Lululemon: Quick Thoughts On Chip Wilson’s Win

U.S. Retail/Consumer - LULU

Don’t normally take victory laps but this one feels exceptionally good. The vast majority of Wall Street thought Chip had no chance in his proxy battle with Lululemon (“maybe he gets one”) – almost to the point of frustration he would even dare to engage in it. Elliott has been radio silent ever since their candidate for CEO was dismissed (another example of Wall Street collectively getting it wrong as most sell-siders were positive it would be Jane Nielsen). Yet rather than just opining from thin air like most others, we did the work. Four extensive notes (46 pages in total) that Wall Street would never write as dug deeply into this specific proxy battle. Numerous discussions with former CEO Christine Day (who went through these issues during her own tenure). All augmented by our extensive decade+ pre-existing knowledge of the company as a former sell-side analyst. This is what real independent research looks like and the perfect example of what we are building at M Squared Capital. We thank our Angel Subscribers for their patience as we focused on this subject.

Tough to be a Lululemon bear right now. The largest overhang to the story has been removed. Management almost certainly sandbagged next week’s earnings for optics heading into what they expected to be a proxy battle later next month. Operationally things are not great (we know the data shows that too), but they also aren’t terrible (total revenue still positive). And the company has 12% of its market cap sitting in cash with enough room on its share repurchase authorization to use it all (not to mention a HSD FCF yield).

This deal with Chip Wilson is probably the best possible outcome for long-term shareholders at this moment. The depressed valuation of Lululemon reflects a narrative that either this noisy battle would continue for years to come, or the incumbent Board is poised to run the company into the ground. The former is taken off the table, and the latter seems less likely with these new additions (particularly Marc Maurer). We had previously speculated that Lululemon might be acquired should this situation persist. We would have been dismayed to sell our shares below cost in that situation as fully recognize the long-term value of this company. Yet we probably would have voted yes to a transaction as have lost all confidence in the incumbent Board to realize that value.

At the end of the day, we understand why the incumbent Board thought they had a leg to stand on: other than the stock price, things really aren’t that bad at Lululemon. Yet. Last year they ate a bigger impact from tariffs than almost any other company (due to de minimis) and still delivered ~20% EBIT margins on MSD revenue growth. But we also understand Chip’s point of view that this is the reason why change can still occur before the brand is impaired past the point of no return. Another year in the current direction and it’s quite possible that nothing could be done to fix the business for a very long time. For the first time this year investors can be reasonably optimistic about this story. The announcement of Heidi O’Neill as CEO clearly didn’t provide that optimism but even she benefits from some of this whitewashing.

It’s also nice to see language from Marti Morfitt that the company needs to clear a path forward for Heidi. Unsure if included in the final agreement but we note Reuters mentioned yesterday that Chip will have access to Heidi on a regular basis. This should end any speculation that Heidi will be pushed out and at this point the company needs to use all resources necessary to ensure her tenure begins on a high note to repair damage caused by this unfortunate and poorly managed (from a corporate governance perspective) battle. However, we recommend that the company takes no actions that risk breaking her non-compete agreement with Nike (such as the town hall she hosted a few weeks ago), to ensure that yet another crisis does not follow the conclusion of this one.

The main thing that remains to be seen is who will step off the incumbent Board to make way for Chip’s two current nominees and a nominee to be named later this year. We assume Marti Morfitt will be the member that steps down later this year as the company still needs her to oversee as Executive Chair until Heidi joins in September. Highly difficult to see her surviving this deal given her extremely long tenure at the company and poor decision to engage in the proxy battle that ultimately gave Chip what he wanted to begin with (three Board seats).

We are looking forward to seeing how much this proxy battle costs the company as it certainly seems they spared no expense engaging in it. We are less concerned with the donation to Kitsilano Beach to cover Chip’s expenses given the company’s long-standing history in that area (birthplace, SeaWheeze Half Marathon, etc) but that also is coming out of the pockets of shareholders. We wonder whose brand benefits most from that donation, Lululemon or Chip Wilson, given that Chip already has a day named after him in Vancouver (October 3^rd is “Summer and Chip Wilson Day”).

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