In late July, Bloomberg Businessweek ran an article about the similarities between Lululemon (NASDAQ:LULU) and Gap‘s (NYSE:GPS) Athleta brand. Right down to the store locations, the two seem embroiled in a serious fight.
Long-time followers of Lululemon knew the day would come when other companies homed in on its yoga/active lifestyle demographic. Hoping to maintain its cult-like following, Lululemon is doing whatever it can to ensure its customers stay loyal. Act of desperation? Let’s look more closely.
The most recent indication that Lululemon is feeling the heat: The Vancouver-based company filed suit Aug. 13 against Calvin Klein, which is owned by PVH (NYSE:PVH), seeking damages and costs for infringing upon the design of its yoga pants. In addition to Calvin Klein, Lululemon’s named G-III Apparel Group (NASDAQ:GIII) in the suit, holder of the Calvin Klein license and manufacturer of the pants.
Lululemon CEO Christine Day is playing hardball with a high-profile competitor, hoping the tactic will scare off further copycats. It’s a bold move, but it could backfire.
I’ve followed Lululemon’s stock for several years, and the shorts’ argument against its rich valuation has always been that yoga pants are a fad and competitors like Gap, VF (NYSE:VFC), Calvin Klein and many others will eventually take market share from the company based solely on price. Hedge fund manager Whitney Tilson has been a short on and off for more than two years.
I’m not sure I’d have the courage to short a stock that’s up 40% in 2012 and has averaged an annual total return of 148% in the three years prior to this one. Nonetheless, it’s reasonable to wonder how many stores Lululemon can open that generate $2,000 a square foot in sales. In the past four quarters ended April 29, it opened 38 stores, 27 of them in the U.S. In 2012, it plans to open as many as 37 locations, including two outlet stores.
With same-store sales growth hovering above 20% and the number of store openings in 2012 only slightly behind its pace in 2011, nothing in the numbers suggests any weakness.
However, in addition to the patent suit, there is something that indicates Lululemon management sees slower growth ahead — and that’s the expansion of its Ivivva brand, which is currently undergoing a slow rollout in Canada. With seven stores in three provinces, the brand caters to young girls who are active. Think Lululemon, only smaller sizes.
Clearly, Lululemon wouldn’t be looking to a second brand if it thought its legacy brand’s growth was unlimited. On the other hand, you can argue that opening a brand catering to young girls only broadens its fan base and should keep the growth curve from plateauing.
Several years ago, Gap tried to create a niche market with its Forth and Towne division catering to women over 35. After spending $40 million on a brand that made middle-aged women feel old, it pulled the plug in early 2007. Sometimes, it doesn’t pay to be different. Investors should know by 2013 or 2014, at the latest, whether Ivivva is here to stay.
Getting back to the alleged patent infringement, Lululemon believes Calvin Klein and G-III have violated a total of three design patents issued in 2011 on its Astro Pant. Design patents are an inexpensive way for companies to protect a unique design for up to 14 years. The problem is that anyone can take a piece of clothing, slap a design patent on it and that’s supposed to be good enough to prevent others from reinventing it.
I don’t think so. In order for Lululemon to successfully argue its case, it will have to demonstrate that the Calvin Klein products appear “substantially similar” to an “ordinary observer.” Everything I’ve been able to find online about the case suggests that the waistbands of the two companies’ products are clearly different and that Lululemon is trying to protect its turf from Calvin Klein and other less expensive brands.
Using the argument that both companies developed their products from “prior art,” Calvin Klein should have no trouble defending itself in court.
Do I think Lululemon’s lawsuit is an act of desperation? No. Rather, it speaks to the company’s level of arrogance. This argument was going to happen eventually. I’m just surprised it decided now was the time to plant its flag. If it loses this case, everyone will know Lululemon’s products aren’t unique.
This is a huge gamble with little upside. I think the company just blinked.
As of this writing, Will Ashworth didn’t own a position in any stocks mentioned here.