In this episode of Industry Focus: Wildcard, Dylan Lewis chats with Motley Fool contributor Dan Kline about the acquisition of Mirror by Lululemon (NASDAQ:LULU). The guys give a breakdown of both their businesses and how the acquisition affects both companies. They discuss the competition in the home fitness space, future opportunities for the combined entity, and much more.

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This video was recorded on July 1, 2020.

Dylan Lewis: It's Wednesday, July 1st, and we are talking about the home fitness market. I'm your host, Dylan Lewis, and I'm joined by Fool.com's Dan Kline. Dan, how's it going, man? How are you doing?

Dan Kline: Wow! This one came out of nowhere. I'm doing great; I've been living on air, so [laughs] it is a very different universe. But I'm really excited to talk about this one today.

Lewis: Yeah. So, we got some great news. Great news! I mean, news for us is great news, because it's something fun to talk about. Apparel company Lululemon is buying a lifestyle fitness company, Mirror, for $500 million. We probably need to unpack Mirror a little bit, because this is a relatively young company, Dan -- only about two years old.

Kline: So, I know this company, because after we did the show talking about Peloton (NASDAQ:PTON), about 80% of my ads on various websites have been other fitness-related products. So, I've been besieged by Mirror ads. But this is a relatively new start-up. They don't have a ton of sales, about $45 million in sales. They've been advertising like crazy. And it is literally what it says it is, it is a mirror that is also -- and this is demeaning to put it this way -- it's basically a giant iPad that delivers fitness classes. That, it's not very obtrusive, you know, it's not that fun necessarily to have an exercise bike in your bedroom or in your spare room; this, when it's not operating, it's a mirror. And a lot of people have a full-length mirror in one of the rooms in their house. So, that part of it is a real positive.

They run fitness classes [at] basically the same price point -- $39 a month, just like Peloton; it's a similar model. The difference is, it's not actually a piece of exercise equipment, it's just a screen. And that's kind of where I lose the narrative, though I do think this fits really well for Lululemon.

Lewis: Yeah, I have to say there are, kind of, pros and cons to the more minimalist hardware approach here. You know, it is not nearly as invasive. And if you look at it, it's a wonderfully slick device. I highly encourage people to just google it and look at some of the product videos and stuff. It's beautiful, it fits into that aspirational lifestyle aesthetic that they are trying to pitch customers on. And it is priced like one of those products.

I will say, the Mirror, you know, when you're done with your workout, becomes a mirror; and if you don't work out, it's still a mirror, whereas if you ... [laughs]

Kline: [laughs] A very expensive mirror.

Lewis: Whereas, Dan, if you buy a Peloton and you're not using it, you have a very expensive clothing rack sitting in your bedroom or perhaps next to your window looking over your scenic view of Los Angeles. [laughs]

Kline: Yeah, I question the utility of this. So, they're running live classes, but I would argue, and again, this is a good pickup for Lululemon, and we'll get into that. I actually thought Apple was going to buy them, that's how slick a product this is. It is a beautiful product. But my iPhone can get classes. In fact, I can subscribe to Mirror or Peloton and watch those classes on my iPhone or iPad or stream them to my television. My television is in my living room; that is where my Mirror would have to live. It doesn't seem all that necessary. On the other hand, there's a huge market of people who are buying Pelotons, when for half the price they can get a very similar product from other reputable brands. So, there's definitely an aspirational high-end model.

And you can gussy it up a little bit. They sell some resistance bands and things that sort of enhance your workouts. There is some tie-in with heart rate monitors and things like that. But, folks, I've got a Fitbit. You can buy a Fitbit for $70. This is a $1,500 mirror that gives you exercise classes. I see the pluses. I've thought about buying it myself, so I'm not 100% negative on it, but it's not as useful as an exercise bike. On the other hand, it's not as limited as an exercise bike, because you could, in theory, do a yoga class or a cardio class or a dance class. And eventually -- they've talked about other uses for it -- you might be able to do a virtual therapy or, you know, maybe there could be some telemedicine. It works a lot better to have a Teladoc appointment when a person can see you full-size than when they're looking at you on an iPhone. So, there's definitely some utility here, and it aligns really well with $100 yoga pants.

Lewis: It really does. And what's kind of interesting is, if you take a step back and look at this marketplace overall, we've talked about how this is an expensive aspirational product, Dan. But if you look at the other offerings in this space, Mirror does not seem particularly expensive. You mentioned that $1,500 price point; that's roughly where things sell. You have that $39 monthly subscription. And Peloton bikes start at about $2,300. Their treadmill starts at around $4,300. Those are higher prices, but you are getting actual fitness equipment, whereas this is a mirror. So, in some ways Mirror is more accessible, but they follow exactly the same model, $39 a month for access to all these classes. You have live classes; you have this huge archive of content that people can also access as well.

There are other players in the space that pretty much operate within this spectrum of price points. There's Tonal, which is a smart home gym; there's Hydrow, and they specialize in rowing machines; [and] FightCamp, a boxing-focused version of these types of companies. And really, I mean, this is kind of a golden age for [laughs] stay-at-home fitness, both because the technology is there and because, I think, the market opportunity has been proven out. It was certainly proven out pre-COVID, but people are seeing more and more the strength of these types of offerings.

Kline: And even when we're not in the pandemic, the idea of not leaving the house to exercise is a benefit. You know, Dylan, I work out with a trainer three times a week. And my building, at the moment, isn't allowing outside people in our gym. So, once a week I go meet him at his gym, which adds cost to my workout, but more importantly, it adds 20 minutes of time, because I don't like to be late. So, even though it's about five minutes away, I get there about 15 minutes early. And then I have to get home. So, that's maybe a half-hour extra. And as you know, we're pretty busy these days. We don't have that extra half-hour, so that has to come from somewhere. So, I've had to resort to my trainer sending me a workout via email and we text during me actually doing the workout. That's not really worth the money I'm paying him. That said, it's a long-standing business relationship; I want to protect his business.

The Mirror allows you to do yoga and classes, things people typically leave the house for, when we're allowed to do that, and it lets you do them at home, but with kind of the same experience of being in class. So, as a past yoga enthusiast -- my last year in Connecticut, I did +200 yoga classes -- it would have been really nice if on days where I was stressed out or it was snowy outside, if I could have just turned on my Mirror and done a similar level of class, but not felt like I was doing it alone. So, I see the pluses of this.

And look at the Lululemon customer, obviously, some of their customers are buying yoga pants as a fashion statement. They're not buying yoga pants to do yoga. A lot of their customers, though, based on being in many yoga studios, are buying those yoga pants because they're really good yoga pants. Other than that brief bit where they had a problem with them being see-through, they hold up really well. They don't get pilly, they're not see-through, they're very durable, they're comfortable -- I'm told; I've never worn Lululemon yoga pants. That audience is going to yoga studios, they're going to yoga classes. I could see them. If you can spend $100 on yoga pants, you might spend $1,500 and $40 a month on this type of product, and they have hundreds of retail stores where they could show this off. Right now, obviously, that's a little difficult, but going forward, you know, malls have public spaces, they can do Mirror-led classes in the public area of the mall, they can really make this an aspirational upsell.

And for what they spent -- I mean, $500 million for a company this size is a big purchase. They had to use available cash and increase some of their credit lines to do this, but that said, I think this product goes right next to Peloton to the top of the heap, because just it being a Lululemon product is going to accelerate it massively.

Lewis: Yeah, and I think it's worth spending a little time looking at the nuts and bolts of what this value prop is for people that are in this market. You know, we are obviously not in this market, because your home workout style is slightly different than this. I am someone who has a very minimalistic home routine during COVID, and I like to bike a lot and get outside. And so, we are not the boutique class market, that's just -- we're not going to be people that fall into this.

But if you are one of those people, Dan, you can buy a 30-pack of SoulCycle classes for $900. So, that's about $30 a class, right? And if you are someone who is regularly doing that type of stuff, you love those types of routines, you miss out on the social element if you're doing this kind of stuff at home, but the payback period winds up actually being relatively quick if you are an avid user and you stick with this. So, while we are scoffing a little bit at the sticker price [laughs] for some of this hardware, there is a point to it if you are in their market.

Kline: So, this makes sense to me for a Peloton or for a physical piece of exercise equipment. I will point out that when I was a member of a yoga studio, it was over $100 a month, but I went to four to six classes every week, and one class was $20. So, that's a really good value that I got, because I lived less than a mile from the studio, I have a flexible work schedule, so it was pretty easy for me to do that. When it comes to buying something that's really just a version of something I could already get on my phone, they would really have to sell me. I'd have to go do a class in and see how interactive it is. How much feedback is it giving me? Can they do things like correct my form in yoga? And, you know, how personalized is it? They say there's a personal training aspect of it, but is that one person looking at thousands of people? Is there some sort of AI being used here? That part of it is a little bit unclear, whereas the idea of getting on a rowing machine and it tells me you're in a race, you're competing with this guy, look, now you're going over the falls -- like, that speaks to me a lot more than, hey, I'm watching someone lead a calisthenics workout or an abs workout or whatever it is, that feels to me like I could do it already and I don't do it, so I'm not sure I'd want to spend that money.

I wish my gym had this. If I could go upstairs in my building and do, you know, a 20-minute ab workout as the warmup to lifting weights, I'd probably do that, and that would be fun. I'm not sure I could justify the money, even though you're absolutely right. You know, I spend over $200 a week on personal training. And I point that out, that's out of necessity. Like, I need to make myself work out to stay in somewhat acceptable conditions. Certainly, I could see people doing this. And I think the Lululemon fans are going to create a whole community around this, would be my guess.

Lewis: Yeah, let's talk a little bit about this company just because, you know, I mean, people that are Lululemon shareholders, and this is a stock that I know a lot of folks in the Fool community own and follow, probably want to know what this [laughs] business just went out and bought with Mirror. We mentioned before that it was young; I mean, this company launched in September of 2018. It has not been around for a long time. It was a private business, and over the course of being a private business, raised about $70 million. The most recent valuation that I was able to find was about $300 million.

So, Lulu paid about $500 million. There's a decent premium there, but this is a relatively fast-growing market. Peloton, I think up until a couple of quarters ago, was posting over 100% year-over-year growth. They're quite a bit larger than Mirror, but I have to think Mirror's growth is more or less the same.

Kline: It's also worth noting, Dylan, that Lululemon was an early investor in this company, so they already owned a piece of it -- probably meaning that before this, they've been very privy to the financials and the growth pattern. So, this happened quickly. My guess is, there was another suitor. This is a consolidating space, and they probably went to Lulu and said, you know, whoever it is, Apple, Google, [Alphabet] somebody, you know, Google buying Fitbit makes it a really logical tie-in. They probably went to Lululemon and said, while we'd really like to marry you, you're going to have to pay us a premium. It's a pretty small company when it comes to sales -- I mean, $45 million last year, so that's more than a 10X multiple on sale. That's rich, but you can understand why it's worth more as part of Lululemon than it is as a stand-alone company.

Lewis: Yeah. And I think the numbers that I saw from the slide deck that Lululemon had put together was roughly $100 million run-rate for 2020 in terms of full-year revenue. So, I mean, on a forward basis, the acquisition looks a lot cheaper. The valuation does not look crazy, though, when you consider what's going on with Peloton and the value that the market is giving that company. They have just short of $1.5 billion in trailing 12-month sales. I believe they're a $17 billion, $16 billion company. So, they're trading at 10X sales. And, obviously, [they're] a huge beneficiary of stay-at-home trends, so maybe that's [laughs] kind of giving them a little bump right now.

Kline: There's also a pretty massive operational savings here. So, Mirror advertises very heavily. Maybe that's just cute to me, and I am getting, you know, an over-picture of that, but clearly, they're running television commercials, they're spending a lot on ads. I'm not sure they need to do that right now, because Lululemon can go to its huge marketing list and start marketing, and saying, hey, here's what we have, you can finance this so you don't need the money out of pocket. You can make an appointment to come see one in our store, and maybe if they could figure it out with social distancing, maybe even do a mini workout. So, I'm not sure they need all of the apparatus they had. They certainly don't need their back office. They can get rid of accounting people and other functionality. So, this becomes a cheaper company to run. There might also be some manufacturing efficiencies, some shipping efficiencies. Obviously, if you're buying a $1,500 mirror, I don't know how efficient it is to throw in two pairs of yoga pants. On the other hand, [there's] the profit margin for that, and you're probably not paying any extra to deliver. So, there's going to be a lot to gain here.

It also wouldn't surprise me if Mirror has other products in the pipeline, and this becomes a more direct competitor. I'd also love to see more of a tie-in with a specific partnership with a fitness watch or somebody else, as opposed to it being somewhat agnostic. So, they could, you know, sell those. You know, hey, Fitbit, we're going to sell you now in Lululemon stores with the Fitbit Mirror or whatever the exact tie-in is. There's a lot of places for growth with this match-up.

Lewis: Yeah. And actually, I am less concerned about the other wearables element of this. The way that I understand it, and you know I basically had to gather what I could from videos and from testimonials, is you are basically using your smartphone and the app, the iOS or the Android app that they have as a companion app, because you have this beautiful consumer device, this Mirror, and they don't want you touching it and smudging it, [laughs] and so you can be set back and be, you know, doing your workouts and control everything off of your phone.

I do think getting into specialty hardware can be a slippery slope, and all of a sudden you wind up spending a lot of money developing something that nobody necessarily wants or needs. So, I think that they've been relatively smart with how they've done smartphone integrations, focused on making one product really good. One other thing that I really like about this business is they're intentionally lean. And I think they have maybe two physical locations. They are primarily driving all of their sales online. And that's a really good model, it's a really successful model.

And now, they get to go and say, well, we get to have the storeroom experience inside a Lululemon. They're going to let this company operate as its own business. They're going to keep the CEO, I think, in place as the leader of this company, Brynn Putnam, but they are essentially getting what seems like a pretty successful high-growth company and then being able to enjoy a lot of the benefits that come with being [a] partner with a much bigger company.

Kline: Yeah, it feels like they're trying to preserve the culture. It's maybe not that different a culture from Lululemon anyway. So, clearly these companies knew each other on a pretty intimate basis to make this move happen so quickly. And it's one of those scenarios where it's hard to picture a better fit. You know, Lululemon, this is exactly their core audience. And I get it, there are some people who just wear Lululemon to go to sleep or to sit on the couch, but you're probably not spending that money if you're not somewhat engaged in exercise.

And we all know, Dylan, a lot of people buy these products because they might use them, just like we all join the gym because we're supposed to go to the gym. I'm sure there's a lot of people that have, you know, added a little bit of pandemic weight that are going to justify buying an exercise product. And it's easier to justify a $1,500 Mirror than a $2,500 Peloton. It's also, for all the aesthetic reasons, you know, maybe an easier sell for the other people in the house who aren't going to be using it, because at least it's a mirror for them. So, I don't know, I can't see any negatives to this, except for the fact that maybe people will decide that a $1,500 giant iPad is maybe not worth $1,500 compared to actual exercise equipment. That's the only sticking point for me.

Lewis: Yeah, the aspirational brand strength is strong, it seems, with this company and with their new parent, Lululemon. I mean, they really became a much better-known brand thanks to a lot of, I think, unsolicited celebrity endorsements. There's this viral moment of Alicia Keys getting a Mirror for Christmas and absolutely losing it, like, you know, just being so thrilled. And I know other celebrities -- I think Ellen DeGeneres and several other very high-profile celebrities -- have gotten it, spoken about it in interviews. And, I mean, that's the benefit of [laughs] catering to that audience, is you get a lot of free marketing as a result. The Venn diagram between Lululemon customers and Mirror customers is probably pretty high.

Kline: Yeah. And this probably becomes a status symbol, because the reality is, just because I could do something using my television, that doesn't make it as cool or as aspirational. And I would like to assume that Lululemon will build out the community aspect of this, which is something Peloton has done really well. There's more of a competitive nature to what Peloton is doing. But in this case, yoga has often been about communities, you know. Certainly, so have many of the various aerobic crazes over the years and the dance, the Zumba, that kind of stuff. I feel like Lululemon can make this something its customers want, and they won't really focus on, oh, wait a minute, I just could have put my iPhone on a music stand and done this the same way, you know, because it is pretty and it does feel like you're doing something. And they do tie-in things like heart rate monitors, so you can monitor performance and personal bests and -- again, there's a lot of programming. You know, if they have a screen in your house, there's a lot extra they could do with that. Maybe they could show off new Lululemon pants in a way that's -- and I know they sell more than pants, but, you know, you might have a sales channel. Don't push it down people's throats -- that would be very, very negative. But if you add your ability to look at them in full-size, press an order button -- I'm pressing as if I'm pressing on the Mirror, but you'd be pressing on the app -- there's also a lot of optionality here.

But I'm really excited about this, because Lulu has made all the right moves. And as an aspirational brand, they've been very protective of that. They have not allowed their products to sneak out into the discount world. You know, if you're buying Lululemon, you're buying it from Lululemon and you're paying Lululemon prices.

Lewis: Yeah. Let's talk about the strategic fit a little bit here, Dan. You touched on that idea of having something installed. And I think that that is something that most retailers would kill for, the idea that you can have something that is something that people encounter daily in their house and it is somehow part of your brand. It's really hard to get in there. There aren't a lot of products that scratch that. I mean, there's the iPhone, there's whatever uses a computer, but people don't even have that attachment with the TV.

Kline: It's the entire reason the Amazon Echo exists. It's not what people are using the [laughs] Amazon Echo for, but that's what Amazon wanted. They wanted a piece of real estate in your kitchen, so you would say, "Hey, Alexa, I'm out of paper towels. Order Bounty," and you would. The reality is, people don't. Amazon discontinued the Wand, which was a product that you could scan barcodes as you ran out of stuff and it would order it for you. They got rid of the Dash Button, which was, you know, you could put a little button next to your washing machine that would order Tide, when you were out of Tide. These all seem like good ideas. The problem is, it's not that difficult to shop or to [laughs] order on Amazon, so we didn't necessarily need something that made it 2% more convenient.

But think of the tie-in here, so I'm watching a yoga class and it's a -- you know, they have their pick of teachers. You've got your fun teacher, your serious teacher, your mean teacher, all different ages, you know, pick the person you're comfortable with. And that person is wearing the new Lululemon gear. And at the end of the show, they just say, hey, if you happen to notice, I'm wearing the new Lululemon leggings from the so-and-so line; you can buy those in the app. And if you want to see me modeling them, just hit these buttons. That's it, that's all they need to do, not obtrusive, doesn't feel like -- it's just like us pushing Shop.Fool.com on one of our podcasts, our new store. People are looking for the merchandise, so it doesn't feel like a negative ad. They'd literally have a walking advertisement on the Mirror. That tie-in for that should be huge, the fulfillment in it. They're a website company. This is not particularly difficult; they do a lot of their sales digitally. So, that tie-in is perfect.

It's like the Pinterest model. People like to buy something when they choose to buy it. So, if I'm looking at Dylan's hat, and I go, "Oh, hey, where can I get that hat?" and Dylan tells me, that's not an ad, that's a service. Dylan, is that a new hat from the new swag system?

Lewis: No, this is an old hat. This is like a memorabilia item at this point. This is a Motley Fool Germany hat, Fool DE. So, no longer in run, I think. I don't have a new hat yet; I still have to go to Shop.Fool.com and get mine. But, Dan, I think when I heard about this acquisition, I immediately went to what Lululemon had laid out as their strategy. And I think they formally announced this a little over a year ago in 2019: This power of three concept.

And the idea here is, they want to meaningfully drive growth for their business over the next five years by focusing on three different things -- product innovation, omni guest experiences, and market expansion. I think this acquisition checks all three of those boxes.

Kline: It does, because it's also -- Lululemon has struggled to bring men into the picture. They have their line of men's clothes, which I wanted them to call Lulu Larry, but they didn't. But it's generally not a brand you and I are considering. Now, maybe if you're in there with your girlfriend or I'm in there with my wife, maybe we'll look at it. We'll go, hey, I could use a new pair of workout shorts. I'll buy some. But I'm much more likely to buy my workout shorts at Target or at a discounter. I'm not particularly concerned with the fashion statement I am making while working out.

But if my wife came to me and said, hey, you know, I really want to do some more yoga. I'd like to buy a Mirror. I would do some classes with her, and that could bring me into that brand, expose me to more of their products. There's a large array of accessories they could go into. Right now, they only sell a few things. It's a cover for the Mirror, I believe, some resistance bands, but they could sell branded weights, they could sell all sorts of things that go along with this. And that could expand their brand too. And clearly, they have those manufacturing channels. You know, not all of these are bodyweight exercises. You could, in theory, have a giant muscle-bound personal trainer putting you through a dumbbell workout and they could sell something like the Bowflex adjustable dumbbells, you know, while you're clicking into different weights. That all speaks really well to this. And, of course, it would also work with regular dumbbells. You would not need to buy the Lululemon branded dumbbells.

Which I think some people would like, because you know, if Mom is using it four times a week and Dad is using it for one workout, maybe he can use the existing weights he already has sitting in the garage or the closet or whatever it is. So, there's a lot of optionality and expandability to this, just in the exercise space, not even counting that this could move. Look, you could do guitar lessons on this. Like, there are a lot of things you could use this for. We could do one-on-one personal financial coaching in life-size; we're not allowed to do that, but our division that does that could do that using the Mirror as a platform. And I'm teasing a little bit, but anything you could do via iPad, and looking at someone on a tiny screen, in theory, could be brought into the Mirror universe. And they're going to be really careful about that -- they are not going to clutter this up -- but they are going to find other things that speak to this. You know, I'm sure they already do meditation, but there's lots of ways you could build out to more than just an exercise class model that would fit the Lululemon lifestyle brand.

Lewis: Yeah. And to your point about the demographics, Dan, I believe that the Mirror customer base is much closer to a 50/50 split than what we traditionally see. Stereotypically, the Lululemon customer is a woman, [but] they do have that men's line. And I will say, I have a lot of friends who work in, kind of like, factory floor-type jobs and love the Lululemon pants, like they swear by them. They look professional, but they can also be on the move with them, and they absolutely love them. So, I mean, they've been able to gain more traction in that market, but this certainly helps them because they already are requiring a business that has more male customers.

I want to also spend a little bit of time talking about the idea of, kind of, omnichannel and community, because that has been something that Lulu has focused on. They've done it a little bit more with these ambassadors. They have these pro athletes and then they have these, kind of, local community ambassadors, folks that represent the brand but also stoke activity, especially in the case of these local folks who are doing runs and yoga sessions and things like that. I think that this immediately gives platform to a lot of those efforts.

Kline: It does. I mean, imagine they do a special class with Ellen DeGeneres and maybe her trainer putting you through a class. And anything that sort of fosters the "I'm in the club" aspect of Lululemon. They want you to be engaged in the brand. Because, look, here's the reality, you can go to Target and buy pretty decent yoga pants, but there's no community. There are no Facebook groups built around Target yoga pants. There are no celebrities other than the ones paid to endorse them that are talking about that. So, this is something that happened pretty organically, and it's difficult to maintain.

One of our questions in the Q&A here is asking about, well, what about Under Armour? Yeah, you can go wrong pretty quickly by diluting your brand, by putting it into the wrong channels. Lulu has shown so far that it can avoid doing that and keep this as a high-end product, keep it aspirational. You want as many people to be able to afford to get in as possible; that's why there's financing available on the Mirror. You can't finance your $100 pants, but you could put them on a credit card. And $100 for most people, while it is expensive, it's not out of reach for the person who is actively in a position to spend money on exercise.

So, none of these are crazy price points. And when you get in, it becomes hard to leave. It becomes part of your social circle; it becomes something you identify [with]. I mean, think of all the people you know who are on a Peloton, that, like, 80% of their Facebook posts are like, oh, I just got five. Or people who go to Orangetheory Fitness that are posting about their splats! and their blams! and I don't know what Orangetheory -- they never explain it, [laughs] so having never been there, I don't know what any of this means. But clearly, it becomes a community, it becomes important to you. Mirror allows that to happen on a grander basis. It allows the teacher during that live class [to] be like, hey, way to go, Dylan, like, that's a personal best, like, you are more flexible than you were a month ago or like whatever data they're feeding them. And that makes you want to do it again. Look, it's part of why I pay a trainer. It forces me to go, it tracks progress.

If you are identifying online, like, hey, I did four Peloton classes this week. And you stop posting that, people are going to notice; there's an accountability there. That's going to hold people loyal to this brand. And ultimately, that's going to push more sales of Lululemon products. And I'm guessing the profit margin on a $39-a-month subscription, that is a library plus live classes, that is probably an incredibly viable high profit margin, once you've built up that big library in each area. Because certainly you have to have some live classes at all times, but you don't have to have hundreds of live classes at all times.

Lewis: I don't know if you looked at this point in our notes, Dan, but I did dig into the margins, because I was curious. [laughs]

Kline: [laughs] Dylan, I've placed my light in a different position, so I have the notes in front of me, but I literally cannot see them, so. [laughs]

Lewis: [laughs] So, that's always a question. When you're looking at one business acquiring other companies, like, if this other business scales dramatically and becomes a much larger portion of revenue contribution, what does that do to the company's gross margins? And Lulu is in pretty rare air, if you look at the apparel business. They are generally operating with gross margins in the +50% range. And for comparison, Nike is about 40%-ish, ditto for Under Armour. We do not know the nuts and bolts of Mirror's business -- we've actually gotten very little information about it from Lululemon -- but if you want to look at an analog that is a slightly scaled-up version of Mirror, we have Peloton as a publicly traded company.

Up until the end of the year, and so we're going to ignore some of the impacts of COVID, they were growing revenue over 100% every quarter, and margins were in the 40% range. So, I was a little surprised by that. These are generally lower margin sales than what we're seeing from Lululemon's apparel business, but to your point, Dan, when you start scaling things out and you are collecting more and more subscription revenue rather than hardware revenue, that business probably becomes much more attractive over time.

Kline: Yeah, I'm guessing the hardware sale is not all that relevant for Mirror. That seems like a pretty expensive product to make. So, it might be a zero-margin business. Their business is selling you the subscription service. And the brilliance of it being $39 a month is, if you cancel that subscription, you're admitting two things: I wasted $1,500 on a mirror and, hey, I'm not going to get in shape.

And I think we've seen, from the history of gyms, that people will stay members of gyms for an astoundingly long time just so they can feel like they're doing something. Now, the best-case scenario is more the Peloton model, where not only do you pay for it, you actually use it and feel there's value in it, because that makes you a brand ambassador. You're going to tell all your friends, ah, I never did this with cycling classes at the gym, but I do three Peloton classes a day and I've lost 600 pounds or I'm four inches taller, like, whatever the Peloton does for you.

I think Mirror has that ability that people will, if you're going to lay out $1,500 and spend $39 a month, you're probably going to use it. If they deliver a good class, you're probably going to like it and you're probably going to tell your friends. That is going to build this community to the point where they become Netflix, where they're collecting tens of millions of $40/month, which is like 3X what Netflix costs, with way less cost.

Dylan, I don't know about you, but producing a movie with Will Smith where he battles orcs or whatever Bright was on Netflix, or a season of Ozark, costs way more than hiring a yoga instructor to teach for an hour. Even a really good yoga instructor might get, say, $100 versus the $100 million that that movie costs. So, there is a very low-cost structure here.

And as they expand into other areas, they build a bigger lineup. You might find that, like, you know what, I really love doing the 10-minute ab crunch workout, the same workout, I do it four times a week and I work on getting better at it or adding weights or whatever it is. There is a very, very attractive model here, because they do not need to spend. They just need a camera, a decent mic, and a couple of people. And frankly, they're probably all fixed cameras anyway. So, this is a really low cost of production to grow -- you know, just do four live classes a day, and at the end of the week you have 28 more classes in your archive. That's really impressive.

Similar to what we're doing here at Fool Live, you know, where if you want to look back and see an old show, you can look that up, and that show might get, you know, 1,000 extra views this year, but then the next 20 years it might get 50 extra views and it doesn't cost us any more money to get those views.

Lewis: So, it sounds like, all-told, Dan, you are a fan of this acquisition?

Kline: Yeah. Look, this is a product that, if it was bought by the wrong company, could easily get lost. I feel like -- and I mentioned Google because of the Fitbit acquisition and that this could have been tied into that brand, but the customer base isn't as devoted. You know, I don't know a lot of people who are out there, like, wearing Google t-shirts, and like, "I search with Google." [laughs] You know, Apple has struggled with acquisitions, and while this fits their profile really well, and, obviously, ties in with the fitness goal of the Apple Watch -- I could see some really amazing integration there -- I'm not so sure there's enough money in this to get anyone at Apple interested. So, this is, in theory, a bigger brand eventually than Lululemon is, like, this expands their reach.

And it wouldn't shock me if they eventually had other products. You know, I don't know what that might be, but it's not crazy to think they could have a bike or something else going into the future, or extensions that build off of this model. But I really like it, because they're going to get the nurturing and the attention. It doesn't take up a lot of space, so their ability to put this right away into Lululemon stores is easy. You know, that's not a big problem.

I think this is an immediate sales lift -- my guess is, for post-pandemic or as inventory allows, because it's not easy to build a lot of anything right now. My guess is they sell in the next three months more than they sold in the past year, because they're getting a ton of publicity. They're going to get a ton of facetime in stores. Again, the Lululemon at my mall was open with, I think, a five-person capacity. So, you know, we're in, sort of, strange times. But a lot of people now know about this product and a lot of couples are sitting down and going, well, we're not going on vacation this summer, and you know, we didn't spend a lot of money on our anniversary, maybe we should get this product. I think it's going to work really well.

Lewis: I'm inclined to agree with you, Dan. I think the big thing I tend to look at with acquisitions in general is: Are we setting this company up for a massive goodwill write down at some point in the next three to five years? And for folks that are unfamiliar, you go out there and you pay more than something is "worth," you have to put that on your business as goodwill. It's value that you might realize down the road, thanks to something like an acquisition. If that value does not materialize, eventually you have to eat the cost and just accept it, and say, you know what, we overpaid for this thing.

In this case, Lululemon is about a $40 billion company. A $500 million acquisition is kind of in that sweet spot where it's not big enough to sink them, [and] it's not so small that we're going to totally have forgotten about it in two or three years.

Using Peloton as an example, this is right now a $17 billion business. They are way behind Peloton in terms of sales, but it's clear that this could grow into something pretty meaningful. And I think strategically, it's an amazing fit for Lululemon.

Kline: Yeah. And I don't know what the Mirror inventory situation is, and that will depend on how hard they push this, how quickly, but just the email to devoted Lululemon customers, "Let's welcome Mirror to the family. We want you all to be on board with this. Financing is available." That's going to sell an awful lot of devices. They may not be able to do that, because they might not have warehouses full of products sitting around. And there might be pandemic-related issues that slow that down, but I feel like there's a faucet they can turn on at some point. And they might choose to drip it, because of the supply chain, but at some point, a lot of people are going to have this.

And you know, look, a million people paying $40 a month is a meaningful amount of revenue for a company the size of Lululemon, especially if that's eventually a 70% or even an 80% margin product. This, to me, is really exciting, and I very rarely think an acquisition is going to go well. Maybe that's my background having worked for Microsoft, where basically every, like, half-year there was, like, a press conference. "We're going to have to take another write down on Skype. Skype now actually costs us money. We paid $8 billion for it. It's actually worth less than $0." [laughs] And that's not true, I'm teasing a little bit. But Microsoft has a long history of buying things and having it not work out.

And frankly, I'm not so sure you can say the Apple-Beats marriage turned out that great. I don't think they marginally changed how many Beats people purchased, and everything else around that, Apple Music and all the expansions, they've been kind of ho-hum. Now, some of that is because Apple is so big. You can be a very successful company and it still doesn't move the needle. In this case, the needle is going to be really obvious. And I think this is going to be a highlight of Lululemon press conferences for the next couple of years, as this company becomes maybe as big as the apparel brand.

Lewis: So, to put a bow on it, even though we are not necessarily buyers of Mirror, we are buyers that this is a good decision for Lululemon.

Kline: I would certainly buy a Mirror, if it was something my wife was interested in, because I would probably use it once a week. It is not something I would buy if she didn't bring it up, simply because I spend way too much money on exercise, and that is probably not a conversation I need to have right now. [laughs]

Lewis: [laughs] Well, everyone finds what works for them when it comes to fitness. Another major option out there now for folks.

Dan, thanks so much for hopping on today's show and talking Lululemon and Mirror with me --

Kline: Oh, thanks for having me. I was very excited to talk about this one.

Lewis: All right. Listeners, that is going to do it for this episode of Industry Focus. If you have any questions, if you want to reach out and say, "Hey!" shoot us an email over at IndustryFocus@Fool.com or tweet us @MFIndustryFocus. Love getting ideas for shows over there. If you want more stuff, subscribe on iTunes or wherever you get the podcasts.

As always, people on the program may own companies and the stocks discussed, and The Motley Fool may have formal recommendations for or against any of the stocks discussed as well, so don't buy or sell anything based solely on what you hear.

Thanks to Tim Sparks for all his work behind the glass today. For Dan Kline, I'm Dylan Lewis. Thanks for listening, and Fool on!