Speculation on Billabong

Walking around a really good Agenda show last week, the question I kept getting asked was, “What’s going to happen to Billabong?”  As I told everyone who asked, I only had access to the same public information they had. Given that information, my best guess is that Billabong will be sold.  Here’s my reasoning. 

As you know, TPG offered, on July 23rd, to buy Billabong for AUD $1.45 a share subject to due diligence and other conditions. They already have an agreement from two Billabong shareholders who together control over 24% of the outstanding shares to sell if there is a deal. Billabong announced on July 27 that “TPG will be granted the opportunity to conduct non-exclusive due diligence in order to reduce the conditionality of its proposal and to improve its understanding and valuation of Billabong.”  
 
Notice it’s nonexclusive, so it’s not impossible for another buyer to pop up. But TPG has 24% of the shares already tied up with deals that give them some upside if higher price is negotiated. TPG also has agreed to allow “…Billabong’s founding shareholder, Gordon Merchant, and Collette Paull to roll over all or part of their respective shareholdings in the company into the TPG proposal.” There seems to be at this point a certain momentum, though a lot can happen between the start of due diligence and the closing of a deal; including an adjustment in the price.
 
The other reason I think a deal will happen is because of the process by which we got to where we are. Back on February 17th Billabong announced the deal to sell half of Nixon to TCP (not to be confused with TPG) for net proceeds of US $285 million. The deal closed on April 12th. That US $285 million, along with other action take to reduce expenses and close some retail stores, was supposed to address Billabong’s capital structure issues. That is, it strengthened their balance sheet.
 
 In the conference call at the time the Nixon transaction was announced, Silvia Spadea, a Merrill Lynch analyst, said, “I guess there’s no question that that will provide you with a short term reprieve with respect to your balance sheet issues. But, in my mind, it doesn’t really do much to address the fact that – you know to improve your current structural issues or stem the current deterioration in your earnings. I guess I’m just wondering how confident you are that the initiatives that you’ve outlined today are going to be enough to permanently fix that balance sheet issue, so that we don’t have this problem a year down the track.”
 
 An excellent question, I thought. In their answers, Billabong CEO Derek O’Neill and CFO Craig White never said anything like “You bet- problem solved,” and you actually wouldn’t expect them to be that definitive. But what they did do was indicate they had confidence in their projections. And my common sense told me that if they had even an inkling that the short term problem wasn’t  well and truly solved, they’d have taken more drastic steps and the Board of Directors would not been quite so cavalier about turning down an offer of AUD $3.30 a share for the company.
 
So imagine my surprise (Yours too, I expect) when Billabong management  announced on June 21st  (Former CEO Derek O’Neill departed the company on May 9th) that they were raising AUD $225 million at $1.02 a share, 44% below the previous closing price.
 
What the hell is going on in there? Had business conditions just fallen off a cliff and Billabong management hadn’t seen it coming?   Almost seems like it couldn’t happen that fast. Had they known it was worse, but had another solution in mind? In the U.S. such a failure to disclose would probably lead to shareholder lawsuits and a flogging from the Security and Exchange Commission. I don’t know what happens in Australia.
  
I suspect it’s not quite as black and white as either of those choices. In doing turnaround work, I’ve noticed a lot of denial and perseverance during periods of change even among highly competent managers/owners and I suspect there might have been some of that in this case.
 
When management has credibility issues, things appear to be going south much faster than anybody (including said management?) knew, and the shareholders take it on the chin and have a stock valued at AUD $1.39 a share they think they could have sold for AUS $3.30 just a couple of months ago, companies find themselves in play.
 
When will we know the outcome? Billabong is scheduled to report their full year earnings on August 27th. That is also the date new CEO Launa Inman is scheduled to present her plan to turn around the company. Due diligence takes some weeks typically, and I wouldn’t be surprised if an announcement coincided with the earnings report.   
 
I wonder what TPG would have found had they commenced due diligence under their previous offer of AUD $3.30? I think maybe there’s an untold story here. Anybody want to tell it to me? 
10 replies
  1. Kel
    Kel says:

    Here’s my guess. TPG will discover some not too pleasant stuff when doing due diligence and pull out of the deal or offer a lower price. The Australian Surf Industry where Billabong is heavily invested at retail will suffer as they had become most companies biggest account. The ramifications of Billabong failing are quite heavy on a much broader section of the industry than their own balance sheet. A great example good plan gone very bad for a myriad of reasons.

    • jeff
      jeff says:

      Hi Kel,
      I don’t know enough about the Australian Surf Industry to have an opinion of the impact of a Billabong failure, but I don’t expect a “failure” if by that you mean the whole company somehow goes belly up. There’s too much value in the various brands. Tell me what form you think a failure would take. I agree that TPG could find some ugly stuff and offer a lower price. Always a possibility when you take a peak under the kimono of a company with issues.

      Thanks for the comment,
      J.

      • Kel
        Kel says:

        What I mean by failing is failing to be successful in their plan. They bought a lot of retailers in Australia, really changed the landscape, become the biggest player and biggest customer and not their non ability to make the plan work has cost the rest of the players big time. The market has shrunk with their reduction through store closures. It’s pretty ugly down there right now.

        My sources reckon there is some ugly stuff under that kimono for sure. It will be interesting to see what happens.

        • jeff
          jeff says:

          Hi Kel,
          Okay, thanks for the clarification. I hadn’t really focused on the fact that they are so ubiquitous in Australia as brands and as a retailer that their problems impact everybody else. I think, though, it’s also fair to point out that the lousy economy is hurting Australian retailers, and we can’t lay that at Billabong’s feet.

          thanks,
          J.

  2. Jay Wilson
    Jay Wilson says:

    I had a talk with a major retailer in the main stream and they where not looking for any surf brands anymore they indicated that they where full up! This does not mean that the core or specialty are sour on Surf. I also had a conversation with a mini major brand in surf and they where looking for street to license or create their own street/artist brand.
    How is the surf poser Hollister doing?

    • jeff
      jeff says:

      Hi Jay,
      I’ll let you know about Hollister when I see Abercrombie and Fitch’s fillings. I don’t think there’s any doubt that traditional surf is at least slowing down, and that it’s made worse by the economy. At the end of the day Surf is pretty narrow market. Street/artist brands have a much bigger potential customer base and if you want to grow, after a certain size, you’re going to have to address it.

      Thanks Jay,
      J.

  3. Chuck
    Chuck says:

    What they may find in due diligence is over valued inventory, and some “unique” accounting for sales between the parent company and its 100% owned retail companies. When you asked what could make things unravel so quickly these are the key areas as you can only do these type of things so long.

    • jeff
      jeff says:

      Hi Chuck,
      I suspect some overvalued inventory is almost a given, as I’ve never met any manager eager to assure their banker about the adequacy of their balance sheet that was anxious to write down inventory. I’d love to have more information on the intercompany accounting issue.

      Good to see you at Agenda.

      J.

  4. Thomas
    Thomas says:

    Jeff- There is a lot of speculation that they would break it up and sell off the pieces for a quick profit (granted there is one). What do you think the motives are for TPG to acquire all of BBG?

    • jeff
      jeff says:

      Hi Thomas,
      I’ve wondered about the issue of breaking it up after an acquisition too. But I don’t have access to the information that would let me do any kinds of calculations about what the individual brands might sell for. And assuming they sold some or all of the brands, what’s the impact on the retail business that’s left? They’ve got big liabilities out there for leases on stores that can’t be made to go away. I guess there’s some value in the retail business by itself but I also think that value changes as they sell brands. Exactly how and by how much, I can’t really tell. I guess that’s part of what’s going on in the due diligence.

      As to TPG’s motives, they think they might be able to get a good deal on some solid brands and make money because Billabong is between a bit of a rock and a hard place. That’s what they do.

      Thanks for the comment.

      J.

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