Billabong mulls a mediocre lifebelt

The offer lobbed by the Paul Naude group last month would probably have been dismissed as too small. But with yesterday's earnings downgrade, it may be the retailers' least worst option.

Paul Naude, president of Billabong’s Americas business, timed the approach of his private equity-backed tilt at his employer near-perfectly.

In confirming market speculation that Naude, with New York-based Sycamore Partners, which specialises in retail and consumer investments, as his equity sponsor and Bank of America Merrill Lynch as his banker had made an indicative offer of $1.10 a share for the ailing surfwear group, Billabong also disclosed another earnings downgrade.

Where previously Billabong had provided guidance of underlying before interest, tax, depreciation and amortisation of between $100 million and $110 million this financial year in constant currency terms, on Wednesday it said underlying EBITDA was expected to be between $85 million and $92 million.

So, it is going to undershoot its guidance by at least $8 million at the bottom of the range and potentially as much as $25 million, with the mid-point of the ranges producing earnings that would be $16.5 million lower than previously flagged.

Already destabilised by an implosion in its earnings and several previous approaches from private equity the latest bad news increases Billabong’s vulnerability to an offer that would in other circumstances be simply dismissed out of hand.

While both TPG and Bain Capital (after tabling indicative offers of $1.45 a share) walked away after conducting due diligence earlier this year Billabong wasn’t expected to endorse offers at that level. Back in February its board had rejected an earlier approach from TPG at $3.30 a share. The $1.10 a share Naude has indicated he might be prepared to pay wouldn’t have evoked any interest at all if Billabong hadn’t stumbled, again.

Naude made his approach to Billabong in the middle of last month. Today, in explaining the earnings downgrade, Billabong said the major drivers of the result were high single-digit declines in sales in its Canadian retail business in October and November and good performances for the Billabong and RVCA brands in the US offset by weak orders for other brands and tough wholesaling conditions in Canada.

Results in South America were weaker than forecast and there had been significant cancellations of orders in Europe, particularly southern Europe, and lower than forecast retail sales and gross margins in the region.

Naude presumably was aware of that deterioration, particularly in the businesses he led, in the lead-up to his decision to stand down as a director and executive while he explored the potential for a leveraged buy-out of the group. Naude has led Billabong’s North American business since 1998. He may not, however, have appreciated the precise impact of the downturns in the Americas and Europe on Billabong’s numbers.

The Naude consortium’s proposal contained a provision that it would be withdrawn immediately if its confidentiality was lost – which it was this week. Billabong said this morning it was seeking to confirm the status of the proposal to see whether that condition will be invoked and also whether the trading update has had an impact. In a subsequent statement, issued this afternoon, it said it had received confirmation in writing from the consortium that its proposal remained unchanged, except for the removal of the confidentiality condition.

The Billabong board, under new chairman Ian Pollard, remains in an awkward position. No one knows whether TPG would have persisted with its original $3.30 a share approach had it been embraced rather than rejected. Its subsequent return and, as with Bain Capital, withdrawal after due diligence suggests not.

Billabong shareholders, however, having experienced the subsequent collapse in their company’s earnings and share price are most unhappy and restless and would probably appreciate any opportunity to exit at a premium to the market. Billabong shares, which were trading at 74 cents before Naude’s interest emerged, fell about 11 cents to 87 cents in the immediate aftermath of today’s announcement.

If Naude were to continue to pursue his proposal there would be considerable pressure on the Billabong board despite an indicative price that in different circumstances could easily be dismissed.

Their problem is that while their relatively new chief executive, former Target managing director Launa Inman, has a plan, it is a four-year plan. She is embarking on a comprehensive restructuring that she believes could release more than $155 million of incremental earnings by 2016.

Billabong’s previous botched execution of a retail strategy and poor retail expertise within the group means there is no quick fix available to her and therefore no near term relief for the shareholders.

The weak and, it now appears, again weakening retail conditions in the Americas and Europe, while perhaps not surprising, will compound the degree of difficulty she and Billabong confront in trying to execute and fund the strategy.

Billabong said today it noted the significant gap between its market capitalisation and shareholders’ funds and will conduct a full review of the carrying value of its assets – i.e. there’s going to be some more big non-cash write-downs.

Pollard said the board supported the Inman strategy and that it had already delivered some early improvements in operations and in managing costs.

The earnings downgrade, however, underscores the reality that external conditions over which management has no control can overwhelm the impact of any restructuring.

For Billabong and other lifestyle apparel retailers those conditions are hostile and deteriorating and there is little expectation that the European economy will show any real signs of life any time in the next few years and only slightly greater optimism about the near term prospects of the US economy.

If Naude continues on, the board, and shareholders, at least would have an option available. If he and his backers, like TPG and Bain, withdraw, the only option will be to persevere and hope that conditions improve and Inman’s strategy gives Billabong better leverage to any improvement.

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