Lululemon Athletica: Strategic Buyer May Pay $51-$63 A Share

Lululemon Athletica: Strategic Buyer May Pay $51-$63 A Share
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Analysts are split on whether Lululemon Athletica inc. (NASDAQ:LULU) has much of a future. Citi analysts think a leveraged buyout is likely and provided some analysis of the numbers. They think the company’s insiders and the company itself are looking at the possibilities and also “standalone status quo of operations.”

“Something” will happen with Lululemon Athletica

In a report dated June 23, 2014, analysts Oliver Chen and Nancy Hilliker said there’s some sort of transaction likely in Lululemon Athletica inc. (NASDAQ:LULU)’s future. They cite risks of near-term deleverage because comparable store sales have been lower than expected. Other reasons they see are the need for transformation, which could be better done without the scrutiny of investors, and the brand’s “attractive” attributes in a segment of the apparel market that’s growing. They also say the company must speed up its “global and online / omnichannel efforts.”

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The Citi team notes that Lululemon Athletica inc. (NASDAQ:LULU) doesn’t have any debt and still holds net cash of about $5 per share of $75- million. In addition, the apparel retailer generates between $160 million and $170 million of free cash flow each year. On the list of types of transactions that are possible, they see a potential combination of financial, management, insider and strategic buyer. They think some sort of deal might drive a 20% or more premium from Lululemon’s current share price.

A base case for Lululemon Athletica LBO

When using their base case estimates, they see 15% return leverage buyout numbers as working. They say that a bid of $55 per share, plus a 16 to 17 times entry and exit LTM EBITDA multiple. $2.6 billion debt from the leveraged buyout at +6% to 7% and about 55% equity contribution would work. In their estimates, that would yield “an illustrative” 15% to 16% 5-year internal rate of return.

They say this is possible because of Lululemon Athletica inc. (NASDAQ:LULU)’s about $400 million of average annual EBITDA, plus the assumption of a $115 capital expenditure run rate. They think this would provide a cushion for at least $150 million of interest expenses.

lululemon athletica  LBO

Their base case assumes 16 times LTM EBITDA, which is a 33% premium or $55 per share valuation. They note that luxury transaction comparable sales are between 15 and 19 times and provide a stock price range of between $51 and $63 per share, as shown below. They see this range as being the price a strategic buyer would be willing to pay for Lululemon Athletica inc. (NASDAQ:LULU).

lululemon athletica acquisitions

Positives to Lululemon Athletica making a deal

The Citi team sees a handful of reasons why Lululemon Athletica inc. (NASDAQ:LULU) should make some sort of deal. First, they said it’s feasible for the company to raise $2.6 billion in debt. They also think the market will be able to digest such a deal. Second, they calculated “compelling IRRs of over 15% vs. a likely +M-Teens return hurdle” as being required. Third, they say Lululemon Athletica inc. (NASDAQ:LULU) has “strong brand equity” in a segment of the apparel market that’s growing in spite of the weak sales trends.

They remain Neutral-rated on Lululemon Athletica inc. (NASDAQ:LULU) with a $40 per share price target.

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