Pacific Dunlop's figures not alluring enough

PACIFIC Dunlop the company that owns households brands such as Bonds, Berlei, KingGee and Rio has lifted its financial skirts and shown corporate suitors its undergarments, but found no takers.

The traders and hedge funds that had taken a position in Pacific Brands were clearly disappointed and the company's shares were dumped. In reality, the market should not have been all that surprised. The smart money had discounted the idea months ago because it was always going to be a tough deal.

It was the private equity funds that had been doing due diligence on Pacific Brands the likes of KKR and reportedly TPG and others. These vulture funds pick over cheap and unloved companies, sell parts quickly to recoup some of the price and then cut the fat out of costs and resell the slimmed company back to investors at a profit.

There are two reasons private equity may not have been able to make Pacific Brands stack up. The first is that the company's future profit performance was sufficiently uncertain that the exit strategy would have been hazardous.

The second is that the company had already undertaken much of the restructuring and the upside was therefore limited for a new owner. Pacific Dunlop has already exited some business units, the outcome of which has been lower revenues. The bottom line is there is not much left on the bone for buyers wanting to make some money.

The only measure on which the company fitted the private equity criteria is that it was cheap and unloved. But this is not enough. Unloved companies can ultimately become more unloved, which makes them a value trap. Pacific Dunlop has already issued profit downgrades but in the present retail environment who is to say that there won't be more.

Andrew McLennan of CBA Equities says the stock looks tremendously cheap but admits it is hard to have conviction when the retail environment has not yet stabilised. McLennan is a bit more positive about the outlook for retailers. He reckons the shift from spending into savings has mostly already happened and the move from consumer spending in the shops to travel has probably run its course. The fall in interest rates is a positive but the trend towards increased unemployment remains a concern.

In the six months to December the company announced a loss of $362 million. Most of this was due to write-downs in the underwear business, along with some restructuring costs. But even before these were taken into account net profit was down 38 per cent.

Some of this can be placed at the feet of the poor retail environment, but not all. The company is clearly too reliant on the discount department stores as a distribution channel and the loss of Kmart as a customer was a clear example of how this can blow up revenue.

Retail experts point to it still having a long supply chain and inventory risks. But the bigger issue is it is now competing with its retail customers who are selling their own house brands more cheaply. Pacific Dunlop's response has been to open its own retail stores, but this is expensive.

It has also attempted to differentiate its brands through extensive advertising to justify higher prices for, and better margins on, its apparel. Online competition will also take a toll on Pacific Dunlop, but probably not to the same degree as the more expensive brands.

How the company's share price will fare in the short term depends on whether there will be another downward guidance revision before the end of June. It could be that those sitting at the upper end of guidance may be disappointed, though this could be said for almost all retail stocks. Pacific Dunlop yesterday reaffirmed its general profit guidance but said there would be a small ($9 million) increase in the significant item losses around restructuring costs.

Pacific Dunlop is no Robinson Crusoe in the retail sector when it comes to an uncertain earnings future. Nor is it the only company that has been assessed by would-be predators. But it does not augur well for the company that it has revealed its inner financial secrets to a number of players and not hitched a buyer. In an uncertain future, one positive aspect is the company's balance sheet remains relatively robust.

Billabong is another retailer that has recently caught the attention of private equity. But in its case major shareholder Gordon Merchant was not prepared to sell out and told predators where to go. Billabong has installed a new chief executive, Launa Inman, and received a fresh influx of cash from joint-venturing its Nixon business.