Lululemon Corp: Must-Have IPO or Market Opportunists?

Lululemon (Nasdaq: LULU) is a fast growing designer and retailer of athletic apparel in North America. The hot brand is well known for their women’s yoga apparel. The company was founded in 1998 in Canada, and expanded to the US in 2002. Currently, Lululemon operates 52 stores.Financial performance is nothing less than impressive:

Our net revenue has increased from $40.7 million in fiscal 2004 to $148.9 million in fiscal 2006, representing a 91.1% compound annual growth rate. During fiscal 2006, our comparable store sales increased 25% and we reported income from operations of $16.2 million, which included a one-time $7.2 million litigation settlement charge. Over that same period, our stores opened at least one year averaged sales of approximately $1,400 per square foot, which we believe is among the best in the apparel retail sector. (Lululemon Corp. Form S-1.)

So, investors must be lining up to balance their investment-life portfolio with shares of LULU? Not so fast. Last Friday the company filed a revised prospectus to cut the number of IPO shares by nearly ten percent to 16.4 million. If demand is the key reason to get in early on an IPO, we may want to wait and see before clicking ‘buy’ in our online brokerage account.

In my opinion, the disappointing appetite for LULU stems from the use of proceeds from the IPO. Although I love nearly everything about this company (e.g., strong management, solid financials, excellent brand value, tremendous growth potential), like Warner Music Group (NYSE: WMG), the people benefiting most from this IPO are the founder and private equity investors: existing Lululemon shareholders will account for nearly 14.1 million of the 16.4 million IPO shares. Yep. That means, as the Form S-1 so eloquently reads, “We expect to receive net proceeds from this offering of approximately $20.3 million.” That’s out of approximately $164M raised.

Wall Street may not be predictable all the time, but one thing most investors frown upon is market opportunists. Some companies like Blackstone (NYSE: BX) have the PR and hype to get over this issue, but little known niche companies do not. Such behavior is unfavorable because LULU will now use more money from cash flow, rather than IPO proceeds, to fund growth. This, in turn, eats into value metrics that support stock prices as well as premium values that a prospective buyout player may be willing to pay. In this case, during 2007-08, Lululemon has budgeted $28.0 million to $34.0 million for new store openings. Tack on working capital and expanding G&A, and the proceeds from the IPO seem more like a windfall for existing shareholders than future shareholders.

Will LULU become another must-have apparel stock like Abercrombie & Fitch (NYSE: ANF), Aeropastal (NYSE: ARO), American Eagle Outfitters (NYSE: AEO), and Urban Outfitters (Nasdaq: URBN)? Or, will the company’s founder and private equity investors take all the icing off the cake? We will stay tuned …

Disclosure: SmartGuyDH does not own shares in any of the companies listed above.