Billabong’s Announcement: Short Term Solution, Longer Term Question.

With last Thursday’s announcement, Billabong has moved to address its balance sheet issues. But, to paraphrase one of the analysts in the conference call, "This is all well and good, but how do we know we won’t be discussing the same issue a year from now?"

Let’s look at the steps Billabong took and its half yearly numbers. Then we’ll talk about Billabong’s longer term strategy and see if there’s an answer to the analyst’s concern in there somewhere..
How Did We Get Here?
Billabong is suffering from a strong Australian dollar, a weak world economy that hasn’t recovered as quickly as they expected, an aggressive, opportunistic retail strategy, and having paid what looks in the ever perfect hindsight to be a bit much for some of their acquisitions. Of course, if the economy wasn’t so weak and the Australian dollar so strong, the last two might not be such an issue. But we are where we are.
Billabong announced back on December 11 that its “…sales growth trend has deteriorated significantly…” in November and the first part of December. They indicated they were concerned about their level of debt and violating their loan covenants. I wrote about that in some detail here. Last Thursday, before their announcement, I described briefly what I thought their choices were.
What Have They Done?
First, they sold 48.5% of Nixon to Trilantic Capital Partners (TCP).   They are keeping 48.5% themselves. Nixon management will own the other 3%. They expect to raise US$285 million, all of which will be used to pay down debt. That solves the immediate balance sheet issue, reducing net debt at December 31 from $527 million Australian dollars to $259 million Australian dollars on a proforma basis.
Because Billabong now owns less than half of Nixon, Nixon will no longer be consolidated on Billabong’s financial statements. That is, its assets, liabilities, revenues and expenses will no longer flow through them and Billabong won’t be responsible. I think what will happen (at least it’s what would happen here) is that Billabong’s share of Nixon’s income will be included on Billabong’s income statement under “Other Income.”  
Nixon product will continue to be sold in Billabong owned retail. Billabong has signed a long term supply agreement with Nixon (no details available) to insure that. The TCP group may be really nice people, but I’m guessing they’d like Nixon to make as much money as possible. So I assume that the prices at which they sell Nixon product to Billabong will be consistent with prices to other retailers. Billabong, under those circumstances, will just get a normal retail margin on their sale of Nixon product.
Most intriguing to me is what TCP’s plans for Nixon might be. There were some comments in the public material and the conference call about Nixon already being distributed outside of Billabong’s traditional channels. The release says, “Nixon will be a stand-alone business focused on continued growth into areas such as Billabong’s core action sports channels, as well as high-end department stores, quality electronics stores and other channels.”
Hmmm. Does that sound to anybody besides me a bit like the Skullcandy strategy? Nixon is doing headphones already. It occurs to me that Billabong might not have been able to finance Nixon’s growth opportunities. Untying Nixon from Billabong may benefit it.
Billabong bought Nixon for $55 million in 2006 plus a deferred payment of US$76 million. The transaction values Nixon at around US$464 million so Billabong will report a one-time gain on the transaction (size unknown) at the end of their fiscal year.
Second, they are going to close between 100 and 150 of the 677 company owned stores by June 30, 3013. They think that once this process is complete, they will have reduced rent expense by $20 to $30 million Australian dollars and will increase EBITDA by $5 to $10 million Australian dollars in the year ending June 30, 2013. They noted that they had closed 30 stores in the last six months.
Third, they’ve got a program to reduce annual costs by $30 million Australian dollars. These cuts will be across the board. There will be about 400 full time jobs lost including 80 in Australia. I’d be interested to know how many of the 400 will be the result of closing stores.
Finally, Billabong is going to reduce its dividend payments.
The net of all this, according to Billabong management, is that the loss of Nixon’s earnings “…will be more than offset…” by Billabong’s share of profits from the Nixon joint venture along with the other expense reductions.
The Six Months Results
Here are the income statement numbers in Australian dollars for the six months ended December 31, 2011.
Sales rose 1.5% to $850 million dollars compared to the prior calendar period. Constant currency revenues were up 6.3%, but down 2% excluding the impact of acquisitions. Over two years, Billabong has seen the translated value of its profits from Europe decline by 40% because of the decline in the value of the Euro against the Australian dollar.
The cost of goods sold stayed almost constant at $455 million, but the gross profit margin fell from 54.4% to 53.4%. Selling, general and administrative expenses were up 10.4% to $316 million. Other expenses and finance costs were more or less the same. There was a $15 million impairment charge for Billabong’s South African operations.
Profit for the six months fell to $16 million from $57 million in the same six months the previous year.
What happened? CEO Derek O’Neill, in his presentation, sites four challenges. First, sales were lower than expected in November and early December in Europe and Australia. Second, they couldn’t recover all their higher product costs in a “…highly price sensitive retail environment.”
Third, there was a lot of discounting going on at both wholesale and retail in Australia and Europe. It wasn’t as bad in the U.S., but it was still there. Fourth, add on to that aggressive clearance of inventory, which obviously kills your margins, and you can see why it wasn’t a great six months.
You can see in their balance sheet some of the issues I’ve discussed above. Inventories have risen $56 million from a year ago even though sales aren’t up significantly and accounts for the whole rise in current assets. Trade and other payables have risen $40 million over a year ago and accounts for the whole rise in current liabilities. Long term borrowings rose from $570 million to $701 million, reflecting a decline in deferred payments (partly for acquisitions) from $188 million to $86 million. The interest coverage ratio has fallen from 8.8 to 4.2 times.
Tactics and Strategy
We’ve reviewed Billabong’s half year results, seen how they got themselves in a bit of a hole, and outlined the tactics they’ve used to resolve their immediate balance sheet issues. Given their circumstances and the choices they had, what they are doing seems appropriate to me.
But it doesn’t address that inconvenient analyst question: “How do we know we won’t be here a year from now discussing the same thing?”
Billabong’s strategy, we all know, has been to expand their owned retail to increase penetration of their brand portfolio and benefit from the vertical margin.  Pretty simple to state. I thought it was a good strategy when they started it though, as I wrote at the time, I was unsure about the West 49 deal. But the devil’s in the details. Let me quote what I wrote last Thursday.
“How much of your owned brands can you put in a retailer before it’s perceived as a Billabong store regardless of the name on the front? How do you handle the other brands those owned stores carry when you’re trying to make room for your own higher margins brands?   How do they feel, as one of those non-owned brands, about being in those stores and the way their brand may be merchandised? I am sure Billabong management spent, and is spending, time on those issues every day.”
That, to me, is the heart of the strategic issue and we came away from the public documents and conference call with basically no insight into how the implementation of this central, long term strategy is going. That analyst’s question kind of implied it, but the answer wasn’t very helpful. To be fair, I can’t really expect Billabong management to just drop their drawers for their competitors in an open forum, but it is still the central issue given that direct to consumer now accounts for 49% of Billabong’s revenues.
One paragraph of one slide from CEO O’Neill’s presentation gave us a bit of information. We learned that Billabong family brand share is now about 37% in West 49 stores compared to 15% at the time of acquisition. It was 32% at June 30, 2011.
The owned brand share is 38% in the acquired SDS banner, and close to 50% in the acquired Rush store. We don’t have any information as to what it was when the deals closed.
That’s it. That’s all I know for sure about the major strategic bet that Billabong has placed. How far can we expect those percentages to rise? Any perceived blowback from consumers yet? How have other brands reacted? Did Billabong just get ahead of itself in an economic environment it misjudged and commit a one-time balance sheet faux pas? Or is the strategy dependent on improved economic growth? If so, and we don’t get that growth, what happens?
I don’t expect to ever get quality answers to those questions unless I fly to Australia and drag those guys into a bar. In the meantime, I invite you all to review at Billabong’s investor site the documents I’ve referred to in this article, and see if you can figure the answers out. 

 

 

2 replies
  1. tom
    tom says:

    i wonder if it would be worth billabong turning some of these retail stores into vertical. i.e – dakine store, rvca store, billabong store…. especially if they owned multiple stores within close proximity

    • jeff
      jeff says:

      Hi Tom,
      It’s an interesting question, and if we were at a different time and place, I might think it worth considering. But I think Billabong has its hands full just managing their current circumstances. They already have stand alone Billabong stores, but those stores sell all their brands. I guess I’m not quite sure those other brands could do enough volume to justify their existence.
      Thanks,
      J.

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