banking on being able to match that same level of success (and more) with its acquisition of MIRROR.

The potential for the MIRROR acquisition to enable Lululemon to generate reoccurring revenue streams represents an interesting opportunity. As an athletic and athleisure apparel company, Lululemon is highly levered to the state of consumer discretionary spending in North America (namely the US and Canada). During fiscal 2019 (period ended February 2, 2020), Lululemon generated ~72% of its net sales in the US and another ~16% in Canada.

While Lululemon’s dependence on North American consumer discretionary spending levels will continue to be the case after the MIRROR acquisition closes, recurring revenue streams from a digital subscription service could help smooth out the cyclicality of consumer spending on athletic and athleisure apparel (at least to some degree). Digital subscription revenues, once a certain level of scale has been realized, tend to be quite lucrative. However, whether that scale can be realized remains to be seen as this is a relatively new space.

Lululemon could use the purchase to better market its apparel products directly to its core consumers, and build an ecosystem around health, fitness, working out, etc. There is room for upside via synergies resulting from greater direct-to-consumer sales (growing revenue streams from apparel sales that generally speaking carry higher gross margins by taking out the middleman). Analysts have noted that there is significant overlap between MIRROR’s customer base and Lululemon’s customer base, meaning that there is room to cross-sell relevant products and services here.

Reportedly, MIRROR is expected to bring in $100 million in revenue this year and by 2021, MIRROR is expected to either break even or generate a profit. We will know more once the deal closes and Lululemon provides an update on the company’s trajectory. For reference, Lululemon generated $4.0 billion in GAAP net sales and $0.9 billion in GAAP operating income in fiscal 2019.

Concluding Thoughts

This is an interesting deal and likely not one many were expecting to see. Lululemon will retain a solid balance sheet after the acquisition closes, though we caution that the company would be wise to bulk up its cash balance in the future to maintain its financial flexibility over the long haul. Once the deal closes and more information is provided on integration efforts, we will have more to say on Lululemon.

Being forward-thinking and proactive in the retail space is the only way to stay ahead of the curve and remain relevant in the past-faced 21st Century. While the deal appears pricy, we appreciate that Lululemon is willing to make big moves, and please note that as the firm has had a stake in MIRROR for some time, Lululemon should have a good idea of what it is buying into.

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Luxury Goods (Established Brands Industry) – EL LULU NKE PVH REV SIG UA UAA VFC

Related: PTON, IYK, XLY, ADDYY, ADDDF, PMMAF, FL, VSTO, SPWH, DKS, AEO, ANF, COLM

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Callum Turcan does not own shares in any of the securities mentioned above. Both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios include a SPDR S&P 500 ETF Trust (SPY) put option holding with a $295 per share strike price that expire on August 21, 2020. Some of the companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.