LULULEMON (LULU)

Brian McGough Alec Richards

@hedgeyeretail

LULULEMON (LULU)

June 25, 2014

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DISCLAIMER Hedgeye Risk Management is a registered investment advisor, registered with the State of Connecticut. Hedgeye Risk Management is not a broker dealer and does not provide investment advice for individuals. This research does not constitute an offer to sell, or a solicitation of an offer to buy any security. This research is presented without regard to individual investment preferences or risk parameters; it is general information and does not constitute specific investment advice. This presentation is based on information from sources believed to be reliable. Hedgeye Risk Management is not responsible for errors, inaccuracies or omissions of information. The opinions and conclusions contained in this report are those of Hedgeye Risk Management, and are intended solely for the use of Hedgeye Risk Management’s clients and subscribers. In reaching these opinions and conclusions, Hedgeye Risk Management and its employees have relied upon research conducted by Hedgeye Risk Management’s employees, which is based upon sources considered credible and reliable within the industry. Hedgeye Risk Management is not responsible for the validity or authenticity of the information upon which it has relied. TERMS OF USE This report is intended solely for the use of its recipient. Re-distribution or republication of this report and its contents are prohibited. For more detail please refer to the appropriate sections of the Hedgeye Services Agreement and the Terms of Use at www.hedgeye.com

LEGAL

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KEY POINTS

Let’s Be Clear About What Kind Of Call This Is. This is not KATE, and it’s not RH where there are superior management teams finding/creating white spaces. We have zero faith in the current LULU management team, and think that the operating plan is perfect for a $500mm company. Unfortunately, LULU has $1.8bn in sales. We think this story is all about change. Almost any way this story changes (about 80% chance), we get to a stock well above $41.

Activism in this name has been a non-starter in the past due to Chip Wilson (LULU’s perennial liability), who now owns 27.7% of the stock. But he has divided the Board, and is going activist on his own.

Due to the structure of the Board that Wilson inadvertently created, we think that his campaign is destined to fail. His actions could be his own undoing. We’re at a point where this can’t easily be prevented.

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KEY POINTS (CON’T)

The most likely scenario, we think, is that he loses and sells his stock. That opens up the door for the Board to rebuild this company, accelerate growth and tap the $2bn+ global growth potential that we think is out there for LULU.

The next most likely scenario is a Chip-led Buyout, or someone Acquires LULU. We review the candidates in this deck including Year 1 accretion/dilution and leverage – some are obvious, some are not.

Worst case scenario is anything that prolongs the status quo. Because status quo management means a lower than status quo stock price ($30/$32). Anything that suggests that this organization will hold off change will likely make us pull the plug on our call.

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FINANCIALS

DATA SOURCE: HEDGEYE RISK MANAGEMENT, FACTSET & COMPANY REPORTS

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SENTIMENT HAS NEVER BEEN WORSE

LULU SENTIMENT MONITOR This triangulates Buy Side (Short Interest), Sell Side (Ratings), and Inside activity. A score below 10 almost always indicates a Buy. The inverse is true at 90+.

DATA SOURCE: HEDGEYE RISK MANAGEMENT & FACTSET

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“As he puts it, don’t look to hire great people: hire them and then teach them to be great, and to represent the company’s vision and core values.” -Kerry Gold (Price Waterhouse Coopers 4/1/14)

CHIP’S HIRING PHILOSOPHY

SOURCE: HTTP://UPFRONT.PWC.COM/TALENT/548-POWER-PEOPLE

SCENARIO ANALYSIS

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“That’s the number one issue my wife and I both have, is moving out of management, definitely. It’s frustrating, because we probably think we’re the best in the world at it. And now we have a forever non-compete [clause] as long as we own so much of the company, so it’s a tough situation for us. I never recognized this would happen when I went public.” -Chip Wilson to Price Waterhouse Coopers (4/1/14)

CHIP IS TIRED OF HIS HANDCUFFS

SOURCE: HTTP://UPFRONT.PWC.COM/TALENT/548-POWER-PEOPLE

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ACTIVIST CHIP: POSSIBLE OUTCOMES

DATA SOURCE: HEDGEYE RISK MANAGEMENT

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MANAGEMENT UPGRADE – 49% PROBABILITY


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DEAL – 30% PROBABILITY


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STATUS QUO OR CHIP AS CHAIRMAN – 21% PROBABILITY


BOARD CONSIDERATIONS

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OWNERSHIP/INFLUENCE ARE DECLINING

CHIP’S OWNERSHIP HISTORY ‘05 Advent Int’l and Highland Partners acquired a 48% stake. Key part of that deal was the removal of Chip as CEO. Stepping away from Chairman role in ‘13 was a mistake.

DATA SOURCE: COMPANY REPORTS

100%

52%

37.6% 34.8% 34.5% 32.5% 30.8% 29.5% 27.7%

$0

$10

$20

$30

$40

$50

$60

$70

$80

20%

30%

40%

50%

60%

70%

80%

90%

100% % Ownership Stock Price (right)

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THE BOARD: PRE-IPO

3 appointed by Advent International 1 appointed by Highland Capital Partners 3 appointed by Chip Wilson

IPO BOARD COMPOSITION

SOURCE: COMPANY REPORTS

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THE BOARD: NOW

We count Wilson, Pitcher, & Potdevin on Team Chip Morfitt is an unknown Stemberg’s relationship with Costin outweighs any possible loyalty to Chip

VERY FEW LEFT ON TEAM CHIP


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THE BOARD HAS AN OFFENSIVE WEAPON

BOARD COMPOSITION The Board size is authorized at 3 (yes 3) to 15. Chip has 30% of the Board. 40% on a good day. Far from the majority he needs. With 15 seats, the Board could take ‘Team Chip’ to 20%.


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IPO FY08 FY09 FY10 FY11 FY12 FY13 FY14

Insiders Independent

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• Classified Board Structure – 3 yr tenure and staggered voting

• Special Shareholder Meeting – May be called at anytime but only by the

Chairman of the Board, CEO, or by a majority vote of the board of directors

• Vote – No director may be removed from office by

the stockholders except for cause and then only by the affirmative vote of 2/3 of the shareholders

– Non-cumulative voting

REMOVAL OF DIRECTORS

Chip has a better chance of getting LULU sold outright then successfully calling a special shareholder vote. This is an unintended consequence of anti-takeout measures.


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BOARD VACANCY: SCENARIO ANALYSIS

Vacancies are filled by a majority vote from the remaining Directors Newly appointed Director holds office until Director class stands for re-election & need not be confirmed by share holders In this scenario – the New Director would stand for re-election at the 2017 Annual Meeting


DEAL OR NO DEAL

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LEVERAGE PRE-POST LULU DEAL Nike probably won’t touch it. It’s likely going to the Germans, French, or Japanese.

DATA SOURCE: HEDGEYE RISK MANAGEMENT, FACTSET, & COMPANY REPORTS

21%

4%

-3%

-30%

42%

18% 13%

-67%

-2%

44% 49%

65%

24%

71% 62%

26% 29%

87%

-70%

-50%

-30%

-10%

10%

30%

50%

70%

90% Pre-Deal Post-Deal

NET DEBT / TOTAL CAPITAL

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OLD FORMAT = $800/SQUARE FT NEW FORMAT = $1,300 SQ FT

LULU ACCRETION MATH

SENSITIVITY ANALYSIS Accretive for everyone at $40. Only marginal dilution for some at $60.

PRE-TAX EPS ACCRETION AT $60/SHARE

Adidas does not care about dilution. Never has, never will. Kering on the hunt for sports brands. Fast Retailing was all queued up to buy J Crew for $5bn.

DATA SOURCE:

-4.9% -3.9%

-2.1%

1.2% 2.1% 2.3%

6.8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

APPENDIX

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AFTER TAX EPS ACCRETION ASSUMPTIONS

DATA SOURCE: HEDGEYE RISK MANAGEMENT, COMPANY REPORTS, & FACTSET

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CLASS I DIRECTOR BIOS


Michael Casey – Joined board in Oct 2007. Chairman starting in 2014. Former CFO of Starbucks. Former CEO El Torito Restaurants. Former board member of Nasdaq. A.B. Harvard College. MBA Harvard Business School

RoAnn Costin – Joined board in Mar 2007. President of Wilderness Point Investments. Co-Founder Paola Quadretti Worldwide. Former President Reservoir Capilat Management. Board Member of: OLLY Shoes, City Sports, Alvin Valley Holdings. B.A. Harvard University. MBA Stanford.

Laurent Potdevin – CEO and joined board in Jan 2014. Former President Toms Shoes. Former CEO Burton Snowboards. Worked at Louis Vuitton/LVMH. Degrees from Ecole Superieure des Sciences Economiques et Commerciales and Engineering School, Ecole Polytechnique Federale de Lausanne

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CLASS II DIRECTOR BIOS


Martha Morfitt – Joined board in Dec 2008. Principal Ricer Rock Partners. Former CEO Airborne. Former CEO and COO of CNS. Board Member of: Graco, Life Time Fitness. HBA University of Western Ontario. MBA York University.

Rhoda Pitcher – Joined board in Dec 2005. Managing Partner Rhoda M Pitcher Inc. Masters from University Associates.

Emily White – Joined board in Nov 2011. COO Snapchat. Former Director of Business Ops Instagram at Facebook. Worked at Google. Board Member National Center for Women in IT. BS Vanderbilt University.

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CLASS III DIRECTOR BIOS


Robert Bensoussan – Joined board in Jan 2013. Director Sirius Equity. Former CEO LK Bennett. Former Chairman Jeckerson Spa. Former CEO Jimmy Choo Ltd. Board Member of: Inter Parfums, Celio International, Zen Cars, Aurenis, LK Bennett, Jeckerson Spa.

William Glenn – Joined board in Dec 2012. CEO Global Business Travel-American Express. Former President Pepsi-Cola. Worked at Proctor and Gamble. Board Member Boys and Girls Club of Amerca. BA and MBA Lehigh University.

Thomas Stemberg – Joined board in Dec 2005. Managing Partner Highland Consumer Fund. Co-Founder Staples. Board Member of: CarMax, PETsMART, Guitar Center, City Sports. AB Harvard University. MBA Harvard Business School Dennis (Chip) Wilson – Founder and Chairman 1998 until Jan 2014. CEO 1998 to 2005. Founder /Former CEO Westbeach Snowboard. BA University of Calgary.

FOR MORE INFORMATION CONTACT:

[email protected] 203.562.6500

LULULEMON (LULU)

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