Lululemon Athletica (LULU 1.20%) made a mistake -- it's just that simple. But no company can execute perfectly, so errors are to be expected. The bigger question for investors now is, what does that mistake mean for the athletic apparel company's long-term future?
In my view, this particular blunder is likely to be a net, though expensive, positive. Here's why.
Brand extension
Lululemon has seen phenomenal success in the sports attire space. At first, it predominantly catered to women; then, it branched out into men's apparel. Although quality and function are both important, form is the real selling point for this fashion brand. Sales and earnings have grown dramatically over the past decade as the company's brand continued to resonate with customers, the company expanded its retail footprint, and management continued to execute at a high level.
LULU Revenue (Annual) data by YCharts.
The downside to this impressive growth history is that Wall Street now has high expectations for the company. Lululemon's price-to-earnings ratio today is a lofty 56, which is even higher than its five-year average of 54. Both are the sorts of figures you'd expect from a technology start-up, not a company that makes clothing. When investors have big demands, companies sometimes try a little too hard to meet them.
At this point, it's clear that Lululemon did just that when it agreed to buy Mirror in 2020.
The deal and the fallout
Lululemon bought Mirror, which makes an interactive exercise device housed in (you guessed it) a mirror, for $500 million. At the end of 2022, it wrote down the value of Mirror by $442 million, recognizing that most of the value of its investment had evaporated. And, more recently, there have been rumors that Lululemon is trying to sell Mirror.
When the original deal was announced, Lululemon described Mirror as an exciting opportunity to build upon its vision to be "the experiential brand that ignites a community of people living the sweatlife." Clearly, that didn't pan out quite like management expected -- demonstrating at least in part that Lululemon is more adept with fashion and fashion trends than with high-priced exercise equipment. Notably, the company's effort to enter the sneaker space went much better than its Mirror plans. The company is expanding its footwear lineup in 2023 to include a trail shoe, and it has set a goal of entering the men's shoe market in 2024. Basically, Mirror was a lesson in limitations -- one that likely pushed management to focus more on what Lululemon is good at.
That said, one of the fallouts from the Mirror debacle was a harder push toward fitness apps as a way to connect with customers. Lululemon has long held fitness classes in its stores, so an app that offers similar features makes sense. And it gives the company a way to create a community that doesn't require a huge up-front outlay from customers.
Interestingly, Peloton Interactive (PTON 4.79%) came to a similar decision -- it's shifting away from hardware to a degree, and more toward subscription services delivered digitally. The differentiator here is that Lululemon has a massive retail business to support its business decision. Peloton can only hope it can get its customers to keep paying subscription fees or it may not have a business. In fact, even if Lululemon's subscription service never generates any direct revenue, if it keeps customers engaged with the brand, it will likely be a big win. But a win that fits with the company's broader appeal, unlike Mirror, which was a new technology that came with high material costs for the customer (and Lululemon), and had minimal connection to its core business.
A great business
Lululemon's core apparel business is so strong that the Mirror misstep is really a non-event. It was basically a costly lesson that the brand is strong, but it shouldn't try to be more than it is. The added benefit from that misstep was management's recognition that its efforts to engage with customers need to be more aligned with its core. With any luck, management will stick to its knitting from here on out. If it does, and if history is any guide, there's more growth ahead for the retailer as it continues to expand its geographic reach and product lineup.
