With the stock down 50 per cent, investors are worried about 'Starbucks syndrome'

LIANNE GEORGE February 18 2008


With the stock down 50 per cent, investors are worried about 'Starbucks syndrome'

LIANNE GEORGE February 18 2008



With the stock down 50 per cent, investors are worried about 'Starbucks syndrome'


Friends are more important than money—or so decrees one of the dozen or so Chicken Soup for the Yogi’s Soul-style tenets of Lululemon Athletica’s corporate manifesto. It’s not a bad rule to live by, unless the friends you’re trying to make are investors.

Only seven months have passed since the company first sold shares to the public amid a frenzy that hailed it as the second coming of the Gap. But lately, observers have taken to calling it the most overvalued stock in the retail universe. In late October, amid the early fanfare, the stock (LULU) surged to a high of US$60.70, but it soon began a long plunge back to earth, last week dipping below US$30. On Jan. 22, Lululemon was officially (and perhaps belatedly) downgraded by BMO Capital Markets to “underperform,” only a week after an analyst for Goldman Sachs cut earning estimates and price targets on the entire athletics apparel industry (including Lululemon) because of the looming fear of a U.S. recession. In times like these, apparently, high-tech hoodies and Boogie crop pants are among the first luxuries to go.

Cheerleaders for the brand insist that business remains strong despite the stock’s recent tumble, and the numbers certainly tell the story of an emerging retail phenomenon. Sales in the most recent quarter, which ended Oct. 31, were US$66.l million, up from US$36 million in the same stretch a year earlier. Quarterly profit more than quadrupled to US$7.1 million. Now, Lululemon’s executive team has devised an aggressive plan to expand over the next several years—aiming to double or triple its current size (a total of 70 locations in Canada, the U.S., Australia and Japan).

Even after recent declines in the stock, the company is still valued at US$2.3 billionthanks largely to the brand’s devoted and growing legion of fans. Last week, in Calgary,

Lululemon held its first-ever three-day warehouse sale in that city on the Stampede grounds. The sale, a rarity for those who know the brand, was publicized only on Facebook, and yet thousands lined up to stand for hours in the freezing cold for a shot at marginally discounted yoga-wear.

That kind of excitement has translated into the stock market as well. On average, analysts expect the company to earn a profit of 46 cents per share over the next four quarters, giving the stock a price-to-earnings ratio of roughly 74(According to data from Zacks Investment Research, the average for the retail clothing industry is 16.) The question is, can LULU live up to the hype?

On the surface, Lululemon has all of the elements of a stellar retail brand. Their clothing is priced high, but it’s flattering and well-made—which is why the brand tops the apparel industry with an average of $1,400 in sales per square foot in its stores, according to the Torontobased firm Accountability Research. The company also wisely got in early on the wave of eco-products and spirituality marketing. Despite an increasingly crowded playing field in yoga-wear—Roots, Aritzia, La Senza to name a few—analysts are quick to point out that Lululemon is the only one considered to be an “authentic yoga brand,” not a fad-driven

offshoot of a larger fashion company.

But the yoga mentality that gives the brand its authenticity is what may prove to be its undoing on the open market. Lululemon was never intended to be a mass market operation. From the beginning, it targeted rich, slim and stylish women who aspire, as Oprah would say, to “live their best lives.” But the quarterly growth imperative of being a public company is fundamentally incompatible with the hippy-dippy, get-to-know-yourself-and-the-planet mentality upon which Lululemon’s consumer loyalty is premised. Between its expansion goals and its floundering stock, some observers say the company is exhibiting early signs of what might be called Starbucks syndrome.

Like the coffee giant, Lululemon has had great success selling a premiumpriced product with feelgood ideological underpinnings. But replicating a premium niche model for the mass market is a whole other thing. Starbucks, exhibit A, now finds itself in a precarious position, having expanded too aggressively—both geographically and in terms of its range of products, which now includes breakfast sandwiches and music compilations— under the watch of former CEO Jim Donald. To stop the bleeding, the company has brought back its founder and former chairman Howard Schultz to reprise his role as CEO, close stores and scale back product offerings. Most recently, Starbucks began testing out a $1 coffee in its hometown of Seattle, in an attempt to win back consumers who’ve defected to McDonald’s or Tim Hortons, where the coffee is cheaper and the quality—thanks to years of competition from Starbucks—is sufficiently high.

Perhaps it should come as no surprise that

Lululemon's clothing is expensive, but it’s well-made, flattering and fashionable

Lululemon has been shopping at Starbucks for its executive team. Recently, it brought in Christine Day, who spent over two decades overseeing growth at Starbucks, to be its executive VP of retail operations. In October, the company also hired former Starbucks senior vice-president and chief financial officer Michael Casey to serve on its audit committee and its board of directors.

But coffee, at least, never goes out of style. That may not be true of yoga and its attendant “mindset.” “Yoga is a trend that we’ve seen before,” says Bruce Philp, managing partner of the Toronto-based firm GWP Brand Engineering, “and it didn’t necessarily have a lot of traction or longevity.” A 2005 survey by Yoga Journal found that 16.5 million people in the U.S. are practising yoga. Which sounds like a lot, but that factors in the dabblers—and there are many of them. According to a 2005 customer survey, only 25 per cent of Lululemon sales are to customers seeking yogaspecific gear. The rest are either in the market for athletic wear for non-yoga purposes, or they simply enjoy the look of yoga-wear as a casual fashion statement.

Already, there are signs that, much in the way aerobics petered out in the late ’80s, a sort of yoga fatigue is setting in. Independent studios are shutting down by the dozens in the U.S., and many of the remaining ones are consolidating, under chains like California-based Yoga Works. Yoga retreats, plagued by competition, are trying to attract the broadest possible market by offering holidays that are a blend of yoga and chocolatetasting, or surfing. It’s possible that soon only the hard core will remain, and along with the fashion, the yoga mentality could just as easily go out of style: bamboo-infused fabrics and an anti-corporate manifesto could come to seem cloying from an aspiring retail giant.

Until now, Lululemon has strived, and generally succeeded, to position itself as a moral authority in the world of retail. But when “authenticity” and “integrity” are a

brand’s core values, it has to be hyper-vigilant in staving off potential threats to its credibility, particularly before it is well-established in the U.S., the holy grail of retail markets. Lululemon says, for instance, that its target consumer is “globally aware.” But this didn’t stop the company from moving the bulk of its production from Canada to China and Taiwan, where labour laws and environmental restrictions are more lenient.

The first time many Americans even heard of Lululemon, it was associated with a scandal that arose in November when the New York Times published a report finding that the brand’s VitaSea products actually contain no significant amount of seaweed, which the company claimed gave them anti-bacterial, stress-reducing and antiinflammatory benefits.

(Lululemon agreed to voluntarily change the health claims on its tags.) Not long after, Herb Greenberg, a columnist for MarketWatch. com wrote a column suggesting CEO Bob Meers had exaggerated his professional credentials. Meers has declined to respond.

To some, it all seems like a company growing up too quickly. “My sense is that they went public way too soon,” says Philp. “There’s a period of time when you stand up and take a moral position, when you’re going to be dealing with a lot of skepticism and people trying to figure out if you’re for real. That’s not the time to make these mistakes, and purely from a branding perspective, that’s not the time to go public.”

Still, optimists say Lululemon will succeed where a company like Starbucks faltered because it has a grassroots, community-based approach to introducing new stores that makes it unique. Historically, before the company enters a new market, it will send a liaison

to get to know the community, build relationships with local yogis and trainers, and become involved in local events to ensure a good, strong fit. And their targeted growth rate is reasonable, says New York-based analyst for RBC Capital Markets Howard Tubin. “If you look at the square footage growth rate, it’s pretty significant,” he says. “It’s around 50 per cent new square footage growth this year, but that’s only because it’s coming off a very small base. So I would say 30 to 35 new stores is not too aggressive.” But the Lululemon method is time-consuming, which ultimately translates into being expensive.

“They’re going to have problems,” says Mark Rosen of Accountabilty Research in Toronto. “I’m sure they’ll have trouble rolling out some of their strategy and corporate culture to that many locations, and they’re going to have a bit of a challenge getting the right people in there to manage it properly.” As Lululemon reaches this new level of success, it will need executives who really know how to manage rapid growth, which will inevitably create pressure to take shortcuts that are antithetical to the company’s stated culture. “The company is in effect a baby,” says Philp, “and therefore it is much more vulnerable to the conflicting agendas that the capital markets are going to bring to the equation.”

One hallmark of the Starbucks strategy is already in the works. The company is planning to broaden out its product line, in part to diminish the risk of yoga fatigue, adding apparel for other sports, plus athletic accessories and menswear. All this to bolster growth and perhaps to justify the market’s lofty expectations. When they start introducing breakfast sandwiches, we’ll know they’re in trouble. M

Starbucks ran into trouble when it grew too large, and is now closing some stores