Billabong's back-handed hedge fund compliment

The US hedge funds that have taken on Billabong's debt see hope of salvaging the ailing surfwear maker. But their preferred outcome would be dire for shareholders.

It is tempting to see parallels between the role US hedge funds played in the recapitalisation of Nine Entertainment and the displacement of Billabong’s bank lenders by two US funds, one of them a key player in the Nine saga. At this point, however, there is at least one fundamental difference.

When Nine fell into the clutches of Oaktree Capital and Apollo Global Management last year, all the equity, and then some, had long been wiped out. The negotiations which ultimately led to the hedge funds acquiring control of Nine were between the funds and mezzanine debt holders owed more than $1 billion, who ended up with about 10 cents of value in the dollar.

In Billabong’s case, the market, which values the equity in the company at just under $100 million, is attributing some modest equity value to the ailing surfwear group and there is some prospect that its board and management can salvage something for shareholders, along with some upside.

Billabong, despite the failure of discussions with two potential bidders earlier this year, is still in discussion with both those groups, Altamont Capital and Sycamore Partners, about both a potential re-financing of its debt, injections of equity and asset sales.

Unless those negotiations fail to produce a deal and Billabong breaches covenants on its borrowings of about $270 million (according to its last published balance sheet) the Billabong board remains in control of the group’s destiny and the US hedge funds – Oaktree, again, and Centerbridge Partners – are just lenders without any more leverage over Billabong than the banks they displaced.

The funds are said to have bought out Billabong’s bank lenders at prices ranging between 80-90 cents in the dollar so their worst-case outcome would be if Billabong were able to successfully negotiate a deal with Altamont or Sycamore and their exposures were repaid at 100 cents in the dollar, which would give them a $40-$50 million "turn" for a couple of months’ work.

In that case, the Billabong play would be a simple distressed debt deal rather than the kind of debt-for-equity swap that Oaktree was involved in at Nine and, before that, Alinta.

Billabong appears hopeful that it can strike an acceptable deal with Altamont or Sycamore, led by former Billabong Americas president Paul Naude. The Altamont team includes former Oakley president and Nike vice-president Scott Olivet, who has impressed the Billabong board and management with his insights into the industry and their business.

The board would be acutely aware that while the displacement of their bank lenders by the two hedge funds represents a fall-back option for the business, it offers little, if any, prospect of value for shareholders, making a successful deal with Altamont or Sycamore imperative.

The emergence of the hedge funds, which would have outlaid more than $220 million to buy Billabong’s debt, does in a perverse way validate the Billabong view that the business and shareholder value is salvageable despite the difficult retail environment it is operating in. The funds wouldn’t have bought the debt even at discounted prices if they didn’t see upside within the business.

While conditions in Europe and Australia remain tough, there are signs that the US recovery is developing some momentum and therefore that if Launa Inman is given some breathing space with a more stable balance sheet to continue the restructuring of the group, which is expected to generate earnings before interest, tax, depreciation and amortisation of between $67-$74 million this year, it might yet have a viable future.

For the long-suffering Billabong shareholders to participate in that future and, hopefully, salvage some of their lost value, however, the company does need to nail one of the deals it is negotiating and avoid falling into the hands of the opportunistic new holders of its debt.