Suitors leave Pacific Dunlop on the shelf

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

Pacific Dunlop - the company that owns households brands such as Bonds, Berlei, King Gee 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.

The modus operandi of these vulture funds is to pick over cheap and unloved companies, sell off parts of the company quickly to recoup some of the price paid, and then cut the fat out of costs and re-sell the slimmed down company back to investors at a profit.

There are two reasons that private equity may not have been able to make Pacific Brands stack up on this criteria. 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 that there is not much left on the bone for buyers wanting to make some money out of Pacific Dunlop.

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 current retail environment who is to say that there won't be more.

Andrew McLennan from CBA Equities says the stock looks tremendously cheap but admits it is hard to have conviction when the retail environment has not yet stablised.

In response to downgrades, value investors have been piling into the stocks like JB Hi Fi and Harvey Norman. They will now be sitting on losses while they wait for the company's fortunes to turn.

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.

Those that are holding Pacific Dunlop stock are thinking positively about the future prospects but to date it has been mostly bad news. In the six months to December the company announced a loss of $362 million. Most of this was due to writedowns 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 the fact that it still has a long supply chain and inventory risks.

But the bigger issue is that it is now in competition with its retail customers who are selling their own house brands in basic apparel - and more cheaply.

Pacific Dunlop's response has been to open its own retail outlet stores, but this is an expensive

exercise.

It has also attempted to differentiate its brands through extensive advertising - using the likes of Sarah Murdoch - 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. Any slippage would worry investors.

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 retains relatively robust.

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

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