Food for thought for the Billabong board

Along due diligence process inside sportswear group Billabong finished on Thursday, with the two consortiums involved believed to have firmed up their earlier indicative takeover proposals.

Along due diligence process inside sportswear group Billabong finished on Thursday, with the two consortiums involved believed to have firmed up their earlier indicative takeover proposals.

Billabong's board is expected to meet over the Easter break to consider the confirmed offers, from the US-based leisurewear group VF Corporation and its private equity partner, Altamont Capital Partners, and from Billabong's top US executive, Paul Naude, and his American private equity bidding partner, Sycamore Partners.

It is expected that the offers are substantially below the indicative price of $1.10 a share that was floated to Billabong by Naude and Sycamore in mid-December, and by VF Corp and Altamont in mid-January. Billabong shares eased by 2¢ to 73¢ on Thursday, and the market speculation is that offers of about 80¢ a share are possible.

It is also worth noting that Billabong has its own recovery plan in train, and has said consistently that it will support only an "acceptable" binding proposal. Given that any takeover would be by way of a scheme of arrangement that bidder and board would take jointly to shareholders, this is an important caveat.

Confirmation that offers have been made should however be seen as a plus for Billabong, which was forced to suspend trading in its shares briefly on March 21 after a wave of selling on rumours that the consortiums had pulled out.

The shares fell from 81¢ to 63¢ and then rallied to 69.5¢ before trading was halted. Billabong said the due diligence processes were alive but the shares stayed weak and closed at 73¢ on Thursday as the informal deadline for bids arrived.

Developments now hang on how much has been offered and how Billabong reacts, and the attitude of 14.5 per cent shareholder and Billabong founder Gordon Merchant will be important.

Merchant rejected a $3.30 a share takeover proposal from private equity group TPG early last year, saying $4 was not enough, but that was then, and this is now. The extent of Billabong's problems is better understood, and so is the execution risk that accompanies the attempt to revive the group's fortunes that has to be mounted regardless of who owns the company.

In August, when Billabong chief executive Launa Inman unveiled her own plan to rationalise and renovate Billabong, it owned 12 retail chains and offered 25,239 individual styles, or clothing products, for example. Less than a quarter of them were generating 80 per cent of the group's sales.

Administrative systems had not been merged as Billabong undertook a series of expansionary acquisitions in Australia, the US and Europe, and there was no integrated view of the operations.

Given the execution risk a bid at $1.10 a share would probably have been recommended. A lower one might be, too.

The Dow Jones Industrial Average had already made it, and on Friday morning Australian time, Wall Street's Standard & Poor's 500 share index got there as well, rising by 0.4 per cent to beat a closing high set on October 9, 2007, for the first time.

The S&P's rise above a high that was set before the global crisis bloomed malevolently is arguably of more moment than the Dow's new high three weeks ago. It's a bigger index than the 30-share Dow and a more accurate pointer to the overall health of the US market, which is still the world's most important market weathervane.

At 4966.5 points, the Australian sharemarket's benchmark S&P/ASX 200 share index is 27 per cent short of its all-time high of 6828.7 points on November 1, 2007.

On a total return measure that includes dividends, it is only 3.7 per cent short, but US companies do enjoy some advantages over Australian ones.

Energy costs are falling in the US, for example, as America's shale gas boom feeds low-cost gas to US manufacturers.

US interest rates are lower than they are here, and while a high Australian dollar is hurting Australian exporters and sucking in cheap imports, the reverse is the case in America: quantitative easing and record low interest rates have pulled the US dollar down, boosting the export competitiveness of US companies and making imports into the US more expensive.

Morgan Stanley market strategist Gerard Minack noted ahead of the S&P 500's rise to a new record that signs of economic recovery had been multiplying in the US, and shares there had gained on the back of improving profit margins as operating costs fell, not because share valuations overall were expanding.

The S&P 500 index rose almost 20 per cent from May 2011 while emerging markets fell by more than 10 per cent and developed markets outside the US fell by 5 per cent, he said.

The earnings of the S&P 500 also rose 20 per cent, and the earnings of companies outside the US fell by 15 per cent. Investors were accordingly paying pretty much the same multiple of earnings for the S&P universe as they were in May 2011, even though Wall Street was at record highs.

The earnings multiple of the other developed markets has risen an average 30 per cent over the same period, as investors pay more for less robust earnings.

The US market could trade higher on an overall market valuation upgrade if America's recovery continues, and if concerns about Europe fade again after the scare of Cyprus' bailout. Those are big ifs, but it is certainly conceivable.


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