Billabong caught with pants down in wipe-out

Shareholders can't wait to jump off the once-mighty company that is struggling to make its brands relevant, writes Elizabeth Knight.

Twenty-five years ago, Billabong basked in street cred - the clothing of choice for surfing dudes and wannabes who aspired to be cool. Today, as one fashion industry insider quipped, the brand has become the barbecue short for the sausage sizzle.

If the 45-year-old fathers are wearing boardies with elasticised or velcro adjustable waists to accommodate a middle-aged muffin top, their 15-year-old sons are not in the market.

On Friday, the future ownership of this famous brand hung in the balance. Two American corporate sharks (in suits) have been circling the bleeding Billabong carcass for a couple of months, and intense talks are continuing over the weekend.

The decision by the Billabong board and its largest shareholder and founder, Gordon Merchant, to hang out the "for sale" sign, is the ultimate recognition the company has lost its way.

Five years ago, Billabong was a $5 billion company and its stock traded at $14 apiece. The offers from these financial syndicates today are less than 70¢ a share - the financial equivalent of the bin at the front of the store, housing the end-of-season/couldn't sell stock that customers rifle through.

At this price, the company is worth closer to $300 million.

It is the final ignominy for Billabong, whose financial performance has been in such steep decline that it has lost the support of many of its large investors and has been playing a dangerous game of dodgeball with its bankers. The previous management was ditched last year, following a series of poor results and profit downgrades. Long-serving-chairman Ted Kunkel hung up his boardies, as did other directors.

The replacement regime, headed by former Target boss Launa Inman, devised a new restructuring plan but the results to date suggest it has not gained much traction.

Inman's remit was not about business growth. In a practical sense, her job is more akin to managing a business that is in run-off.

She did not create Billabong's problems, she inherited them. But there has been a large question mark over whether she can fix them.

Six weeks ago, Billabong reported a $536 million loss for the six months to last December. In doing so, it breached agreements with its bankers, who ultimately continued their support, but at a price.

The banks took security over the assets and Billabong became their hostage.

The ever-shrinking company is now so small, a retail analyst says "the only people interested in this stock are the ones that own it and want to get out at any price".

For investors, it has been all about damage control. The retail recovery story is selling about as well as last season's Billabong board shorts.

The path of Billabong's demise is littered with poor investment decisions, strategy blunders, hubris and flatfooted management responses to structural changes in market conditions.

The poor retail environment just exacerbated the problems.

When Merchant created the Billabong brand in the 1970s, it had serious credibility. In the tight and difficult-to impress surfing circles, it passed all the tests to receive a coveted stamp of approval.

For more than 20 years, the must-have product was on the growth path, being sold primarily to small surfwear shops dotted around Australia's vast coastline and increasingly into international markets.

It was not until after 2000 - when the company listed on the Australian Stock Exchange - that it started to broaden its horizons, buying new brands such as VonZipper and Element.

It was during the mid-2000s - when Billabong was at its peak growth - that the seeds were sown for its ultimate corporate challenge.

The retail landscape had started to change. As a retail authority recalls, the small surf shops that made up Billabong's retail arteries for distribution began to consolidate. Larger operators starting buying up smaller shops, dividing them into massive territories and creating retail surf cartels.

Many of the small independents that remained formed loose co-operative buying groups, covering multiple stores.

Where big manufacturers such as Billabong and Quiksilver once had the product and could command terms, the power was shifting to retail operators, who started to dictate through whom the surf brands could be sold.

Billabong had a few stores by early 2004, but in response to the growth of big retail groups, it took a strategic decision to plunge further into retail to get control of the relationship with its customers.

By 2011, it had 639 stores around the world and had morphed into a vertically integrated manufacturer and retailer of surfing, skating and ski gear, and various accessories.

Further complicating matters, some of the large retailers that were not bought out by Billabong were also taking the bit between their teeth and expanding into manufacturing.

The market was getting messy and crowded.

Billabong's retail strategy was being executed in tandem with the purchase of several new brands.

During 2009 and 2010, the company spent heavily, adding Dakine, Swell, RVCA, Jetty Surf, Rush, Surf Dive'n Ski and West 49 to its arsenal.

In corporate presentations back in 2010, Billabong called this its transitional year.

This is corporate-speak for undertaking major change that is yet to pay dividends.

By June 2011, the management was promising they would see the fruit of their new strategy translate into improved earnings the following year.

History now shows there was no harvest last year, nor will there be any this financial year. The dying parts of the trees just kept getting pruned.

Meanwhile, the expensive debt-infused acquisitions had placed a strain on the company's balance sheet. It was a dangerous pincer - increased interest costs and slowing cash flow.

By last year, Billabong was being crushed by its debt and in desperate need of an influx of capital.

One of the few bright spots among the corporate gloom was the acquisition of watch brand Nixon. Billabong had spent $80 million on this asset and it was exceeding all expectations. It rapidly became the jewel in the portfolio of brands.

However, Billabong needed money, and offloading a near-half share in Nixon was the easiest and quickest way to get it.

The deal netted Billabong about $US285 million, but several retail analysts did not support the move. They believed it was a short-term fix that could worsen the longer-term problems.

A Merrill Lynch report at the time said, "In our opinion, Billabong has sold one of its best assets. And this is on top of a business that is already struggling to generate growth in earnings due to the underlying maturity of its wholesale business and with a considerable amount of poorly positioned retail assets."

The analysts were right in one regard. It was a short-term fix.

By June, the company was again in need of money and was at risk of breaching its banking covenants. This time it appealed to shareholders to buy new shares at a deeply discounted price in order to raise $225 million.

It also had to deliver the bad news that the full year 2012 profit was going to be lower than what was promised a few months earlier. By now, shareholders had become familiar with profit downgrades from Billabong.

Inman's stewardship was in its early days but even the injection of new management and the promise of a new board was not enough to cure shareholders of disappointment fatigue.

Less than six months after she had taken up the role, Inman twice had to face the analyst mob and admit to profit downgrades. She had to repeat the ugly experience again a few weeks ago.

For Inman, it has been a race against the clock to try to unravel most of the strategy put in place by her two predecessors over the past decade. She needs to reduce costs faster than the decline in company revenues - a frantic quest to close many of the expensive stores, reduce the number of styles, rationalise the supplier base and get rid of some sub-scale and unprofitable brands that have been collected over the past 10 years.

A report by Credit Suisse last month contained its verdict on this: "It is unlikely that the lost gross profit from brand rationalisation will be matched by a reduction in fixed and variable costs resulting in a reduction in wholesale profit."

The bottom line is that institutional shareholders are sick of waiting. They just want to get off the Billabong train.

The decision by Merchant last year to reject a $3.30 per share conditional offer from private equity group TPG greatly angered shareholders. With 15 per cent of stock, Merchant had enough power to veto this offer and he exercised it.

He believed the company was worth $5 a share. The advisers may have been telling him this but it beggars belief that he was unable to see what was happening inside the company on which he sits as a director.

TPG came back six months later, as did another private equity group, Bain Capital. But the offer price had dropped. To get another look under Billabong's hood, both made indicative bids of $1.45 a share.

Within weeks, Bain Capital had been frightened off by what it saw. TPG lasted three weeks longer and bailed out in October.

But the parade of private equity tyre kickers moved on.

It was only two months later that one of Billabong's executive directors, Paul Naude, teamed up with private equity group Sycamore Partners to lob an even less generous indicative offer of $1.10.

By January, Billabong was also being courted by US-based leisurewear group VF Corporation and its partner Altamont Capital Partners pitching at the same price.

Naude's team is said to have the inside running but that $1.10 "indicative offer" turned out to be an opening bid that could have as much as halved.

The pressure on Billabong's board to accept almost any offer has been intense. To reject any offer of more than 50¢ carries enormous risk. The share price will plunge and no one can predict where it will land. Analysts have been changing price targets rapidly over the past six months.

Some such as Credit Suisse suggest that in a worst case, it is worth nothing.

What started as a simple business by Merchant has become a complicated one. What was lost or forgotten in the process was the need to nurture the brand.

Sponsoring surfing contests and buying buff-bodies and sun bleached surf ambassadors is not enough to cut it.

Regardless of who owns Billabong, the task of rebuilding an inter-generational youth brand is mammoth.

And it is even harder when the management is financially constrained and its ownership clouded.

Brand renovation is not impossible and there are plenty of success stories, including Burberry, which reinvented its staid British brand into a more youthful and sought after glamour one, and Vans, which is experiencing a huge resurgence in the market for under-21s.

Brand specialists point to Apple and Puma, which also staged massive comebacks.

The theorists say it's all about staying relevant. It's about having a clear sense of what the brand stands for - in effect, its essence. The Billabong brand is now considered as mature as the surfers who wore it in the '70s.

Billabong is not the only Australian surfwear company to suffer from a lack of brand relevance.

Quiksilver has also had its fair share of troubles in a financial and brand sense. It was bailed out by a US private equity group and a couple of banks in 2009. While it is now financially stable, its brand relevance remains questionable. However, it has managed to steal the lead in the girls-wear market with its Roxy brand.

There is a school of thought that believes the surfwear market could be structurally shrinking.

It could also be that the fad-driven and fickle youth market is not being sufficiently captivated by what's on offer. Experts agree that sustaining a brand in this market is the hardest task of all.