Lululemon Athletica's Founder Chip Wilson Sending The Right Signals

| About: Lululemon Athletica (LULU)
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Lululemon has a divided boardroom and a principal-agent problem.

The stock (LULU) is a "SELL".

Turnaround is likely to take much longer.

Mr. Chip Wilson publicly announced his disapproval of the company’s board and its strategic vision; he has a point.

Lululemon Athletica Inc. (NASDAQ:LULU) lost 17.3%, from Tuesday's (4/10/14) close of $45.48 to Friday's close on April 13, 2014 at $37.61. Its founder and largest shareholder Mr. Chip Wilson publicly announced his disapproval of the company's board and its strategic vision. Mr. Wilson owns 27% of LULU shares.

This article investigates LULU's board structure and surveys strategic challenges and offers solutions.

Mr. Wilson said he had voted against reelection of Michael Casey, Chairman of the Board of Directors, and RoAnn Costin, an independent director. RoAnn Costin has been a Board member since March 2007 and Michael Casey since October 2007.

It is hard to understand why Mr. Wilson voted his shares against only those two Directors. Both have served on the Board since 2007 but are not the longest serving members as seen below. Both also were elected to the board when Mr. Wilson was Chief Product Designer at the company from December 2005 until March 2010. Mr. Casey is from Starbucks (NASDAQ:SBUX) and has restaurant industry background whereas Ms. Costin has investment advisory experience and comes from retail.

Lululemon Athletica Inc.'s Officers and Directors:

  • Laurent Potdevin, chief executive officer - January 2014
  • John E. Currie
, chief financial officer - January 2007, resigned on June 12, 2014
  • Tara Poseley, chief product officer - October 2013
  • Delaney Schweitzer
, EVP retail operations NA - 2002
  • Robert Bensoussan, director - January 2013
  • Michael Casey, chairman of the board of directors - October 2007
  • Roann Costin, director - March 2007
  • William Glenn, director - December 2012
  • Martha a.m. Morfitt, director - December 2008
  • Rhoda M. Pitcher, director - December 2005
  • Thomas G. Stemberg, director - December 2005
  • Emily White, director - March 2012
  • Dennis J. Wilson, director, founder 1998

What signal does issuing a press release against your own board members on the eve of its annual meeting and a divided boardroom send to the investors?

Mr. Wilson said he wants to send a signal to the financial community that the company must address the problems in the boardroom, that the team is heavily weighted toward short-term results at the expense of the brand, product and long-term goals. LULU has a divided boardroom. Mr. Wilson criticized the Board's lack of focus on product, innovation, culture, brand and longer-term corporate goals.

Mr. Wilson is the largest shareholder with 27%. We have here a principal - agent problem. The management team running the company has the authority to make decisions. The managers are the agents. Their decisions apparently run counter to Mr. Chip Wilson's vision and strategic direction that he would make if he were the 'management'. He is the principal. This is a typical principal-agent conflict.

Mr. Wilson has a point. All key insiders, excluding Mr. Wilson, own only 266,781 shares. Martha A. Morfitt Independent Director owns 70,061 shares. Everyone else on the board owns less than 50,000 shares each. Out of 145,861,000 outstanding shares, the management and directors, excluding Mr. Wilson owns only 266,781 shares. The float is 87,610,000 shares.

The company however has put aside 14,832,290 shares in an equity compensation plan approved by the stockholders to be issued to the management and to the board in the future. Therefore it is in the management's best interest to increase the stock price in order to qualify to exercise 14,832,290 shares in an equity compensation plan approved for a certain period of time.

In order to support the share price, the company also announced a $450 million share repurchase program to be completed in two years. Share buybacks is a valid method of supporting the share price if you think that the shares are undervalued or if you think that the shares will rise in the future regardless of its current value. In order to finance the share buyback program though, the management decided to repatriate its foreign earnings. In the process the first quarter tax rate rose to 73.4%, and resulted in the one time adjustment (what I would call a "loss") of $30.9 million. That is a 6.9% loss to finance the buyback.

The best way to increase the shareholder value for LULU is to solve its current problems and focus on quality, innovation, and brand value.

LULU's Problems and Proposed Solutions:

1. Public Relations: Mr. Wilson obviously had inside information about the company's results and released his press release before the company released its earnings. This was totally inappropriate. He should have never made his disagreements public or he should have waited until the end of the earnings release. The Company needs to speak with one voice, one investor relations department, and one leader. If Mr. Wilson agrees for the Company to have "one voice", this will go a long way in solving the principal-agent problem.

Boardroom conflicts, especially when made public, hurts shareholder value by making employees insecure, reducing morale, and wasting management's time.

2. Image Issue: Board infighting, CFO leaving, founder issuing press release against the board, and clear low quality perception of some of its products lead me to conclude that LULU is a permanently damaged brand. The company needs to continuously emphasize that their apparel is not only hip but of highest quality and prove it going forward to fix this permanent damage.

3. Transition Risk: Chief Financial Officer John Currie is going to retire by the end of the fiscal year, January 2015; CEO is newly appointed in January 2014; and Mr. Wilson pushing for changes in the company's board all point to a period of further transition at the top, which coupled with the strategic turnaround since the product recalls in March 2013, makes this a very challenging period.

Mr. Wilson's public spat with the board, which is relatively rare in corporate America, clearly shows he believes, that his vision is not being implemented at all or not fast enough. He is impatient not only with the pace of the turnaround strategy the company has been undertaking but the very nature of the company's strategy. The majority of the board apparently is not aligned with the core values of product and innovation. There is also product and sales channel transitions into "direct to consumer" sales, international expansion and a new product line for men.

4. Quality Risk: Quality problems reached a new high in March 2013 with the recall of 17% of its stretchy black yoga pants. The company never took full control of this problem. The solution should have been to accept the problem; outline steps to correct it, inform the customers, implement the solutions and speak with "one voice". LULU needs to appoint a top quality control executive with supply chain experience reporting directly to the CEO. Company's strategy should be to produce the best yoga wear in the world, not just a yoga wear.

5. Timing Risk: The turnaround is not going well. The company guided lower for the 2nd quarter of 2014 and the fiscal year 2014 in its June 12 press release.

6. Morale Risk - Divided Board: There must be insiders on and off the board supporting Mr. Wilson, and there must be insiders against him. There must be employees talking about and favoring Mr. Wilson in his boardroom fight, and there must be employees thinking that he is wrong.

Infighting in a sports team, in the family or in the boardroom always leads to anger, confusion, uncertainty and people leaving. The company must find its strategic direction and convey it with "one voice" to resolve the morale issue.

7. Product Development and Innovation Risk: While the management wastes its time fixing the quality issues and dealing with board infighting, innovation tends to suffer and development of new fashion items are usually delayed.

Today's consumer demands newness in every season. The Company hired Tara Poseley 
as the New Chief Product Officer in October 2013. She has background from Wal-Mart (NYSE:WMT), Disney (NYSE:DIS) and Gap (NYSE:GPS). Mr. Wilson obviously believes that the company's focus on product development and innovation is not deep enough, fast enough, precise enough.

8. Digital Strategy and Customer Satisfaction Risk: The company announced that direct to consumer revenue increased to $66.0 million, or 17.2% of total Company revenues, in the first quarter of fiscal 2014, an increase from 15.6% of total Company revenues in the first quarter of fiscal 2013.

Direct to consumer execution must be impeccable, like that of Amazon (NASDAQ:AMZN). Customers otherwise will get upset and return the items. LULU has faced these customer satisfaction challenges in its direct to consumer sales. If tops and bottoms arrive at the customer's door at different times, they will not be pleased and cancel the orders. LULU should just poach someone from Amazon.

9. New CEO: It is hard to know if Mr. Laurent Potdevin, Chief Executive Officer only since January 2014, is going to be able to solve critical supply chain, quality problems and successfully expand internationally. While he is dealing with the turnaround, competition from Gap's Athleta, Under Armour (NYSE:UA) Inditex is eating his cake.

As Philip A. Fisher, says, "Very often, the best way to be successful in the long run is not to aim at being successful in the short run. The history of capitalism has been lurched forward by people who weren't looking primarily for the rewards of narrow, immediate gain." Share repurchase by repatriating foreign earnings, 14,832,290 shares in equity compensation plan and with almost no management and board ownership of the stock, the management and the board is taking a short term strategic vision. If that continues, LULU is not likely to lurch forward. Mr. Wilson has a point.

I believe the turnaround to take longer than expected given the divided boardroom, permanently damaged brand name, low quality control, lack of innovation and new products. The stock therefore is a "SELL".

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.