Gap Beats Out Lululemon to Buy Athleta

Includes: GPS, LULU
by: FP Trading Desk

Women’s sports active wear company Athleta, which does most of its business online and via catalog, is being bought by Gap Inc. (NYSE:GPS) for $150-million in cash, but it may have also appealed to Lululemon Athletica Inc. (NASDAQ:LULU). The deal reinforces interest in the women’s athletic apparel niche, which could make Lululemon a takeover candidate for a larger player, according to a new report.

RBC Capital Markets analyst Howard Tubin said:

Given the current retail environment, investors should take seriously the fact that capital is flowing to serve this market niche.  Investors also should ponder that LULU itself could be the retail solution for a larger player.

He suggested that Lululemon management was fond of Athleta and may have been considering it as an e-commerce partner. Gap will run Athleta as part of its Internet operations, allowing products from its Old Navy, Banana Republic and Gap stores to be shipped with Athleta items. There is also a chance that Athleta products will be sold in stores eventually.

While the deal reinforces the competitive appeal of yoga apparel retailer Lululemon, it also provides it some valuation support, according to RBC.

“Looking at Athleta’s offering and positioning, investors can see the similarities between LULU and Athleta,” Mr. Tubin said, adding that while they serve a similar clientele, their approaches were different.

RBC believes the deal values Athleta at three to four times sales, which is roughly in line with Lululemon, given that it is trading at 4.3x 2008 estimated sales and 3.3x for 2009.

Credit Suisse analyst Paul Lejuez told clients:

Although the acquisition is small relative to the size of GPS [Gap], it positions the company to compete in a new category of apparel.

He considers the acquisition as an incremental negative for Lulemon, since the largest specialty retailer in the U.S. now owns one of its direct competitors.

Mr. Lejuez said:

Although the product is somewhat less technical than LULU and serves a slightly different demographic (price points are generally 15-20% lower), Athleta will now receive broad exposure to the U.S. market.

As for the Gap, CreditSights said the deal will have little credit impact, given the retailer’s strong balance sheet with $1.68 billion in cash and only $188 million in total debt.

Mr. Lejuez said:

With GPS suffering from a steady erosion in same store sales at its Gap, Old Navy (and, more recently, Banana Republic) stores, the addition of a growth-oriented brand should be a positive, if the new brand is well integrated.

Mr. Lejuez said Athleta provides a near-term positive for Gap shares, but he remains concerned that Gap, Old Navy and Banana Republic continue to struggle to drive sales and traffic.

Mr. Lejuez said:

Unless the top line improves, the company will have difficulty increasing earnings in fiscal 2009 as they will have few expenses left to cut.