Lululemon is No Bargain for PE

NEW YORK (The Deal) -- Lululemon Athletica (LULU), the Vancouver-based retailer of yoga-inspired apparel, may be too expensive for private equity buyers, according to industry sources.

With founder Chip Wilson hiring Goldman Sachs & Co. Inc. to advise him on alternatives, according to a Wall Street Journal report this past weekend, and the board likewise looking for financial advice, according to other news outlets, the usual chatter started about PE eyeing it as an attractive target.

Not taken into account was that, while the company has no debt, PE firms tend to steer away from retailers, particularly in the volatile and cyclical world of apparel, if the unaffected stock price is much above 7 times Ebitda, sources said.

With a market cap of almost $6 billion, and an enterprise value of about $5.25 billion after subtracting cash on the balance sheet, Lululemon trades at about 12.5 times the $420 million in Ebitda projected for its current fiscal year.

With a 20% to 30% premium to that unaffected stock price, the deal valuation approaches a multiple of 10 times, the upper range of what PE firms have historically paid to take apparel retailers private.

The higher the multiple, the more equity a PE firm or firms have to sink into a deal, and the riskier the investment becomes.

And PE firms have shown restraint when it comes to deal-making in the apparel sector. Last summer, when Jones Apparel Group Inc. stock spiked on buyout rumors, potential bidders lost interest because a potential deal became too expensive.

It wasn't until Jones' stock price cooled off that talks started up again in the fall and Jones Group agreed to a leveraged buyout by Sycamore Partners LLC for $2.2 billion in December, or about 8.8 times Ebitda.

Granted, Lululemon is still projected to grow revenue and eventually reclaim lost Ebitda, according to analyst estimates compiled by Bloomberg. And if Wilson were to roll his 27% stake into a buyout, that would reduce the need for both leverage and equity in a deal.

But even after taking out Wilson's stake, which would be worth roughly $1.62 billion at current stock prices, that would mean the buyers would have to line up about $3.6 billion in financing even after the nearly $750 million in cash is figured in.

In the current lending environment, retailers have been able obtain debt financing of about 6 times Ebitda, perhaps in some cases up to 7 times Ebitda, though that would be more of an outlier.

Based on the $420 million in projected Ebitda, that would equate to about $2.5 billion in debt financing, and up to $2.9 billion under the more rosy 7 times scenario.

The minimum equity check for such a deal would be around $700 million, but if the deal got debt financing of 6 times Ebitda, that would equate to an equity check of around $1.1 billion.

And that's assuming the company were to sell at its current market cap. The numbers would only become larger if any premium to its current stock price is figured into a deal.

All of these scenarios are based on many assumptions: that Wilson has a few hundred million to over a billion of his own cash to sink into a transaction, or perhaps he's even willing to sell his stake, and a strategic would be willing to a pay a huge growth multiple for a cyclical apparel business.

The problem with Lululemon, according to industry observers, is that it was priced to perfection in the past, and any small mistep was going to send the company's stock to a more normal, realistic level, which is exactly what happened. That doesn't make it a buy, however.

Still, though the retailer's shares dropped from a 52-week high of $77.75 per share to trade near $40 per share (it got about a 2% bump up on the adviser hiring report), at 12.5 times Ebitda, it is still being awarded a growth multiple, industry observers emphasized.

And depending on whether the company can restore the brand's image, often a struggle once it's lost, the company may still not be much of a bargain.

It was Wilson's public comments that tarnished the brand in the first place, sending consumers to competitors who offer essentially the same product for a cheaper price. When it comes to undifferentiated, commoditized product, brand integrity is everything in being able to not only fuel growth, but charge the kind of premium that leads to large margins and profitability.

"Frankly, some women's bodies just don't actually work [for the yoga pants]," Wilson said in an interview on Bloomberg TV. "It's more really about the rubbing through the thighs, how much pressure is there over a period of time, how much they use it," he added.

That comment led to Wilson's agreement with the board that he would resign as chairman in December.

Of course, Wilson, may simply be looking to shake up the board and regain some influence at the company he founded. On June 11, he said in a statement: "After being asked by the Board to come back from Australia to help the company recover from the product recall last year, I have decided to vote against the re-election of the company's outside board members. While I am excited about the new management team that I helped put in place, I am concerned that the Board is not aligned with the core values of product and innovation on which lululemon was founded and on which the company thrived. As a 27% shareholder in the company, I believe change is now needed at the Board level to increase shareholder value."

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