Under Armour Inc (NYSE:UAA) has finally reaped the rewards from years of misspending. The company has dug itself a big hold that will be difficult to recover from, and UAA stock holders are paying a big price.
UAA shares have fallen 60% over the past year, and that’s not just a sentiment-and-momentum play. The fundamentals are backing up this sob story — margins are cratering due to a price war with Nike Inc (NYSE:NKE) and Adidas AG (ADR) (OTCMKTS:ADDYY) that’s clearly not winnable.
Under Armour is in desperate need of reinforcements. Lululemon Athletica Inc. (NASDAQ:LULU) could do the trick.
The Under Armour Growth Story Is Broken
In March, I discussed the growth story at Under Armour and how Jefferies analyst Randal Konik believes it’s still intact. Personally, I find that argument hard to swallow when you consider that Under Armour’s 21.8% revenue increase in 2016 translated to just $9 million in additional operating profit.
Nike, a far more mature company, did a much better job converting revenues to profits in the past year providing plenty of ammunition, in my opinion, that Under Armour’s growth story is in fact broken.
A month earlier, I suggested that Under Armour CEO and founder Kevin Plank remove himself as chief executive before he does irreparable harm to his company and UAA stock. Nothing that has happened since has changed my mind. It’s too personal for Plank; he’s not going to be able to do the things that need to be done to turn the ship in the right direction. At least, not quickly.
Phil Knight had the right idea when he and the board chose to bring in an outsider to run Nike; they just hired the wrong guy. It happens. But at least NKE tried to shake things up.
Bringing in a new CFO is not the solution.
Time to Circle the Wagons
I thought VF Corp (NYSE:VFC) would be the company to make a play for Lululemon, but it has had its own troubles to deal with, and that has kept the apparel conglomerate relatively quiet on the M&A front. That could change at any time, so the fact Under Armour is in its weakest position since its founding in 1997 makes this an opportune time for LULU to consider a deal.
Under Armour and Lululemon ought to come together to fight Nike and Adidas. Both firms currently face serious challenges as they cope with growth. Together, they would make a formidable team.
LULU founder Chip Wilson floated the idea back in February when he rented a Vancouver bus shelter outside the company’s headquarters that stated: “Lululemon, Buy Under Armour Now!”
“Lululemon’s way more profitable,” Wilson told CNBC while talking about the reasons for placing the bus shelter ad. “It’s super weak right now. (I) wouldn’t want to be working at Under Armour right now.”
The irony of that statement is that LULU stock took a tumble March 30, falling more than 20% on weak Q1 2017 guidance.
One week before announcing its fourth-quarter earnings, InvestorPlace contributor Laura Hoy made a whole bunch of arguments why a Lululemon/Under Armour tie-up made no sense. While I respect her opinion, I think she has it wrong for a couple of reasons. Her valuation concerns make sense, but she’s forgetting several attributes of both businesses that had Wilson broaching the subject in the first place.
5 Reasons Why Lululemon and Under Armour Should Combine
Here’s a quick-hit list of reasons why a merger would make sense right now:
- Lululemon has higher gross margins than Under Armour; LULU’s are getting stronger, UAA’s are getting weaker.
- LULU is generating free cash flow, Under Armour is not.
- Lululemon is overweighted to a female customer while Under Armour has more men buying its clothing. A tie-up solves that dilemma.
- Lululemon doesn’t sell shoes. Under Armour gives them that category on a platter.
- Lululemon is more about lifestyle wear while Under Armour was founded on performance wear. Together, they could tackle both markets head on giving Nike and Adidas a run for their money.
Bottom Line for UAA Stock
In my opinion (Chip Wilson probably doesn’t agree), Lululemon CEO Laurent Potdevin would make an ideal leader of the combined company because he has managed to re-ignite LULU profitability over the past three years while continuing to improve its sourcing and quality control.
While it’s not perfect, the team in place is a heck of a lot better than it was before his hiring. I see good things ahead for the company and its stock despite the naysayers.
Under Armour, on the other hand, has a CEO who is too busy empire building (he’s got a liquor brand) to realize that he’s losing a war he can’t possibly win.
As my InvestorPlace colleague James Brumley so aptly said, “Under Armour stock needs a change, and soon.”
Amen to that.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.