Brand Extensions, Market Niches, Internships and Other Notes from the Agenda Show

/8 Comments/in /by

Agenda did its usual good job of putting on what I’ll call its youth culture show in Long Beach last Thursday and Friday. I don’t really like that term, but I like “action sports” less at this point in our industry’s evolution and I really hate “fashion.” And not everything is “urban” or “street” wear so it’s youth culture until somebody comes up with something better. I’m waiting for your suggestions. 

My request to Agenda is that they keep the booths small and low, the food trucks coming, the signage easy to follow, that they never move out of Long Beach (because the airport is easy for me) and that they flee into the night whenever somebody tells them they are “the new ASR.” They’ve replaced ASR, but they need to fight not to become it. I know they are.
 
Beware Product Extensions and Know Your Niche
 
Nikita contacted me a couple of weeks ago and asked me to stop by their booth at Agenda. I told them I wasn’t so much interested in reviewing their product line (in spite of all that I obviously know about women’s fashion) as in talking about their business history and strategy. Strangely enough, they wanted to talk to me anyway.
 
Nikita, you may recall, came out of Iceland about ten years ago with the tag line, “for girls who ride.” As I wrote at the time, it was simply the best, most succinct definition of a market niche I’d ever heard. It gave the company direction and focus and it was a niche nobody else was focused on.
 
Things, I guess, went well for a couple of years. And then they extended, trying to come out with a line of clothing for guys and I went, “Oh shit.” Brand extensions are hard enough, but when you’re defined as “for girls who ride” and then try to make clothing for guys, well, I was concerned.
 
Seems I was right to be. To make a long story short, about a year ago they were acquired by Amer Sports. Under the tutelage of the group at Bonfire (owned by Salomon, which is owned by Amer) they’ve spent a year revamping, rethinking, restructuring and now relaunching the brand. They’ve done something I think is really smart; they’ve hired somebody from outside the industry to help them evaluate the brand and it’s positioning. We all talk to each other way too much. Having somebody without a bundle of preconceptions and no fear of stupid questions should produce some interesting results.
 
Of course street clothing for girls who ride was a pretty small niche and Amer is a public company interested in growth. That’s the danger of niches. You can own yours, but it doesn’t leave you with any place to go if you’re a smaller, thinly capitalized company. Happily, Amer isn’t.
 
The group at Nikita is trying to figure out where they can take the brand. I think I can say with certainty it won’t include a guy’s line, but there’s some street wear as well as their snow line in their current offering. “Girls who ride” do more than snowboard and if pursued cautiously and consistently, there should be an opportunity.
 
Meanwhile, over at what apparently continues to be the very well received Stance sock brand that is now, what, four years old there are definitely no brand extensions on the horizon. I was sitting chatting with somebody when I saw Stance CEO John Wilson walk by and, fresh from Nikita and having noticed that it was easier to list the brands that weren’t making shoes than those that were, I yelled out, “Wilson! No brand extensions!” I got a smile, a thumbs up, and a high five. The trouble is when you’re sitting down and high five the not exactly short Wilson, you can damage your shoulder. Mine should be fine in a couple of days.
 
I didn’t ask him, but I’ll bet anything he’s been asked when he’s going to move into shoes. I mean, shoes to go with socks- what could be more natural (note extreme sarcasm). I’m sure there will come a time- someday- when there will be another Stance product. But I predict it won’t be shoes and it won’t be for a while. Four years is not a long time to build and position a brand that can support product extensions.
 
Meanwhile, I walked by Wolfgang Man and Beast and found a new market niche for upscale dog collars and leashes (think of an $80 collar). I also found industry veteran Luke Edgar who, along with four other dog lovers, started the brand. This is what Luke does when he’s on vacation from Skullcandy. I kind of smiled, but then I reminded myself of just how much money people are now willing to spend on their pets, so maybe there’s a market there. I’m told the initial reception is positive.
 
If you’re in the private equity business, you go around collecting cards from new brands that might have found a market to exploit. Then in a year or two you check back to see if they’re still around and are succeeding. I ran into one private equity guy I know and, sure enough, he already had a card from that business. So we’ll all check back in a year or so.
 
Consumers seem to trust new brands a lot faster these days. Maybe it’s more accurate to say they don’t distrust them. Anyway, finding a niche that’s derivative of the whole youth culture market is a good thing. You know, I’m wondering if first movers are at the same disadvantage they often were in the past.
 
Child Labor
 
A conversation with somebody in the core skate industry lead to the usual bemoaning about how there were fewer skaters, the old business model didn’t work anymore, there was nothing new product wise, and it was getting harder and harder to figure out what was relevant to young skaters.
 
The last point led to an offhand comment about skate brands needing to hire 12 year olds. When somebody made a point that it would violate child labor laws, we were immediately off and laughing, imagining the head of some skate company explaining to a judge that they only had a bunch of kids working at their company because they were trying to find out what was cool again. I can see the prosecutor holding up a deck with the graphics the 12 year old created, and “contributing to the delinquency of a minor” being added to the charges.
 
Skate companies will say with some justification that they already do that with team riders (find out what’s cool- not the illegal part). But team riders are the top 2% or so of skaters and besides, they get free product. I have never been quite sure just how relevant their input was to the broader skate market.
 
Well, maybe 12 is too young, but I’m wondering if anybody has ever hired some kids as interns (paid or unpaid) in the marketing and/or design departments. They should be kids who skate, but are not necessarily great skaters. Maybe some of them should even be long boarders.
 
Have a contest with some retailers to select a couple of kids who’ll be paid to work for you during the summer or a few afternoons a week after school. Have them occasionally bring in a few of their friends. Pay them a few bucks, teach them something about business, and get them to create and react to new product ideas. Then take a chance with what they come up with. Put whatever graphics they come up with on a deck and let that deck be sold at the shop they hang out at.
 
Maybe this is already happening, but as business risks go it’s pretty low and who knows what might come out of it.
 
And kind of related, I found out about the Next Up Foundation. It “…provides after-school and summer mentoring programs that teach today’s youth life skills through skateboarding.” I heard good things. I have a kid who was sort of drifting and unhappy until he found something he loved that gave him some focus, self-respect and friends. In his case, it was music. But if it had been skateboarding, that would have been just fine too, and that seems to be at least part of what Next Up does.
 
I don’t have the list, but obviously some brands are involved in and contributing to Next Up. I’m wondering if any of those brands are using that involvement to get a sense of new cool stuff while at the same time helping the foundation meet its goals.
 
See you at the next show.
 
    
 
 
 
 
             
 
 
 
   
 
 
 
    
 
 
 
 
 
 
 
 
    
 
 
 
              
 
 
 
 
 
 
 

Brand Extensions, Market Niches, Internships and Other Notes from the Agenda Show

 
Agenda did its usual good job of putting on what I’ll call its youth culture show in Long Beach last Thursday and Friday. I don’t really like that term, but I like “action sports” less at this point in our industry’s evolution and I really hate “fashion.” And not everything is “urban” or “street” wear so it’s youth culture until somebody comes up with something better. I’m waiting for your suggestions.
 
My request to Agenda is that they keep the booths small and low, the food trucks coming, the signage easy to follow, that they never move out of Long Beach (because the airport is easy for me) and that they flee into the night whenever somebody tells them they are “the new ASR.” They’ve replaced ASR, but they need to fight not to become it. I know they are.
 
Beware Product Extensions and Know Your Niche
 
Nikita contacted me a couple of weeks ago and asked me to stop by their booth at Agenda. I told them I wasn’t so much interested in reviewing their product line (in spite of all that I obviously know about women’s fashion) as in talking about their business history and strategy. Strangely enough, they wanted to talk to me anyway.
 
Nikita, you may recall, came out of Iceland about ten years ago with the tag line, “for girls who ride.” As I wrote at the time, it was simply the best, most succinct definition of a market niche I’d ever heard. It gave the company direction and focus and it was a niche nobody else was focused on.
 
Things, I guess, went well for a couple of years. And then they extended, trying to come out with a line of clothing for guys and I went, “Oh shit.” Brand extensions are hard enough, but when you’re defined as “for girls who ride” and then try to make clothing for guys, well, I was concerned.
 
Seems I was right to be. To make a long story short, about a year ago they were acquired by Amer Sports. Under the tutelage of the group at Bonfire (owned by Salomon, which is owned by Amer) they’ve spent a year revamping, rethinking, restructuring and now relaunching the brand. They’ve done something I think is really smart; they’ve hired somebody from outside the industry to help them evaluate the brand and it’s positioning. We all talk to each other way too much. Having somebody without a bundle of preconceptions and no fear of stupid questions should produce some interesting results.
 
Of course street clothing for girls who ride was a pretty small niche and Amer is a public company interested in growth. That’s the danger of niches. You can own yours, but it doesn’t leave you with any place to go if you’re a smaller, thinly capitalized company. Happily, Amer isn’t.
 
The group at Nikita is trying to figure out where they can take the brand. I think I can say with certainty it won’t include a guy’s line, but there’s some street wear as well as their snow line in their current offering. “Girls who ride” do more than snowboard and if pursued cautiously and consistently, there should be an opportunity.
 
Meanwhile, over at what apparently continues to be the very well received Stance sock brand that is now, what, four years old there are definitely no brand extensions on the horizon. I was sitting chatting with somebody when I saw Stance CEO John Wilson walk by and, fresh from Nikita and having noticed that it was easier to list the brands that weren’t making shoes than those that were, I yelled out, “Wilson! No brand extensions!” I got a smile, a thumbs up, and a high five. The trouble is when you’re sitting down and high five the not exactly short Wilson, you can damage your shoulder. Mine should be fine in a couple of days.
 
I didn’t ask him, but I’ll bet anything he’s been asked when he’s going to move into shoes. I mean, shoes to go with socks- what could be more natural (note extreme sarcasm). I’m sure there will come a time- someday- when there will be another Stance product. But I predict it won’t be shoes and it won’t be for a while. Four years is not a long time to build and position a brand that can support product extensions.
 
Meanwhile, I walked by Wolfgang Man and Beast and found a new market niche for upscale dog collars and leashes (think of an $80 collar). I also found industry veteran Luke Edgar who, along with four other dog lovers, started the brand. This is what Luke does when he’s on vacation from Skullcandy. I kind of smiled, but then I reminded myself of just how much money people are now willing to spend on their pets, so maybe there’s a market there. I’m told the initial reception is positive.
 
If you’re in the private equity business, you go around collecting cards from new brands that might have found a market to exploit. Then in a year or two you check back to see if they’re still around and are succeeding. I ran into one private equity guy I know and, sure enough, he already had a card from that business. So we’ll all check back in a year or so.
 
Consumers seem to trust new brands a lot faster these days. Maybe it’s more accurate to say they don’t distrust them. Anyway, finding a niche that’s derivative of the whole youth culture market is a good thing. You know, I’m wondering if first movers are at the same disadvantage they often were in the past.
 
Child Labor
 
A conversation with somebody in the core skate industry lead to the usual bemoaning about how there were fewer skaters, the old business model didn’t work anymore, there was nothing new product wise, and it was getting harder and harder to figure out what was relevant to young skaters.
 
The last point led to an offhand comment about skate brands needing to hire 12 year olds. When somebody made a point that it would violate child labor laws, we were immediately off and laughing, imagining the head of some skate company explaining to a judge that they only had a bunch of kids working at their company because they were trying to find out what was cool again. I can see the prosecutor holding up a deck with the graphics the 12 year old created, and “contributing to the delinquency of a minor” being added to the charges.
 
Skate companies will say with some justification that they already do that with team riders (find out what’s cool- not the illegal part). But team riders are the top 2% or so of skaters and besides, they get free product. I have never been quite sure just how relevant their input was to the broader skate market.
 
Well, maybe 12 is too young, but I’m wondering if anybody has ever hired some kids as interns (paid or unpaid) in the marketing and/or design departments. They should be kids who skate, but are not necessarily great skaters. Maybe some of them should even be long boarders.
 
Have a contest with some retailers to select a couple of kids who’ll be paid to work for you during the summer or a few afternoons a week after school. Have them occasionally bring in a few of their friends. Pay them a few bucks, teach them something about business, and get them to create and react to new product ideas. Then take a chance with what they come up with. Put whatever graphics they come up with on a deck and let that deck be sold at the shop they hang out at.
 
Maybe this is already happening, but as business risks go it’s pretty low and who knows what might come out of it.
 
And kind of related, I found out about the Next Up Foundation. It “…provides after-school and summer mentoring programs that teach today’s youth life skills through skateboarding.” I heard good things. I have a kid who was sort of drifting and unhappy until he found something he loved that gave him some focus, self-respect and friends. In his case, it was music. But if it had been skateboarding, that would have been just fine too, and that seems to be at least part of what Next Up does.
 
I don’t have the list, but obviously some brands are involved in and contributing to Next Up. I’m wondering if any of those brands are using that involvement to get a sense of new cool stuff while at the same time helping the foundation meet its goals.
 
See you at the next show.
 
    
 
 
 
 
             
 
 
 
   
 
 
 
    
 
 
 
 
 
 
 
 
    
 
 
 
              
 
 
 
 
 
 
 
 
 
   

 

 
 
   

 

 

Billabong Deal Completed

/0 Comments/in /by

Billabong announced today that the interim financial deal with Altamont and its partners and the sale of Dakine to the same group had been completed. They also announced that their syndicated debt liabilities had been paid off in full and that the two proposed Altamont directors would join the board. Here’s the announcement on the Billabong investors web site. It’s the first item under “Recent News.” 

Okay, so now what? Well, Scott Olivet is the new Managing Director and CEO, and Launa Inman is gone. The interim financing has to be turned into permanent financing by the end of the year when the interim loan from Altamont is due. I’m not quite clear on whether or not the asset based line from GE Capital is now in place or not. Billabong has to hold a shareholders meeting to approve various parts of the deal. I assume that will happen as quickly as possible so they can approve the options granted to Altamont and get the interest rate on the additional AUD $44 million convertible note down from 35% to 10%.
 
Questions include:
 
What additional brands, if any, will be sold?
 
Which parts of former CEO Inman’s plan will be retained? I’d expect that some of her operational rationalization will continue.
 
When will West 49 be sold? I assume it’s still for sale.
 
When will Billabong present their results for the year ended June 30? In the past, the date would have been announced by now. I really want a look at the balance sheet.
 
After this rather turbulent period, I hope Mr. Olivet can get employees refocused on running the business. Just like with Quiksilver, the industry needs Billabong to be strong and successful.

 

 

The Dilemma of Growth in Action Sports

/24 Comments/in , , /by

Help me out here. Name me one company that (1) has its roots in action sports, (2) has grown to have revenues greater than, say, $200 million, (3) has gone public, (4) hasn’t been acquired and, (5) is continuing to grow and prosper. In retail, I’d name Zumiez though I imagine some people won’t like that. A nonretail brand? I can’t think of one. Can you?

The genesis of this article is some recent thinking I’ve done after reviewing industry company annual reports. I’ve noted that the requirements of being a strong brand and meeting Wall Street expectations may be at cross-purposes. I have also watched companies struggle the further they get away from action sports and the more they find they have to focus on youth culture and fashion in broader distribution.
Why is that? The economy has something to do with it. But more fundamental are the characteristics of the “real” action sports industry and the dramatically different competitive conditions you discover when you step outside it.
What Is the Action Sports Industry?
To start with, it’s really small. Its customers include the people who participate in the sports and perhaps the first level of nonparticipants who follow the sports and are into the lifestyle. That’s it. Everything else is hype and glory. During “The Best Economy Ever,” anybody who could make or sell a hard good or figure out how to spell “EXTREME!!” was thought to be in action sports. The industry looked way bigger than it was as cash flow covered up evolving structural weaknesses.
Now, in “The Worst Economy Ever,” those structural weaknesses (over distribution, lack of product differentiation, weak balance sheets; I could go on) have been exposed and the action sports industry, bloodied but unbowed (well, maybe a little bowed), has returned to its roots as a community of like-minded enthusiasts that is too small for big companies to really care about unless they can co-opt the action sports ideal to reach the broader market.
I’m not saying this is good—more that it’s a survival mechanism for small action sports retailers and brands that are really in the market as I’ve defined it. And I’m certainly not suggesting nothing has changed and that we’re back where we started. Far from it. There’s the internet and consumer empowerment, the fact that there’s so much quality product everywhere, big companies trying to co-opt and extend the action sports ideal, a declining sense of exclusivity, and yes, the economy.
But if this is where we are, and if you accept my industry definition, what are the implications for growing in the space? Let’s start by looking at how brands used to grow and how they grow now before answering that.
The Process of Growth- Then
It was about patience. Somebody would start a brand or open a store because they wanted to work with their friends, have a job in something that meant something to them, or be able to get in extra days on the hill (little did they know). You’d hand out some stickers, print up some t-shirts, and visit local retailers with your first batch of products which your friends were already using. The process was a bit more casual than it is today and, initially at least, there didn’t seem to be a sense of urgency. Indeed, you couldn’t be in a hurry because the independent specialty shops were pretty much your only choice for retail distribution. There was enough margin to go around and you could rely on distribution being controlled—probably more than you wanted.
Not only did you have to be patient, but humble. You built relationships and waited for the intimate action sports community to look for your product. Spending a bunch of money (which you probably didn’t have anyway) on marketing to try and push your brand was counterproductive. Your brand became credible through supporting the industry and the retailers.
You knew you were succeeding once the marketing guy was trying to hold the finance guy hostage for more budget because the perception of the brand exceeded its actual size and financial resources. You knew you’d arrived when the first retailer asked you for terms.
What’s implicit in this process is the passage of time. I’ve arbitrarily suggested that it used to take five years to really establish your brand with the core action sports consumer. They and the retailers just needed that long to get used to who you were and what the brand stood for. It was hard to circumvent the need to be around a while no matter how good a brand builder you were.
In that time, you became established in the action sports market as I’ve defined it. You’d grown within the specialty retailer community. Next, to provide opportunities for your employees and, truth be known, because you wouldn’t mind making some more money, you looked for opportunities outside that niche.
And it was a niche. You’d work hard to be credible and establish your brand in it. Now you were going to ……”Sell Out!” Remember the outrage of core customers when brands took the first tentative step towards broader distribution?
But it was more like a leap over a chasm. Some of the changes in retail and consumer behavior that are unfolding now weren’t even on the horizon. Expansion of distribution by definition meant going from the “cool” niche market you’d created to the clearly “uncool“ outer circle. There was little of the tiered distribution we have now. Either you were core, or you weren’t. The dichotomy created barriers- both ways.
The Process of Growth- Now
With the coming of the recession forcing an accelerated reaction to trends already in play, the action sports market has devolved back towards what it used to be. In some ways—the number of independent specialty retailers comes to mind—it’s smaller. Meanwhile, the steps to broader distribution are more obvious—less chasm leaping is required–and probably more necessary.
Bluntly, the business model is tougher. Consumers have less money to spend and are more discriminating in where and how they spend it. Sales growth is harder to come by. Product that is truly distinctive is rare. Distribution is wide open and the action sports culture has been melded into and suborned by the youth culture/fashion market.
You no longer have five years to build brand recognition and acceptance. Interestingly, I don’t think you need it.  As soon as you start to get some traction and sales growth, you’ll find that some multi-store retailer or another is interested in giving your brand a try. That’s hard to resist given general market conditions. The retailer will tell you they are going to help you develop your brand. The blowback that used to accompany growing distribution too much and too quickly doesn’t exist. It’s so completely expected that everybody seems to take it for granted, or at least be resigned to it.
But you haven’t spent five years establishing your brand identity. Your customers aren’t all the same customers you would have been selling to had you launched in the past and they aren’t as committed to your brand. The further you get from core distribution, the truer that is. They may know your brand, but they don’t know your story. You are trying to sell to customers (because you’re being “helped” by the retailer) who don’t know the difference between your logoed plaid shirt and the same product at JCP with their store brand logo. The problem, as we all know, is that there may not be much difference.
You didn’t mean to be, or at least you probably didn’t want to be, but somehow you’ve found yourself in the much broader fashion market. You have become dependent on the good will of the large retailers. We all know how long that lasts if you don’t sell well at good margins (of course that’s true, though I like to think not as true, in core retailers as well). Even if you’re doing $100 million in revenue, the competition is ten, twenty, thirty, forty, or fifty times bigger than you. Or more. They have resources you can’t think about competing with. The things that gave your brand strength in the action sports market aren’t as important in the broader fashion market.
The Usual Result
You know, succeeding and being acquired is a good thing. So is sticking to the market niche you know and maybe growing less but having a successful, profitable business. What’s bad is not understanding the impact of growth and the competitive environment it’s going to put you in when you take the step into the broader fashion market. What’s bad is not recognizing the pressures and requirements of being a public company. The requirements of being public can conflict with building and sustaining a brand.
The good news is that consumers are willing to trust new brands faster these days, sometimes at the expense of heritage brands. That’s one reason you can grow faster. No need for five years of building credibility.
Your brand positioning decision is now much more complicated than core or noncore. There’s a whole range of customers and distribution channels to pick from and it takes some hard, thoughtful work to figure out where you belong. Accepting the invitation of the first big retailer that wants to carry you is not the way to approach it. Remember, all those retailers are busy building themselves as brands and carrying lots of proprietary product. I’d approach retailers I think might be appropriate for my brand based on my customer analysis. Yes, I know that you can’t always been that “pure” in who you decide to sell to.  I also know I have the privilege of way over simplifying the decision process, but just think about the concept.
Finally, I’m implying that if you’ve done your homework, you could find yourself turning down some business you might otherwise have accepted. Hard to do, I know. Maybe that’s where the business model I’ve been pushing, where gross margin dollars and operational efficiency have a focus equal to sales growth, comes in. You can’t think of marketing and brand positioning as distinctive from operations and inventory management any more.
You don’t want the usual result. To avoid it, start by recognizing what that usual result has been way too often in our industry and how the environment has changed.

 

 

The Billabong Deal- A Second Offer Appears and is Rejected

/0 Comments/in /by

There are various articles flying around (and on Billabong’s web site) that tell us Oaktree Capital Management LP and Centerbridge Partners LP made an offer for Billabong yesterday (or the day before- I get confused about what day it is in Australia). As you know, the Altamont Consortium made, and Billabong accepted, an offer to buy Dakine, provide short term financing to pay off debt and, by the end of the year, roll that into a longer term loan. Here’s my article on that deal. 

In late June, Oaktree and Centerbridge, both distressed debt funds according to the articles, bought $289 million in Billabong loans at a discount from the original lenders. These are to be paid off by Altamont’s interim financing. According to this article from Bloomberg, Oaktree and Centerbridge “…“very much had a view that they were going to make money” through a debt-for-equity swap, Ben Clark, a portfolio manager at TMS Capital Pty., said by phone from Sydney. “They’ve been blindsided by Billabong’s intention to pay that debt back straight away” through the deal with Altamont.”
 
They bought the debt from Billabong’s banks at some discount, so are already positioned to make a profit when Altamont repaid it. But not being satisfied with that, they made their own offer for Billabong. That offer, according to the same article, “…would instead see A$189 million of the loans canceled in exchange for a 61 percent stake in Billabong, with the balance of A$100 million repaid using a six-year loan with an interest rate of 8 percent. The Australian company would retain its DaKine brand and the funds would seek a majority of board seats.”
 
This article says that Billabong has agreed to study this new proposal.  It further says that incoming CEO Scott Olivet would remain in that position. It’s not clear if he has agreed to that, or if it’s just an offer or assertion by Oaktree and Centerbridge.
 
 They also asked the Australian Takeover Panel to review the deal, saying it was “…anti-competitive and coercive.” The panel declined to stop the deal but said they could review it, as reported here. I don’t know what the possible outcomes of such a review are. Here’s what the panel actually said. “A sitting Panel has not been appointed at this stage and no decision has been made whether to conduct proceedings. The Panel makes no comment on the merits of the application.”
 
Meanwhile, we’re told in yet another article (you may not be able to access this unless you set up an account) that:
 
“Since Tuesday’s unveiling of the Altamont deal, Centerbridge and Oaktree have ramped up the pressure on Billabong, saying the company had refused to see their representatives despite a team of 10 or more flying in from the US to pitch a proposal.
 
Billabong chairman Ian Pollard has been intransigent.
 
He has said Centerbridge and Oaktree were invited many times last week to submit a proposal but refused on every occasion.
 
In the end, the chairman said Billabong had "executed the only executable transaction", which was the Altamont deal.
 
Despite Centerbridge and Oaktree claiming their proposal was superior and unconditional, Billabong said on Thursday it was subject to conditions that could not be satisfied, making any refinancing "far less certain" than the deal with Altamont.”
 
Here’s Billabong’s official response to these media reports from a release on their web site:
 
“The position is as follows:
1. The Company has received today a proposal from the Centerbridge/Oaktree Consortium.
2. This proposal was received by the Company after the Company had entered into the binding
bridge facility and DaKine sale agreement with the Altamont Consortium announced on 16
July 2013, which themselves followed an exhaustive process undertaken by the Company.
3. Prior to the Company entering into the transactions with the Altamont Consortium, the
Company made numerous requests to the Centerbridge/Oaktree Consortium to submit a
refinancing proposal. Despite those requests, the Centerbridge/Oaktree Consortium failed
to do so.
4. The proposal that has now been received from the Centerbridge/Oaktree Consortium is not
an offer that is capable of acceptance. The proposal is subject to conditions, a number of
which are incapable of satisfaction, and others which would make any refinancing far less
certain than under the Altamont Consortium transactions.”
 
What I think is going on here is that Centerbridge and Oaktree wanted to use the leverage from the debt they’d bought, which I believe was due and payable, as a way to get a chunk of equity in Billabong. Altamont’s offer to Billabong, which would have resulted in that debt being paid off next Tuesday or so, would keep that from happening, and they aren’t happy about that.
 
I guess what will be interesting to see is whether Centerbridge and Oaktree have created enough uncertainty on the part of Altamont and its partners to cause this transaction to be delayed. Remember, they have signed a deal with Billabong and I have no idea what that deal might or might not say about conditions under which the closing can be delayed. 
 
I kind of hope the deal just gets done so Billabong can get back to running its business.

 

 

The Billabong Deal

/6 Comments/in /by

As you have no doubt heard, Billabong has reached a deal with “…entities advised by Altamont and entities sub-advised by GSO Capital Partners1 (the credit arm of the Blackstone Group, and  together with Altamont, the “Altamont Consortium”)” to sell Dakine to Altamont, get bridge financing to pay off its existing syndicated bank debt, put together long term financing with Altamont and GE Capital, and to hire former Nike executive and Oakley CEO Scott Olivet as Managing Director and CEO of Billabong, replacing Launa Inman. 

Before we get into the all the gory details, here’s the link to the announcement on Billabong’s web site. It’s the first item under “Recent News.” And here’s what I wrote when we had an update from Billabong in early June.
 
I also want to remind you that it’s a little hard to evaluate the strategic significance of this deal because we don’t have Billabong financial statements, especially a balance sheet, to use. The fiscal year ended June 30, but we don’t yet know when the report will be released.
 
I’m going to use Australian dollars unless I say otherwise.
 
First, the Altamont Consortium is going to provide a bridge loan of $325 million. $289 million will go right out the door to pay off the banks. They are also going to buy the assets of Dakine for $70 million. That plus the part of the bridge loan not being used to pay off the banks means that Billabong gets $106 million in working capital.
 
Dakine was acquired by Billabong in August, 2009 for US$100 million. At the time, that was something like $120 million in Australian Dollars.  I’ll be curious to see what Altamont does with Dakine.  Wonder if they might not flip it to VF which, you remember, was a partner with Altamont early in the evaluation of Billabong.
 
The bridge loan and sale of Dakine are expected to be completed by this coming Monday, July 22. The loan expires on December 31, carries an interest rate of 12% and is to be replaced with the term loan discussed below. As part of the bridge financing, Billabong will issue 84.5 million options to the Consortium. That’s 15% of the company’s fully diluted capital. The option price will be $0.50 a share. The first tranche of options for 42.3 million shares was issued July 15th. The rest are part of the long term financing and each tranche will expire seven years after they are issued.
 
If the company is sold or makes a deal with somebody else before January 15, 2014, they’ve got to pay off the Consortium with a 20% principal premium. So I’m kind of guessing the deal will be with the Consortium. 
 
Okay, that wasn’t too bad. On to the long term financing.
 
Billabong has signed another commitment letter with the Consortium to provide a five year term loan of $281 million. This will include a “base commitment” $221 million and an “upsize” commitment of $60 million. The base commitment will carry an interest rate of 12%, but they can pay up to 5% of that “in kind.” That is, it can just be added to the loan principal rather than paid in cash. The upsize commitment carries an interest rate of 10% and has to be paid in cash. They will use this loan to pay off and replace the bridge loan.
 
The bridge loan, you will recall, is $325 million. The term loan is a total of $281 million so by itself it’s $44 million short of paying off the whole bridge loan. But wait! There’s more!
 
Billabong has also signed a commitment letter to issue a $44 million convertible note to the Consortium. There’s the rest of the money Billabong needs to pay off the bridge loan. The note will be convertible into “Redeemable Preference Shares” (RPS) once approved by Billabong’s shareholders. The interest rate on this note will be 12% and up to 5%, can be payment in kind. That is, it can just be added to the principal balance of the note.
 
Until the shareholders approve the RPS, the note will carry an interest rate of 35%, 25% of which may be payment in kind. With that kind of interest rate, we should expect to see Billabong scurrying to do a shareholders’ meeting for the approval. Once it’s approved, the RPS will be convertible into Billabong commons stock at $0.235 a share and will represent 25% of all shares outstanding (including options and the RPS). The RPS will pay a dividend of 12% of which up to 3% can be paid in common stock.
 
Of the 84.5 million options which are part of the overall deal, another 29.6 million will be granted on completion of the term loan with the balance of 12.7 million will be granted when the required shareholder approval is obtained.
 
The last piece of this is a Billabong commitment with GE Capital “for an asset-based multicurrency revolving credit facility of up to US$160m (A$177m) (“Revolving Facility”), subject to holding sufficient eligible accounts receivable and inventory as collateral.” I think that facility is available as quickly as they can get it into place, but it’s not quite clear.
 
My read on the change in Managing Director from Inman to Olivet is that the people providing the financing required an executive with extensive industry experience who would be immediately credible to everybody involved. In spite of Ms. Inman’s qualifications and significant accomplishments as an executive, it appears that what she accomplished during her tenure at Billabong wasn’t enough to create that perception. Altamont will also get two seats on Billabong’s Board of Directors.
 
Okay, so where does this leave us? If all this happens, the Consortium’s share in Billabong will be between 36.25% and 40.49%. That’s a lot of dilution for existing shareholders. We also know that Billabong will be paying a lot more interest expense. Working capital will increase by $106 million and they will have the asset based line from GE available.
 
None of this reduces the liabilities for store leases on the balance sheet, and I still expect West 49 to be sold. As to further asset sales, I have no idea. Ms. Inman had presented plans to streamline operations and reduce expenses substantially. From her description, I believe there’s money to be saved there, but we haven’t heard anything since the presentation of the plan.
 
Is all this “enough?” Altamont and the Consortium apparently think so and believe the debt load is manageable given their evaluation of the brands and their potential. But they are allowing some interest to be paid in kind just in case there are rough spots.
 
Of course, “the brands and their potential” is ultimately the only thing that matters. Perhaps we’ll learn something about that when they release their results for the June 30 year end.

 

 

Abercrombie & Fitch’s May 4th Quarter; There’s a Lot Going On

/0 Comments/in /by

I’ve gotten out of the habit of reviewing A&F’s results, but a cursory look at their 10Q intrigued me. You don’t typically see sales fall 9% while pretax income for the quarter improved (if that’s what you want to call it) from a loss of $30 million in last year’s quarter to a loss of $15 million. Most of this loss reduction is explained by a rather significant improvement in gross margin from 58.7% to 65.9%. 

At May 4, A&F had 1,053 retail stores. 909 were in the U.S. and 144 in other countries. 283 were Abercrombie & Fitch stores, 149 Abercrombie and 28 operated under the Gilly Hicks brand. The remaining 593, representing 56% of the total, is the ever popular Hollister. To be honest, while I don’t really like what Hollister represents to some of us, I admire what the company accomplished in building the brand and think there’s an object lesson there. Basically, it’s that authenticity (in the eyes of their target customer at least) can be manufactured by marketing. Whether it can be maintained is what we’re finding out.
 
Anyway, obviously things aren’t going all that well right now. Sales fell from $921 to $839 million. A&F store sales fell 13% to $325 million. Hollister was down 18% to $421 million. Interestingly, ecommerce sales fell 6% from $148 to $133 million. U.S. sales fell from $544 to $449 million while international rose from $229 to $258 million. Overall, comparable brick and mortar store sales fell by 17%. The international growth was the result of opening new stores. Looks like they expect to open 20 to 30 international stores during the year and close 40 to 50 in the U.S. 
 
The Stuff That’s Going On
 
Let’s start with an accounting change. How’s that for excitement? The company “…elected to change its method of accounting for inventory from the lower of cost or market utilizing the retail method to the weighted-average cost method effective February 2, 2013.”
 
They had to restate last year’s quarter ended April 28, 2012 to reflect the change. The numbers I’ve given you above include the impact of that restatement. Prior to the restatement, they showed a pretax profit of $5.2 million. The change reduced their pretax income by $35.3 million to the pretax loss of $30 million noted above.
 
That’s quite an accounting change. They did it because, “The Company believes that accounting under the weighted-average cost method is preferable as it better aligns with the Company’s focus on realized selling margin and improves the comparability of the Company’s financial results with those of its competitors. Additionally, it will improve the matching of cost of goods sold with the related net sales and reflect the acquisition cost of inventory outstanding at each balance sheet date.”
 
Any of you CPAs out there who want to chime in on this, please do. They make the explanation sound so benign and reasonable. But that’s a pretty big change in reported results and, as we’ll see, they’ve had some problems with inventory.
 
They tell us in the 10Q that “Sales for the quarter were lower than expected due to more significant inventory shortage issues than anticipated, added to by external pressures, including unseasonably cool weather conditions, and the macro-economic environment in Europe.” The gross margin improvement “…was driven by a mix benefit from selling a higher proportion of current season merchandise and lower product costs.”
 
I’m sitting here wondering how the inventory shortage impacted the gross margin. For the complete year, they expect the gross margin to be in the mid-60s and total dollar gross margin rose 2% in the quarter.   As you know, I’m a believer in controlling your distribution and inventory with the goal of improving sell through and perceived value. Very hard to do as a public company, however, when the market wants revenue growth. Still, I can’t help but note that A&F improved their bottom line performance on lower sales.
 
In the conference call, we find out from CEO Michael Jeffries that “…inventory accounted for approximately 10% of the comp sales decline due to both lower levels of fall carryover and delays in spring deliveries.”
The analysts were a bit uncertain how to think about the inventory as well. One asked, “… just trying to understand the connection between the lower inventory, the comp at Hollister and the gross margin. It sounds like, was it really a factor — you mean to say lower fall clearance inventory — or fall carryover. Does that mean lower clearance inventory? And really, you need that clearance inventory to drive the comp at Hollister, which is why the comp at Hollister was low, and that’s why gross margin was high. Is that an accurate statement?
 
CFO Jonathan Ramsden responded “Broadly, yes” and CEO Jeffries said, “Yes. Yes. I think that’s right on.”
 
Let me see if I’ve got this. They had problems getting the inventory they needed but if they’d had it, they would have had higher sales, but a lower grow profit margin? I’d love to know if total gross margin dollars earned would have been lower instead of 2% higher. But they are in the process of fixing this and are going to have a gross profit margin in the mid-60s for the whole year, they tell us.
 
The analyst, of course, is worried about sales comps at Hollister, because that’s kind of what analysts do. But I’m sitting here screaming, “But they earned more total gross margin dollars without those sales!” I’m not sure they should fix anything.
It needs to be pointed out that their store and distribution expenses as a percentage of sales rose from 49.5% to 53.5% and marketing and general and administrative expense went up from 12.7% to 14.2%. Still, they cut their loss in half selling less at higher margins.
 
Meanwhile, A&F is busy, like so many other companies these days, trying to cut costs and run more efficiently. Also from the 10Q: “We have also made progress on our profit improvement initiative, which includes a detailed review of our operational processes to identify investments that we have made in our business that may have had a return in the past but no longer do today. The initiative is divided into seven work-streams covering general non-merchandise expense, marketing, supply chain, merchandise planning and allocation, home office, store operations, and real estate and construction.”
 
They’ve identified annual savings of $35 to $55 million in general non-merchandise expense and marketing, but don’t expect most of that to be realized until next year. In the supply chain, home office and store operations work streams they have “…completed the diagnostic phase but still need to validate the process-driven savings opportunities through testing and further analysis.” They expect savings in those areas to be “substantial.” They are still in the diagnostic phases for the remaining work streams.
 
They are also involved in a “…cross-functional AUR [average unit retail] optimization initiative” where they “…have identified a number of specific opportunities to date that we anticipate will yield a meaningful gross margin benefit…” Those benefits should start to show up next year. They are also revisiting their overall strategy.
 
There’s not any part of their business they aren’t touching. If I may reiterate one of my favorite points of pontification, they’ve acknowledged the close connection between operations and competitive positioning.
 
Okay, I’m stopping here. A&F earned more gross margin dollars on lower sales and cut their loss in half. True, their operating expenses rose as a percent of sales, but they are in the middle of a top to bottom evaluation process to cut costs and increase operating efficiency including inventory management. If they can create a more cost effective and responsive company structure and keep their gross margin around 65% by managing product and distribution to improve brand perception, who cares if their sales don’t increase as fast as they used to? They’ll make more money.
 
The conference call and some of the discussion in the 10Q kind of waltzes around these issues. Maybe that’s because you can’t tell the analysts that revenue growth isn’t going to be as important as it was. But if they’ve bought into the same analysis as I’ve suggested, the company might do well regardless off what you think of Hollister.