Billabong's blood in the water

Only a few months ago Billabong announced the sale of majority interests in one of its best brands for net proceeds, akin to a capital raising, of $US285 million to more than halve its threatening debt burden, stabilise its balance sheet and see off an approach from private equity giant TPG. Today it announced a $225 million equity raising.

With the underwritten six-for-seven renounceable entitlements issue equivalent to about 48 per cent of Billabong's market capitalisation, the issue is one signal of the pressure the once-iconic surfwear group is under.

The foreshadowed departure of its chairman, Ted Kunkel, and audit committee chairman, Allan McDonald is, after the forced departure of former chief executive and Billabong veteran Derek O'Neill last month, another.

The issue is being made at $1.02, a 44 per cent discount to the Billabong stock price of $1.83 before trading in its shares was suspended. Given that TPG had indicated a willingness to offer $3.30 a share, Billabong needed to make some gesture to appease disgruntled shareholders.

TPG withdrew after founder and substantial shareholder Gordon Merchant said he wouldn't accept anything less than $4 a share. Merchant has now said he will take up 85 per cent of his entitlement to the issue, or $30 million of the shares.

The issue appears to have been prompted by the findings of a review conducted by former Target managing director Launa Inman, initially as a consultant but subsequently as the group's new chief executive. A combination of Billabong's own structural issues and the continued deterioration of conditions in its major markets – Australia, the US and Europe – means this year's financials aren't going to look pretty.

Billabong had expected to report a gain of about $200 million to $225 million on the sale of 51.5 per cent of its Nixon brand to another US private equity firm and its management. Today it said that gain would be more than offset by impairment charges and restructuring costs.

At its half-year in February it had expected to generate earnings before interest, tax, depreciation and amortisation of about $157 million this financial year. Today it said that, on a comparable basis, EBITDA would be about $130 million to $135 million. Adjusted for the Nixon sale it would be $120 million to $125 million and, on a pro forma basis (excluding 100 per cent of Nixon for the full-year) $83 million to $88 million.

Billabong, before it hit a wall, had been aggressively vertically integrating with a rapid and substantial rollout of retail stores to reduce the dependence of its traditional wholesale business on key customers. With hindsight, while the strategy might have made sense, it didn't have the retailing expertise to execute what was an ambitious program and its timing was terribly unfortunate.

Even without the expansion into retailing Billabong – a discretionary retailer – would have been hurt by the steep and continuing downturn in consumer confidence and spending in its key markets. Europe is reeling, the US has been battered and Australian consumers have closed their wallets. The retail exposure has probably magnified the impacts of those downturns.

Even before Inman was appointed Billabong had planned a major rationalisation of its store network. Today it said it had closed 45 stores, would close another 11 by June 30 and would have lopped 140 by June next year. That could generate $6 million of incremental EBITDA. A cost reduction program was targeting an extra $30 million a year.

It would be very difficult, and dangerous, for Inman to be continuing to drive a major restructuring through the group, in the midst of a continuing decline in the retail environment and Billabong's business while carrying too much debt. Debt and retail in the current conditions is not a good mix.

After the Nixon sale Billabong had reduced its net debt from around $526 million to $325 million. The capital raising will cut that to around $100 million and, after a renegotiation of its banking facilities, will provide Inman with some breathing space between the group's recessed performance and her banking covenants.

Inman is a good and experienced retail overseeing a difficult and complex attempt to get the Billabong model stabilised, completely restructure its supply chain and retail network and reinvigorate its brand. By August she hopes to present a detailed three-year strategy and business plan.

This could well be Billabong's last chance, assuming private equity doesn't come knocking again. If it can't arrest the implosion in its earnings and demonstrate a potential to grow in better conditions, the once-stellar brand could be in an even worse predicament.