Billabong and Rip Curl; A Tale of Two Surf Companies and Their Interesting Juxta Positioning

A few weeks ago, you no doubt saw the reports that Billabong (which would mean Oaktree Capital Management– the controlling investor in Billabong) was doing due diligence on Rip Curl as a possible acquisition.  Oaktree, of course, is also a major investor in Quiksilver.

When Oaktree invested in Billabong, there were some rumblings about combining it with Quiksilver, but nothing ever happened.

Meanwhile, we have a bit of information on Rip Curl’s earnings and last week, and Billabong held its annual shareholders meeting where Chairman Ian Pollard and CEO Neil Fiske reviewed the full year results.  Those results were released back in the middle of August and I wrote this article about them.

Ian’s and Neil’s respective speeches didn’t tell us much new about the year’s results.  My take continues to be that Billabong is doing all the right thing but it’s taking longer and being more expensive in a market that continues to be tougher than they hoped it would be by this time.  Companies incur a boatload of expense these days just doing the things they have to do to earn the right to compete.

We did learn that the Billabong, Element and RVCA brands together generate 91% of Billabong’s wholesale revenue.  That’s a reason I continue to expect to see the company sell more of its small brands; the remaining brands don’t appear significant to the company’s overall results.  I further doubt they can afford to invest in them, and it would be contrary to their continuing plan to focus on the big three.

One thing I did remark on in my article was that debt was getting closer to maturity, and that a whole bunch of stock options held by people who would like to recognize value from them were under water and getting closer to their expiration dates.  Chairman Pollard addressed the debt in his meeting remarks:

“Directors continue to consider options related to the Company’s term loan, which matures in a little under two years. This is a priority for the Board, and with the assistance of our advisers we are well-advanced in assessing various options, with the focus on maximizing shareholder value. Whilst considerable progress has been made in this regard, we are not in a position to make a statement to shareholders today. We propose to update shareholders on the outcome as soon as practicable.”

It’s clear from this comment as well as from Billabong’s most recent financial statements that Billabong doesn’t have the money to buy Rip Curl unless that money comes from Oaktree.  But if Oaktree lent Billabong money to buy Rip Curl, that just ends up adding more (expensive?) debt to Billabong’s balance sheet and increasing their interest expense.

How much to buy Rip Curl (a private company remember) anyway?

According to this article, Rip Curl “…generated $485m of revenue in the past financial year and some estimate that it could sell for as much as $450m.  Three years ago, it was generating $23m in annual net profit.”  However, an article in the Australian reported that 2017 profit was $18.44 million, up from $10.058 million the previous year.  Remember those numbers are in Australian dollars.

Mr. Eli Greenblat, in his November 1^st article in The Australian (which I can’t seem to find a link to) makes it clear that Rip Curl’s owners are proactively trying to sell the company.  He noted, “Rip Curl has resisted being dragged into discounting which can crunch margins.”

He’s right.  Once again, we see the value in this market of being a private company, which Quiksilver is now, Rip Curl always has been, and Billabong isn’t.  Here’s what I wrote back in 2015 about how Rip Curl responded to tough times.  They could do what they did precisely because they were private.  It worked.

Billabong would be better off as a private company, but I don’t see a path to privatization that makes sense to Oaktree.

Just because we haven’t heard anything in a month doesn’t mean Oaktree isn’t still kicking the tires.  There two basic kinds of buyers.  Financial and strategic.  Typically, strategic buyers pay more.  If Oaktree is a financial buyer in this case, then their interest will be focused on the return they can earn based on some growth and an exit strategy down the road.  But they are looking at a brand, profitable and stable as it apparently is now, that got that way by controlling its growth and distribution and sticking to what it knows how to do well- making surf products and selling them to surfers.  At least they are more focused on that than Billabong or Quiksilver.

So Oaktree is thinking, “Okay, we’re going to pay the owners a lot of money.  But that money is going into the pockets of the owners- not into the business to support growth.  But if they stick to what’s apparently made them successful, how do we improve the bottom line at an acceptable rate when revenue growth may be constrained in the name of protecting the brand?”

Sure, there may be some opportunities to cut costs, improve efficiencies and margins, etc.  But if revenue growth is constrained by the imperative of maintaining the brand’s market position is there enough bottom line improvement to be had to justify a price of “…as much as $450 million?”  What little information I have makes me lean towards a “no” on that one.

What if Oaktree is more of a strategic buyer?  That’s not hard to argue given their investments in Quik and Billabong.  I have no information about it, but I have to believe there’s been meetings held and analysis done of some form of combination of the three companies.  They’ve been seeking synergies and projecting growth opportunities and imagining various efficiencies.  I would certainly have looked at the possibilities, though with caution.  My experience is that synergies and efficiencies are never quite as real as they looked, and there are some unexpected expenses.

And then…Yes!…Of course!… It’s so obvious!  We’ll be the dominant surf company in the world controlling, oh, I don’t know, a whole bunch of the market.  We could be publicly traded on the New York exchange.  Course, we’d have to grow 10% or more a quarter, but we’d be so big and strong that what could go wrong with some expanded distribution…………………….

Get a grip Jeff.  We’ve seen that movie.  It’s a tragedy and everybody dies in the end.  Remember what the Australian academics who took a rigorous look at the market concluded.

I’d be asking if owning the three largest brands in the surf market that compete against each other doesn’t mean that you’re in danger of finding yourself in some kind of zero sum game, where the success of one of your brands comes at the expense of another.  Maybe you can argue the target market is bigger than the surf market.  Certainly Quik owned DC isn’t a surf brand.  Neither is Billabong’s Element brand.  But Rip Curl, we’ve learned, fixed its problems by focusing on the core market it knows.  That strategy is certainly appropriate to a big chunk of Billabong’s and Quiksilver’s business.

This article turned into rampant, but kind of fun, speculation.  It will be interesting to see if, to whom, and for how much Rip Curl sells.