lululemon athletica (LULU 1.43%) is starting to return to its pre-pandemic growth levels. Over the last three quarters, the business has steadily improved with revenue growth reaching 24% in the most recent quarter. But one of the highlights of the recent earnings report was the performance of Mirror, the interactive fitness company that Lululemon acquired for $500 million last year.

"While the business is still in its early stages and represents less than 5% of our total revenue, Mirror sales exceeded our initial expectations in 2020," Lululemon CFO Meghan Frank said during the fiscal fourth-quarter earnings call

Lululemon now sees an even greater growth opportunity for Mirror than it did at the time of the acquisition. During the call, management outlined how it plans to drive brand awareness and grow the Mirror business over the next year.

A woman lunges during a workout in front of a Mirror fitness device

Lululemon hopes to capitalize on the growth of the at-home fitness market with the acquisition of Mirror. Image source: Lululemon.

The growth strategy for Mirror

Despite its high price tag of $1,495, sales of Mirror devices have been growing rapidly since launching in 2018. Like other interactive fitness hardware on the market, users must pay a monthly subscription fee ($39 per month) to access training programs. It's the lifetime value of this recurring revenue stream that Lululemon is most excited about.

"The value in the Mirror business model is the lifetime value of their guests, and we're going to invest into the current category strength to maximize the long-term value of this asset," Frank said.

Lululemon is planning to spend aggressively this year to drive sales. The priority is to build brand awareness for Mirror, which desperately needs it to catch up with rivals. The leader in this market right now is Peloton Interactive, which spends more in marketing each year than Mirror generates in revenue. Peloton expects its annual revenue to reach $4.1 billion in fiscal 2021, while Lululemon currently expects Mirror to generate between $250 million to $275 million in the current fiscal year.  

It's a given that Lululemon is going to invest in studios and workout classes to expand what Mirror offers. That's the entry-level fee for Lululemon to compete in this increasingly crowded market. It's a who's-who list of players, starting with other subscription services like Nike's Training Club and Apple's Fitness+. Other exercise equipment manufacturers include Echelon and Bowflex owner Nautilus, in addition to Peloton. These companies are investing in workout content and technological features to compete. 

A key factor that could help Mirror stand out from the pack and catch up to larger rivals is taking advantage of Lululemon's expanding footprint of 521 stores. Before Lululemon acquired it, Mirror sold its devices mostly online, with only two physical locations at its disposal. It now has a wider distribution channel available to market and sell its product.

Lululemon tested a shop-in-shop strategy during the holidays by selling Mirror devices in select stores. Management reported during the fiscal 2020 third-quarter earnings call that customers were "blown away" when they saw the device in person. Management is now planning to showcase Mirror across 200 more locations in North America this year. 

An example of a Mirror shop-in-shop in a Lululemon store.

Image source: Lululemon.

Path to profitability

Mirror is not yet profitable, so it will put pressure on Lululemon's earnings in the short term. Plus, the investment in more workout classes, studios, and shop-in-shops will come at a cost too. Management expects Mirror to dilute full-year earnings per share by 3% to 5%, excluding acquisition and integration-related costs. That's really not much and highlights an advantage Mirror has over some of its rivals now, such as being able to tap into greater financial resources that it didn't have before.

Speaking about Mirror's path to profitability during the fourth-quarter earnings call, Frank said, "They are still very early in their lifecycle, and the path to profitability there is very much within our control."

Driving higher sales volume through Lululemon's stores should help Mirror turn a profit faster. But even before Lululemon acquired the business, Mirror was already set up to eventually turn a profit, since it relied on an online sales channel without having to support the investment for showrooms like Peloton. Peloton earned $166 million in net income over the last four quarters, even while investing in studios, content, technology, marketing, distribution, and showrooms. Mirror can follow a similar path.

Including the higher expenses to support Mirror's growth, Lululemon still expects adjusted earnings per share to land between $6.30 and $6.45 for fiscal 2021, representing year-over-year growth of 35% at the midpoint of guidance. Guidance includes revenue growth of 50% to 65% year over year for the Mirror business. 

Lululemon was already well positioned for a bright future, but the addition of Mirror spices things up a bit. As Frank said on the latest earnings call, "We're excited with the momentum we're seeing in this business, particularly the growing community of people sweating with Mirror, which contributes to increased brand awareness and strong long-term financial returns."