A Comment About a Billabong Deal and a Chance to Place Your Bet

/0 Comments/in , /by

I was a bit surprised when VF’s preliminary bid for Billabong came as late as it did, and I was also intrigued by the partnership with Altamont. Why, I wondered, didn’t VF just buy Billabong itself? 

A couple of possible answers occurred to me. The first was that somehow they couldn’t afford it. But a review of their most recent balance sheet made me think that wasn’t the case. However, I did recall that they borrowed a bunch of money to pay for Timberland and had committed in their conference calls to reduce debt. Even though they could borrow the money to purchase Billabong, it might not have been a comfortable place to go for either VF or the analyst community that follows them.
 
Second of course is the fact that VF is primarily interested in the Billabong brand, and it’s a lot easier to just acquire that brand rather than acquire the whole thing and sell off the other brands. Here’s how they put it in the press release:
 
“VF’s primary interest in the transaction is in the Billabong® brand. This interest is consistent with VF’s stated intent to pursue acquisitions, particularly in the Action Sports category, to continue to build shareholder value. Altamont’s interest lies in acquiring Billabong’s other brands and related assets, and is predicated on the firm’s mandate to invest in situations where it can provide strategic and operational support to build business success stories.”
 
When it says Altamont’s interest is in “other brands and related assets,” I wonder what that means. Do the Billabong stores go with the Billabong brand? I guess Altamont would get West 49, though of course I don’t know that.
 
If a deal should be struck, Billabong shareholders would just get money, and they’d be done with it. But VF and Altamont would be the ones who would put up that money, and you have to wonder how they’d decide who put up how much.
 
They would have to agree on a value to the brands or assets being acquired by each of them. That certainly can’t be done before due diligence. How do you decide how much RVCA, for example, is worth before you know how much they are selling and have seen an income statement?
 
But even after due diligence it could be a bit of a hard thing to do. Valuation almost always has an element of subjectivity to it, and one might suspect that both VF and Altamont would want the assets their partner is taking to be valued higher so their partner’s piece of the purchase price was higher. Value also has to do with the future prospects of a brand and reasonable people can disagree on that.
 
Altamont is more what we call a financial buyer. That is, their valuation of an asset is based on what financial return they can expect. VF is more of a strategic buyer in the case of Billabong. By that I mean they look at the Billabong brand and look at how they can improve its operations and results by bringing their own strengths in, for example, sourcing to bear on it. They look for and expect synergies in other words. Read VF’s description of how they are managing their newest acquisition Timberland to improve its performance.
 
So VF might tend to come to a higher value for the Billabong brand than Altamont would, but it would be in their interest to convince Altamont that the value was lower. 
 
Not only, then, do VF and Billabong have a bias in favor of valuing the assets their partner is buying higher (so their own cost is lower), but it may not be easy to agree on those values because of differing perspectives. I imagine there would be ongoing discussions about this as due diligence proceeds. They really wouldn’t want to make a deal to acquire Billabong then find out that they couldn’t agree among themselves on who would pay how much.
 
I am sure you all realize I am speculating here, but I thought it might be valuable to think about the process that has to occur. But if you’re really interested in speculating, you can go to this Australian betting site and place your wager on whether Paul Naude and his group or VF and Altamont will snag Billabong. All bets are off if neither one buys it.

 

 

Paul Naude Offers AUD 1.10, Billabong Reduces Full Year Forecast

/0 Comments/in /by

This is just intriguing. There is so much happening and it’s going on so fast (at least in corporate terms). It’s like a novel you can’t put down or a soap opera where waiting for the next episode to find out who does what to whom is excruciating. 

Like you, I’m working from the Billabong announcement and a couple of press reports so I have no solid information you don’t have. But I’ve always been a student (and sometimes a practitioner) of turnaround management and organizational evolution and this is fascinating. Dare I say fun (for me at least)?
 
All the numbers are in Australian Dollars.
 
Let’s start with a review. In February, Billabong turned down a $3.30 bid from TPG Capital (subject to due diligence) as too low. Subsequently, Bain and TPG withdraw offers of $1.45 after some due diligence (The TPG offer was made on July 24 and withdrawn on October 12.). Meanwhile, on April 12th, Billabong closed a deal to sell half of Nixon to TCP for proceeds of $285 million to be used to pay down debt. Former CEO Derek O’Neill departed the company on May 9 and Launa Inman was appointed Managing Director May 12. On June 21st, Billabong announced that it would sell shares at $1.02 (44% below the previous closing price) to raise an additional $225 million to pay down debt.
 
On August 12th, the company released and Ms. Inman presented Billabong’s half yearly results and plans for going forward. I wrote rather extensively about that.
 
Now Paul Naude, who took a leave of absence as a Director and President of the Americas on November 19, has made a contingent offer of $1.10 per share. When he did this last Friday, Billabong’s shares were trading at $0.73 each.
 
Just to increase the intriguing factor even more Billabong, at the same time they announced Paul Naude’s offer, released a trading update where they reduced their expected EBITDA from $100-110 million in constant currency to $85-92 million in constant currency. But that eighty-five to ninety-two million number is before $29 million of “significant items.” If you include those, the year-end constant currency range is from $56 to $63 million. The release does not describe the previous EBITDA estimate as excluding any “significant items.” As a result, I’d tend to compare that prior estimate to the $56-$63 million estimate. Using the midpoint of both estimates, that’s a decline of 43%.
 
The press release, should you want to read it yourself is on this page at the Billabong site. Right now, it’s the second on the list and is called “Bid Proposal and Trading Update.” This is the third time this year that Billabong has reduced its expected results. You can read for yourself the details of the causes in the release. We can sort of sum it up by saying soft sales and a lousy economy.
 
When I discussed Paul Naude’s decision to put together an offer back in November, I speculated that the offer price might be lower than what we’d seen before. Now I have to wonder, with the price of the stock having fallen since the downward revision of the year end results, if it might be reduced further. I also discussed briefly in that article just how a leveraged buyout, which this deal would be, works.
 
If I could ask Paul one question, it would be, “What did you know, and when did you know it?” It seems likely to me that when he took his leave of absence a month ago, he must have had some sense of the continued deterioration of business conditions. Yet the conditions under which he was allowed to pursue the deal required that he use no confidential information. Regardless of what he knew or was concerned about then, he had to put together his offer, and represent it to his potential partners, using only public information. That would have been the EBITDA estimate of $100 to $110 million.
 
Were I Paul’s partners (Sycamore Partners Management and Bank of America Merrill Lynch) the first question I would have asked in the first meeting was, “You were a director and the President of the Americas as Billabong’s performance went south. Now you’re coming to us and explaining how under your leadership this can turn into a really good investment. Explain to us why your really good ideas couldn’t be implemented.” 
 
I gather he had a really good answer. 
 
We’re a long way from a deal (Remember, I thought there would be a deal with TPG). Whether or not Billabong has to make a deal at some price depends on their balance sheet. If there should be a deal I’d expect the price to decline further as a result of the reduction in projected year end results. And I’m guessing you’d see some brands sold following the deal to pay down debt. The thing I’d be most interested to watch is how they’d propose to manage their brick and mortar retail.
 
I’ll keep watching and speculating right along with you. 

Billabong’s Year and New Plan; I Wish They’d Done This Sooner

/8 Comments/in /by

Billabong’s fiscal year ended June 30. On August 27, they released their full year results and presented their promised strategic plan. The financial results were poor but not unexpected, coming in at the low end of their guidance. The good news is that it looks like they wrote off, wrote down, reserved for or expensed every item they could find that might possibly represent a problem or stand in the way of their new strategic plan. 

I refer to this as the “big bath” approach. That is, if things look bad and your audience is going to hate what you tell them anyway, might as well get all the bad news you can identify behind you. This is good because not only does it mean fewer negative influences going forward (both financially and in terms of management focus) but there’s a reasonable chance that some of these assets you’ve written down will turn out to have some value that will go right to the bottom line in future periods.
 
A really good time to do this is when you have a new Managing Director and CEO coming in and, as you’re aware, Launa Inman joined Billabong on May 9th, coming from Target Australia (no relationship t Target in the U.S. except that they license the name.
 
CEO Inman presented her strategic plan for the company, and I’ll get into the details below. Much of her approach is what I’d call blocking and tackling. That, by the way, is a very, very good thing. It’s fundamental, but it’s critical. Those of you who have followed my suggestions for how companies should be approaching a lower growth, consumer centric environment won’t be surprised that I like what she proposes for Billabong.
 
Housekeeping
 
Here are a few things to keep in mind as we go through this. First, all the numbers are in Australian Dollars unless I say otherwise. Second, “pcp” means prior calendar period.   Third, The Australian Dollar is worth US$ 1.03 today (August 31). On June 30, it was worth US$ 1.016. Fourth, if you want to review the financial report, conference call transcript, or the slides for the fiscal year review or new strategic plan, you can find them here.
 
The TPG Offer
 
I imagine most of you were hoping to find out what’s going on with the July 23rd offer from TPG International to buy Billabong for $1.45 a share. Me too. But all we found out on the conference call was that the confidentiality agreement had been signed and the due diligence commenced. However, in footnote 41 on page 123 of the financial report, I did find the following:
 
“There is no guarantee that, following the due diligence process, a transaction will be agreed or that the Board will recommend an offer at the current proposed offer price. In fact, the Board does not believe that the proposal reflects the fundamental value of the Group in the context of a change of control transaction.”
 
Billabong’s board of directors doesn’t think $1.45 is enough. As you’ve probably noticed, there’s some speculation that other buyers might be out there lurking in the lichens. This will be interesting to watch.
 
The Year’s Results
 
Here’s the broad brush. Billabong lost $276 million on revenue of $1.44 billion. Last year, they earned $119 million on revenue of $1.56 billion. Cost of goods sold rose from $728 million to $765 million. Gross margin fell from 53.3% to 47%.
 
I’m going to go ahead and present some of the other income statement numbers, but starting with sales, I’m going to go back to clarify and explain a bit.
Selling, general and administrative expenses (SG&A) rose 14.2% from $564.7 million to $645 million. Other expenses rose 275% from $144.8 million to $544 million. Last year’s pretax profit was $88.7 million. This year’s pretax loss was $522 million. There was an income tax benefit of $40 million this year and you have to then add in the $206 million gain on the sale of 48% of Nixon to get to the net income number.
 
Billabong operates in three segments. Australasia includes Australia, New Zealand, Japan, South Africa, Singapore, Malaysia, Indonesia, Thailand, South Korea and Hong Kong. The Americas is the U.S., Canada, Brazil, Peru and Chile. Europe is Austria, Belgium, the Czech Republic, England, France, Germany, Italy, Luxembourg, the Netherlands and Spain.
 
The Rest of the World “…relates to royalty receipts from third party operations.” I conclude that the countries listed in the three segments are where Billabong has its own operations. The royalties were $2.6 million during the year.
 
Here’s the revenues and EBITDAI for the three segments for the last two years. 
 
 
I know most of you know this, but EBITDAI is earnings before interest, taxes, depreciation, amortization and impairment charges. Call it the operating result. The impairment charges total $343 million. We’ll discuss them below.
 
Now, the plot thickens. Billabong adjusts the numbers above to “…exclude significant and exceptional items…” These are “…items associated with the strategic capital structure review…” 
 
“Significant income and cost items associated with the strategic capital structure review includes
but is not limited to, doubtful debts, inventory write downs and redundancies partially offset by the gain on sale of 51.5% of the Nixon business (significant items). Exceptional items include other costs and charges associated with certain initiatives outside the ordinary course of operations (exceptional items) (collectively significant and exceptional items).”
 
Here’s the numbers for the recent year with those items removed. 
 
 
It’s a miracle. Instead of an EBITDAI loss in its three main segments of $74 million, Billabong shows an EBITDAI profit of $118 million and a net income of $33.5 million instead of a loss of $275 million.
 
There is justification for making some of these adjustments, and I’m not against trying to show a true picture of operating results. But I’m not quite certain how bad debts and inventory can be removed from operating results. I mean, if some of the inventory ain’t worth much, and you can’t collect the receivables, that’s pretty much about how you operated I think. 
 
I guess the argument is that they identified and took these write downs because of their strategic review, and are starting fresh, have a new CEO, and just want to clear the decks (see “the Big Bath” discussion at the start of the article).
 
In the Australasia segment, they note that “Sales…increased over the pcp principally as a result of the inclusion of a full year of trading for the prior year acquisitions of SDS/Jetty Surf and Rush Surf in Australia.” I conclude revenues would have been at best even without that acquisition related revenue. They mention as factors reduced June shipments and a highly promotional environment. Australia represented 65% of the total segment revenues.   
 
In the Americas, they point to wholesale and retail performance in Canada as a major reason for the reduction in EBITDAI margins. They note issues with West 49 on a couple of occasions. The U. S. was 59% of this segment’s total revenue.    
 
They talk about the impact of sovereign debt issues in Europe having “… a significant adverse impact on consumer confidence and demand, especially in southern European territories…” The result was delays in shipments, weak in-season repeat business, and soft trading conditions in their owned retail. CEO Inman noted that Billabong has historically been very strong in Southern Europe. Unless you live under a rock somewhere, you know that things are pretty bad there. The comment in the conference call  that about 25% of their accounts in Europe having closed was indicative of the situation. France, interestingly, is 83% of the European segment’s total revenue for the year ended June 30, 2012 which further illustrates how bad Southern Europe must be if it can have the impact.
 
Wholesale revenues were $1.07 billion. However, that includes sales to owned retail. If you eliminate sales to owned retail, you get down to wholesale revenue for the year of $831 million. Retail revenues were $719.6 million. Billabong had 634 company owned stores at year end. Same store sales grew 1.4% in the U.S., but fell 10.4% in Canada, 1.9% in Europe, and 3.7% in Australia.  
 
Let’s move on now and look at expenses.
 
The cost of goods sold amount includes $73.5 million of the “significant” items. This includes both a loss on inventory already sold as well as an allowance for writing down inventory that is “realizable below cost.” Total June 30 inventory was $293 million, so that’s a pretty big number. It also goes a long way towards explaining the decline in the gross margin.
 
There’s a pretty long list of “significant” items included in the general and administrative expenses. I thought the best thing to do was just pull the list from the financial report.
 
 
There was another $6.5 million as well, bringing the total to $117 million.
 
As noted above, SG&A totaled $645 million for the year including this $117 million. The $33 million doubtful account expense is a result of their decision to stop working with certain wholesale accounts. That decision, Billabong believes, means the receivables are less likely to be collected and so they’ve taken a provision for them.
 
Billabong closed 58 stores during the year ended June 30, and expects to close an additional 82 during this year. That explains the early termination expense of $58 million.
 
Just to remind everybody, most of these large expenses (and the inventory charges) ultimately free up working capital and reduces annual expenses. So while it hurts in the period you take these charges, it’s a continuing benefit in future periods.
 
Down in other expenses there’s a $343 million charge mostly for impairment of goodwill, brands and intangibles. This is a noncash charge, but it is a real indication of declining expected cash flow and value of the assets.   Along these, lines we see in other income a credit of $22 million for a reduction in already booked earn outs for acquisitions.
 
Equity on the balance sheet fell as a result of the loss from $1.196 billion to $1.027 billion in spite of the gain on the sale of Nixon and the equity raised. But total liabilities fell by 47% from $834 million to $441 million. The total liabilities to equity ratio stayed constant at 1.02 times.
 
Cash rose from $145 million to $317 million but the current ratio deteriorated, going from 2.34 times to 1.47 times. However, that’s mostly because current borrowings rose from $15 million to $229 million, while longer term borrowings fell from $597 million to $249 billion.
 
Receivables fell by 34.5% reflecting in part the elimination of Nixon receivables as well the write down of $33 million for doubtful accounts. Impaired receivables rose from $21 million to $52 million over the year. Just because it is classified as impaired doesn’t mean all or part of a receivable won’t be collected. Billabong increased the provision for its impaired receivables from $20 to $40 million.
 
I guess the way to look at the financials- and especially all the write downs and impairment charges- is to say that they represent an acknowledgement of some mistakes made and opportunities to do some things better.  The question then becomes if they have identified the mistakes and what are they going to do differently. That takes us to CEO Launa Inman’s strategic presentation.
 
What’s the Plan?
 
I thought the meat of the presentation started when she looked at Billabong’s challenges. Externally, these were the “unprecedented macroeconomic environment,” the impact on the Billabong brand of the shrinking account base, and the strength of the Australian dollar.
 
Internally, the challenges she focused on included the organization’s inability to keep pace with its global expansion, the poor performance of the Billabong brand, problems in implementing the retail strategy, and issues with the supply chain costs and responsiveness. That last one includes not just where you have stuff made, but how you move it and how you manage your inventory. It has a lot to do with information systems, or the lack of them. 
 
I want to make two points here. The first is that the internal challenges would have been, and were, challenges even if the external ones hadn’t been as severe. Cash flow and fast growth, I’ve said a time or two, covers up a lot of problems. When the good times ended, the problems became harder to ignore and got meaningful quickly.
 
Second, Billabong had tended (before West 49) to acquire strong brands with solid management and, I’m told, let them run pretty independently. I liked that approach, but you can see how it could create some inefficiencies a company can’t afford when times aren’t quite so good even if the management teams at each company ran their brands well. CEO Inman noted, “One of the things we as an organization have is great entrepreneurs who really understand the customer in many ways but yet at the same time we’ve never really analyzed the data to ensure that everything we do going forward has facts and is fact based so that we can make clear and concise decisions. “      
 
They started to address their challenges by collecting some information. They spent $20 million on consultants doing it. I like the sound of that.   They measured the size of their markets. They did extensive customer research in the U.S., Australia, and France. They did it for all their brands and for snow, skate, and surf. Who are our customers, how do they perceive us, and why do they buy from us Billabong wanted to know. CEO Inman noted, “This was in fact the first time that this research has ever been actually done.”
 
Part of their work with consultants was “… to have a real deep dive into the profitability of the brands, of the actual retail outlets, the supply chain and also even look at the opportunities of e-commerce.”
 
How you can run a business without that information (as best you can get it) is beyond me, and I think it’s great they started with this research even at a time when money was tight. You can’t fix it if you don’t know what’s broken, and an objective, outside, opinion not based on anecdotal evidence is a good place to start.
 
Billabong, as part of its research, benchmarked itself against leading brands (not just in action sports) to see where it stood. Among the things they found out was that “…We had the highest awareness within the board sport market but yet for all that we weren’t really differentiated.”
 
So what are they going to do? They’ve got short, medium and long term plans and you really ought to review the presentation yourself at the Billabong web site. This damned article is already 2,500 words and I’m not done yet. I hope somebody actually reads this far.
 

 

 

Billabong is going to measure, measure, measure. Launa Inman thinks if you don’t measure stuff, it doesn’t get done and that’s certainly my experience. I’m guessing this might be a new experience for some of the brand managers at the level I expect it to happen.
 
They are going to be consumer centric in everything they do. I hope that means they are going to work very hard to control the consumers’ experience at every point where Billabong touches them.  That’s just the environment we’re in. The consumer has perfect information and endless choices. They don’t need you- you need them. Consumers take for granted the product. What you have to give them is a good experience.
 
They are going to focus particular attention on RVCA, DaKine and Element. These are the three brands identified by their research as having the greatest growth opportunities. That doesn’t mean there aren’t opportunities in other brands, but you if you focus everywhere, you focus nowhere.
 
They also talked about simplification. Billabong has 25,239 unique styles, 500 suppliers, something like 13,000 wholesale customers, and 625 stores (we know this number is going down). Those stores are under 15 names and they have 35 web sites. Aside from the customer confusion, imagine the costs savings from rationalizing this a bit. 
 
Billabong has imagined. They found, during their research, that 34% of their styles give them 1% of their sales. They must have just fallen off their chairs when they saw that. I don’t think I would have believed it the first time I heard it. They are going to cut the number of styles by 15% this year. When they see how that works out, they’re going to look to cut it another 15% next year. It cuts costs, but it also “…enables us to concentrate on delivering the correct proposition to the consumer.”
 
Years and years ago, I commented on the snowboard industry’s tendency to increase the number of styles they offered as a response to what their competitors were doing, rather than focusing on what their customers wanted. I guess Billabong is figuring that out too.
 
Moving right along on simplification, they noted that that 85% of product purchases come from 19% (that’s 95 out of 500) of suppliers. What do you think is going to happen to their number of suppliers? I’d be really curious to know how many suppliers go away just from cutting the 34% of styles that give them 1% of sales.
 
Speaking of interesting statistics, Billabong found that 80% of their sales came from 11% of their customers. You can hardly go wrong by focusing on what that 11% want from you. I’d go so far as to say that will probably solidify brand positioning and perception by focusing there. Here are a couple of quotes from Launa Inman that are related to this.
 
“This is all about the experience. It’s all about making them [the customer] feel part of the tribe, and that what we need to work on.”
 
“When we analyzed the issues that have faced the retail, there were some stand-outs, and the most important one is the ability of the organization to integrate the brands as they bought them. The second thing is we were not consumer- and customer-centric enough, but that is changing. In our quest to try and increase profitability, we’ve started to push our own family brands and without understanding whether that was right for the customer, and those are the things that we are now going to be doing.”
 
One of the things that’s going to be required to do all this is better systems. “That means that we need to have organizational design and structure. We need to relook at our IT systems. No strategy can be carried out today unless it is underpinned by good IT.”
 
As I pass 3,000 words, I find myself desiring to figure out how to end this. I haven’t covered everything I’d like to cover, but let’s try and summarize and reach some conclusions.
 
Let’s start with something CFO Craig White said during the question and answer part of the conference call.
 
“Essentially, if you look at the next four years, what you should expect to see is reasonably modest revenue growth, but real margin expansion as we get leverage through improvements in the supply chain and so on…”
 
I think he’s saying, and I agree, that revenue growth isn’t going to be easy to come by as difficult economic conditions persist, but that there are a lot of opportunities to bring more dollars to the operating profit line by running the business better. In Billabong’s case, it may represent the best way to improve profitability in the next year or two.
 
As I’ve written, operating efficiently can no longer provide a strategic advantage. It’s a minimum bar that gives you the opportunity to compete. Companies like VF and Nike, and now Billabong, have figured this out. And as I said in the title, I wish they’d figured it out sooner.
 
But it isn’t just about operating efficiently. Operating well saves you a lot of money. Just as importantly, it gets the right product in front of the right potential customers with the right presentation in a coordinated way at the right time. You have to be consumer centric, and good operations are a critical part of that.
 
When brands started becoming retailers, and retailers brands, it seemed to be focused on generating a little more gross margin (less than most people think- running retail is expensive) and responding to your competitors. What really mattered, however, was that it allowed better control of distribution, and the ability to manage the points of contact with your consumer and the quality of the experience you offered them.
 
Billabong is saying they’ve figured that out and have a strategy to achieve it based on solid data they worked hard to get. It’s kind of conceptually simple, but not quite so easy to implement. As they acknowledge, it’s a multiyear process.
 
It’s also going to require an evolution of their culture. How do you balance entrepreneurial people with the intention to “…totally integrate, in time, our single brands as well as our pure play e-commerce, and also our bricks and mortar.” That may prove to be the most challenging part of the whole plan.

  

 

 

 

Speculation on Billabong

/10 Comments/in /by

Walking around a really good Agenda show last week, the question I kept getting asked was, “What’s going to happen to Billabong?”  As I told everyone who asked, I only had access to the same public information they had. Given that information, my best guess is that Billabong will be sold.  Here’s my reasoning. 

As you know, TPG offered, on July 23rd, to buy Billabong for AUD $1.45 a share subject to due diligence and other conditions. They already have an agreement from two Billabong shareholders who together control over 24% of the outstanding shares to sell if there is a deal. Billabong announced on July 27 that “TPG will be granted the opportunity to conduct non-exclusive due diligence in order to reduce the conditionality of its proposal and to improve its understanding and valuation of Billabong.”  
 
Notice it’s nonexclusive, so it’s not impossible for another buyer to pop up. But TPG has 24% of the shares already tied up with deals that give them some upside if higher price is negotiated. TPG also has agreed to allow “…Billabong’s founding shareholder, Gordon Merchant, and Collette Paull to roll over all or part of their respective shareholdings in the company into the TPG proposal.” There seems to be at this point a certain momentum, though a lot can happen between the start of due diligence and the closing of a deal; including an adjustment in the price.
 
The other reason I think a deal will happen is because of the process by which we got to where we are. Back on February 17th Billabong announced the deal to sell half of Nixon to TCP (not to be confused with TPG) for net proceeds of US $285 million. The deal closed on April 12th. That US $285 million, along with other action take to reduce expenses and close some retail stores, was supposed to address Billabong’s capital structure issues. That is, it strengthened their balance sheet.
 
 In the conference call at the time the Nixon transaction was announced, Silvia Spadea, a Merrill Lynch analyst, said, “I guess there’s no question that that will provide you with a short term reprieve with respect to your balance sheet issues. But, in my mind, it doesn’t really do much to address the fact that – you know to improve your current structural issues or stem the current deterioration in your earnings. I guess I’m just wondering how confident you are that the initiatives that you’ve outlined today are going to be enough to permanently fix that balance sheet issue, so that we don’t have this problem a year down the track.”
 
 An excellent question, I thought. In their answers, Billabong CEO Derek O’Neill and CFO Craig White never said anything like “You bet- problem solved,” and you actually wouldn’t expect them to be that definitive. But what they did do was indicate they had confidence in their projections. And my common sense told me that if they had even an inkling that the short term problem wasn’t  well and truly solved, they’d have taken more drastic steps and the Board of Directors would not been quite so cavalier about turning down an offer of AUD $3.30 a share for the company.
 
So imagine my surprise (Yours too, I expect) when Billabong management  announced on June 21st  (Former CEO Derek O’Neill departed the company on May 9th) that they were raising AUD $225 million at $1.02 a share, 44% below the previous closing price.
 
What the hell is going on in there? Had business conditions just fallen off a cliff and Billabong management hadn’t seen it coming?   Almost seems like it couldn’t happen that fast. Had they known it was worse, but had another solution in mind? In the U.S. such a failure to disclose would probably lead to shareholder lawsuits and a flogging from the Security and Exchange Commission. I don’t know what happens in Australia.
  
I suspect it’s not quite as black and white as either of those choices. In doing turnaround work, I’ve noticed a lot of denial and perseverance during periods of change even among highly competent managers/owners and I suspect there might have been some of that in this case.
 
When management has credibility issues, things appear to be going south much faster than anybody (including said management?) knew, and the shareholders take it on the chin and have a stock valued at AUD $1.39 a share they think they could have sold for AUS $3.30 just a couple of months ago, companies find themselves in play.
 
When will we know the outcome? Billabong is scheduled to report their full year earnings on August 27th. That is also the date new CEO Launa Inman is scheduled to present her plan to turn around the company. Due diligence takes some weeks typically, and I wouldn’t be surprised if an announcement coincided with the earnings report.   
 
I wonder what TPG would have found had they commenced due diligence under their previous offer of AUD $3.30? I think maybe there’s an untold story here. Anybody want to tell it to me? 

News From Billabong

/2 Comments/in /by

I just listened to a Billabong conference call where new CEO Launa Inman announced they were raising more capital, downgrading earnings expectations, and undertaking a top to bottom review of all Billabong operations with the goals of reducing expenses, identifying efficiencies and improving the competitive positioning of Billabong and its brands.

They want to raise 225 million Australian dollars (about $229 million U.S. dollars) by selling shares to existing shareholders at $1.02 for each new share, a 44% discount from the 1.83 Australian dollar share price before the trading halt. The offer is fully underwritten by Goldman Sachs and Deutsche Bank, which means that Billabong will get the money. 

Apparently, business conditions weakened significantly in May and into June. There was weaker in season business and some wholesale accounts delayed shipments. The European, Canadian and Australian markets have deteriorated. The U.S. has some signs of improvement, but it’s too soon to call it a recovery, they said.
 
You’ll remember that Billabong sold half of Nixon and turned down a AUD 3.00 per share for the company not very long ago, saying that it couldn’t justify raising equity at that price. Now, apparently it can and then some, which says something about how conditions have deteriorated. 
 
CEO Inman announced that they were starting a “deep dive” complete review of all Billabong operations, expenses, procedures, market positioning, supply chain, and pretty much anything else you can think of. Nothing is off limit. The goal is not just to cut expenses, but to rationalize systems and procedures. That will be completed and the actions announced August 24th when they present their full year results.
 
My sense from the comments is that there are some inefficiencies and system overlaps/incompatibilities left over from acquisitions that haven’t been fully addressed.
 
The company is already in the process of closing 140 stores and expects that to be completed by the end of fiscal 2013. They had previously announced AUD 30 million in expense cuts, and that is proceeding. I think they expect to find more as a result of the business review.
 
But it’s not just about reducing expenses. They want to improve the retail experience, do more with ecommerce (which is 4% of retail sales and growing), define the customer base, look at perceptions of the brands and positioning, and define their customer base. They seem particularly concerned with the Billabong brand which, they acknowledged, has weakened in recent years.
 
Right now, of course, that’s all just a statement of intentions and they are asking shareholders to pony up more money with no plan in place. I guess that’s an indication of how badly they needed the money. The most important thing, they noted, was “…to stabilize the balance sheet.”
 
They are also hiring a global retail manager. The new executive will be introduced next week.
 
I have no doubt that Billabong will be able to do some things better and make itself more competitive. And I’d note that it usually takes a new CEO with a fresh perspective and no hesitation about questioning everything to make that happen quickly. That was always my experience doing turnarounds. There’s a certain element of ruthlessness required.
 
But the real question, and not just for Billabong, continues to be what happens to the world economy? I think that’s the same point I made when I reviewed their half yearly results. CEO Inman was adamant that they were raising enough money, but then the proceeds from the sale of half of Nixon were supposed to solve the problem too. PacSun and Quiksilver have had a hard time implementing their restructurings and turnarounds swimming upstream against the economic current. Billabong won’t be different.         

 

 

The Management Changes at Billabong

/2 Comments/in /by

Let’s review what’s happened. Over a few years, Billabong transformed itself from a wholesaler with a group of strong brands with some retail to a 600 store retailer that owns brands. The retail growth, I’ve written, probably took place a little faster than they had planned, but if what you think is the right opportunity appears, sometimes you just have to take a leap.

For the brand and retail strategy to work together, they have to get as much of their owned brand product as possible into owned retailers. That maximizes the gross margin dollars they earn.

Accomplishing that is tricky. Here’s how I framed the issue.
 
“How much of your owned brands can you put in a retailer before it’s perceived as a Billabong store regardless of the name on the front? How do you handle the other brands those owned stores carry when you’re trying to make room for your own higher margins brands?   How do they feel, as one of those non-owned brands, about being in those stores and the way their brand may be merchandised? I am sure Billabong management spent, and is spending, time on those issues every day.”
 
How are they doing on this core issue? All we know are their overall financial results. It hasn’t been a good three years. Mostly recently, they raised capital by selling off half of Nixon and announced a program to close stores and cut expenses. I wrote about that in detail.
 
As you know, the plot thickened on May 9 when former Target Australia executive Launa Inman was appointed Managing Director and CEO of Billabong effective May 14. Former CEO Derek O’Neill left the company on the day of the announcement. North American head Paul Naude was promoted to President of the Americas.
 
The company held a conference call that day to discuss the transition, and I’ve read the transcript. Ms. Inman had been consulting with the board for two months, but had only been focusing on the Australian operations. Throughout the call, both she and Chairman Ted Kunkel declined to discuss her long term plans for Billabong, as she hadn’t had the time to do a complete review.
 
The conversation was framed around Ted Kunkel’s statement that “…we need new leadership and we need new skill sets.” Ms. Inman’s appointment is meant to give the company the retail experience it needs given how important retail has become to Billabong. Though Ms. Inman talked about her previous experience with brands, it sounds like Billabong will rely on Paul Naude for his knowledge of brands, branding and the surf industry. Ms. Inman says Paul is going to be working very closely with her. Makes sense.
 
Ms. Inman said, “My real priority is going to have to be focusing on the greater value that we need to extract from the retail network and the strengthening supply chain. “ That’s consistent with how I framed the issue (see the quote above) in my earlier article.
 
We also learned on the call that Derek O’Neill left the company without a consulting arrangement. One analyst noted his strong connections with suppliers, customers and athletes and asked if there were any risks for Billabong in that area. Part of Chairman Kunkel’s response was to say he was “…absolutely convinced that he [Derek O’Neill] will act appropriately.”
 
Another analyst asked, “Has the Board got the necessary leadership, talent and skills to execute this future successfully?” A third, referring to Ted Kunkel, said “…a lot of your very large shareholders are telling me that you’re the guy that should be held accountable and resign,…” Mr. Kunkel didn’t think so. There’s a shocker.
 
One thing that didn’t come up in the call was that Billabong has pinned a chunk of its problems on the poor economy worldwide, the recession in Australia and the strong Australian dollar. No matter how good Launa Inman is, I doubt she can do any more about those factors than Derek O’Neill could.
 
There’s a lot of uncertainty here, and it was reflected in the conference call. Ms. Inman hasn’t had enough time to really figure out what she really wants to do. But, as came up in the call, her choices may be limited as Chairman Kunkel makes it clear that the board believes in the integrated brand and retail strategy. And, he points out they’ve got 600 stores they can’t just ignore.
 
 The issue, I guess, goes back to the ability to maximize gross profit dollars by putting owned brands into owned retail. It will be interesting to watch and see how she approaches that and whether she can do it better. 

 

 

Update on Billabong: The TPG Offer

/13 Comments/in /by

This is kind of fun. As you’re aware, TPG Capital offered to buy all of Billabong for $3 a share before the Nixon deal and other steps were announced. Billabong said no because the deal was contingent on too many things and they needed an immediate, certain solution to their short term balance sheet issue. But now, even with the Nixon deal happening, TPG still wants to buy them for $3.00 a share. What can we learn from that?

First, I guess we can conclude that TPG approves of the actions Billabong management has taken. And apparently they agree with Billabong management that the earnings lost from the sale of half of Nixon will be made up for by store closings and expense reductions being undertaken.

Or maybe the $3.00 a share was a lowball offer made on the assumption that Billabong needed to make a deal (which they did).
 
In what I published about Billabong yesterday, I said okay, great, they’ve solved their short term balance sheet problem, but we are left knowing almost nothing about how Billabong management views the prospects for their longer term vertical retail strategy. I guess we’re about to find something out.
 
If Billabong’s board of directors were to conclude that it’s in the shareholders’ best interest to sell the company for $3 a share (Or $4?) we’d have to conclude they aren’t all that confident in the strategy and their ability to implement it either because of anticipated economic conditions or because their balance sheet, even with the fix of a few days ago, won’t be strong enough.
 
Then there’s the issue of the whole competitive environment in the surf/action sports/youth culture market. I’m actually working on a longer think piece on this. My basic question (perhaps a bit exaggerated for impact) is with everybody trying to respond to weak consumer demand by selling everything they can everywhere (perhaps the wrong approach?) is there enough brand distinctiveness left to make a plaid shirt from a cool brand worth $20 more than the same plaid shirt bought at Target?
 
I remember when the skate hard goods industry was somehow caught by surprise as more and more skaters decided that a $30 deck was just as good as a $55 deck as they were essentially identical in construction and were going to wear out anyway.
 
Just because there’s an offer from TPG doesn’t mean there will be a deal. It is a very preliminary offer with a lot of work to be done. One thing that might be a stopper is the condition that the tax liability associated with the Nixon transaction not be higher than $10 million. Billabong has estimated that, at worst, it might be $45 million. I doubt they’d be willing to guarantee the $10 million number.
 
Somebody (thanks Somebody) sent me this article which discusses the deal in some detail. It’s worth a read. I’ll be watching with you to see how this all plays out.
 

 

 

Billabong’s Announcement: Short Term Solution, Longer Term Question.

/2 Comments/in /by

With last Thursday’s announcement, Billabong has moved to address its balance sheet issues. But, to paraphrase one of the analysts in the conference call, "This is all well and good, but how do we know we won’t be discussing the same issue a year from now?"

Let’s look at the steps Billabong took and its half yearly numbers. Then we’ll talk about Billabong’s longer term strategy and see if there’s an answer to the analyst’s concern in there somewhere..
How Did We Get Here?
Billabong is suffering from a strong Australian dollar, a weak world economy that hasn’t recovered as quickly as they expected, an aggressive, opportunistic retail strategy, and having paid what looks in the ever perfect hindsight to be a bit much for some of their acquisitions. Of course, if the economy wasn’t so weak and the Australian dollar so strong, the last two might not be such an issue. But we are where we are.
Billabong announced back on December 11 that its “…sales growth trend has deteriorated significantly…” in November and the first part of December. They indicated they were concerned about their level of debt and violating their loan covenants. I wrote about that in some detail here. Last Thursday, before their announcement, I described briefly what I thought their choices were.
What Have They Done?
First, they sold 48.5% of Nixon to Trilantic Capital Partners (TCP).   They are keeping 48.5% themselves. Nixon management will own the other 3%. They expect to raise US$285 million, all of which will be used to pay down debt. That solves the immediate balance sheet issue, reducing net debt at December 31 from $527 million Australian dollars to $259 million Australian dollars on a proforma basis.
Because Billabong now owns less than half of Nixon, Nixon will no longer be consolidated on Billabong’s financial statements. That is, its assets, liabilities, revenues and expenses will no longer flow through them and Billabong won’t be responsible. I think what will happen (at least it’s what would happen here) is that Billabong’s share of Nixon’s income will be included on Billabong’s income statement under “Other Income.”  
Nixon product will continue to be sold in Billabong owned retail. Billabong has signed a long term supply agreement with Nixon (no details available) to insure that. The TCP group may be really nice people, but I’m guessing they’d like Nixon to make as much money as possible. So I assume that the prices at which they sell Nixon product to Billabong will be consistent with prices to other retailers. Billabong, under those circumstances, will just get a normal retail margin on their sale of Nixon product.
Most intriguing to me is what TCP’s plans for Nixon might be. There were some comments in the public material and the conference call about Nixon already being distributed outside of Billabong’s traditional channels. The release says, “Nixon will be a stand-alone business focused on continued growth into areas such as Billabong’s core action sports channels, as well as high-end department stores, quality electronics stores and other channels.”
Hmmm. Does that sound to anybody besides me a bit like the Skullcandy strategy? Nixon is doing headphones already. It occurs to me that Billabong might not have been able to finance Nixon’s growth opportunities. Untying Nixon from Billabong may benefit it.
Billabong bought Nixon for $55 million in 2006 plus a deferred payment of US$76 million. The transaction values Nixon at around US$464 million so Billabong will report a one-time gain on the transaction (size unknown) at the end of their fiscal year.
Second, they are going to close between 100 and 150 of the 677 company owned stores by June 30, 3013. They think that once this process is complete, they will have reduced rent expense by $20 to $30 million Australian dollars and will increase EBITDA by $5 to $10 million Australian dollars in the year ending June 30, 2013. They noted that they had closed 30 stores in the last six months.
Third, they’ve got a program to reduce annual costs by $30 million Australian dollars. These cuts will be across the board. There will be about 400 full time jobs lost including 80 in Australia. I’d be interested to know how many of the 400 will be the result of closing stores.
Finally, Billabong is going to reduce its dividend payments.
The net of all this, according to Billabong management, is that the loss of Nixon’s earnings “…will be more than offset…” by Billabong’s share of profits from the Nixon joint venture along with the other expense reductions.
The Six Months Results
Here are the income statement numbers in Australian dollars for the six months ended December 31, 2011.
Sales rose 1.5% to $850 million dollars compared to the prior calendar period. Constant currency revenues were up 6.3%, but down 2% excluding the impact of acquisitions. Over two years, Billabong has seen the translated value of its profits from Europe decline by 40% because of the decline in the value of the Euro against the Australian dollar.
The cost of goods sold stayed almost constant at $455 million, but the gross profit margin fell from 54.4% to 53.4%. Selling, general and administrative expenses were up 10.4% to $316 million. Other expenses and finance costs were more or less the same. There was a $15 million impairment charge for Billabong’s South African operations.
Profit for the six months fell to $16 million from $57 million in the same six months the previous year.
What happened? CEO Derek O’Neill, in his presentation, sites four challenges. First, sales were lower than expected in November and early December in Europe and Australia. Second, they couldn’t recover all their higher product costs in a “…highly price sensitive retail environment.”
Third, there was a lot of discounting going on at both wholesale and retail in Australia and Europe. It wasn’t as bad in the U.S., but it was still there. Fourth, add on to that aggressive clearance of inventory, which obviously kills your margins, and you can see why it wasn’t a great six months.
You can see in their balance sheet some of the issues I’ve discussed above. Inventories have risen $56 million from a year ago even though sales aren’t up significantly and accounts for the whole rise in current assets. Trade and other payables have risen $40 million over a year ago and accounts for the whole rise in current liabilities. Long term borrowings rose from $570 million to $701 million, reflecting a decline in deferred payments (partly for acquisitions) from $188 million to $86 million. The interest coverage ratio has fallen from 8.8 to 4.2 times.
Tactics and Strategy
We’ve reviewed Billabong’s half year results, seen how they got themselves in a bit of a hole, and outlined the tactics they’ve used to resolve their immediate balance sheet issues. Given their circumstances and the choices they had, what they are doing seems appropriate to me.
But it doesn’t address that inconvenient analyst question: “How do we know we won’t be here a year from now discussing the same thing?”
Billabong’s strategy, we all know, has been to expand their owned retail to increase penetration of their brand portfolio and benefit from the vertical margin.  Pretty simple to state. I thought it was a good strategy when they started it though, as I wrote at the time, I was unsure about the West 49 deal. But the devil’s in the details. Let me quote what I wrote last Thursday.
“How much of your owned brands can you put in a retailer before it’s perceived as a Billabong store regardless of the name on the front? How do you handle the other brands those owned stores carry when you’re trying to make room for your own higher margins brands?   How do they feel, as one of those non-owned brands, about being in those stores and the way their brand may be merchandised? I am sure Billabong management spent, and is spending, time on those issues every day.”
That, to me, is the heart of the strategic issue and we came away from the public documents and conference call with basically no insight into how the implementation of this central, long term strategy is going. That analyst’s question kind of implied it, but the answer wasn’t very helpful. To be fair, I can’t really expect Billabong management to just drop their drawers for their competitors in an open forum, but it is still the central issue given that direct to consumer now accounts for 49% of Billabong’s revenues.
One paragraph of one slide from CEO O’Neill’s presentation gave us a bit of information. We learned that Billabong family brand share is now about 37% in West 49 stores compared to 15% at the time of acquisition. It was 32% at June 30, 2011.
The owned brand share is 38% in the acquired SDS banner, and close to 50% in the acquired Rush store. We don’t have any information as to what it was when the deals closed.
That’s it. That’s all I know for sure about the major strategic bet that Billabong has placed. How far can we expect those percentages to rise? Any perceived blowback from consumers yet? How have other brands reacted? Did Billabong just get ahead of itself in an economic environment it misjudged and commit a one-time balance sheet faux pas? Or is the strategy dependent on improved economic growth? If so, and we don’t get that growth, what happens?
I don’t expect to ever get quality answers to those questions unless I fly to Australia and drag those guys into a bar. In the meantime, I invite you all to review at Billabong’s investor site the documents I’ve referred to in this article, and see if you can figure the answers out. 

 

 

Billabong’s Upcoming Half Year Report and Their Choices

/4 Comments/in /by

Sometime late afternoon West Coast time, Billabong is going to release their half yearly numbers and have a conference call on those results. In the meantime, as most of you may know, trading on their stock has been suspended pending an announcement. That announcement may have something to do with this article stating that Billabong has received a US $820 million takeover offer from TPG Capital.

All I know is what’s in the article. But I thought in light of the pending news and possible acquisition of Billabong, it might be useful to review their choices before the announcement.

Back in December, when Billabong announced that they had some issues and were pursuing a review of their options, I did a pretty detailed analysis about what was going on. You can read that here. We haven’t seen a complete balance sheet, so we don’t know the extent of the problem. But when you’re dealing with issues of capital adequacy, there are only so many things you can do. In no particular order, here they are.
 
You can raise some expensive money along the lines of what Quiksilver did with Rhone.
 
You can sell the company as the article referenced above suggests might happen.
 
The trouble with both these choices, of course, is you don’t get a very good price. But then you may not have a choice.
 
You can cut expenses across the board to improve cash flow. What we don’t know, since we don’t know the exact size of the problem, is whether this could have enough impact quickly enough. My guess is no. And of course, this has an adverse effect on the company’s ability to pursue its strategy.
 
You could sell a brand. But Billabong’s whole strategy is focused on putting those brands into their growing retail channels. So every brand less it has makes that strategy a bit less valid.
 
Maybe it could take one of those strong brands it owns public to raise capital. That way they wouldn’t lose control of the brand. But as I am sure you all know it’s a tough time to take a company public. Somebody suggested that alternative to me. Wish I’d thought of it myself.
 
In a few hours, we’ll be able to put some numbers on the problem size, and maybe the solutions will have been announced. But let’s review quickly, in the interest of making the article I’ll write when the report and conference call happen shorter than a novel, how they got here.
 
First of all, the Australian dollar got strong, and the worldwide economy weakened, with the Australian economy being the last to follow others into recession. You can’t blame Billabong for that, but they have to manage the consequences.
 
Second, they chose to purchase West 49 because, well, it was available and consistent with their strategy. Had it not appeared on their radar screen, I don’t think they would have been pursuing an acquisition of that size with its issues. And, as I’ve written, I think those issues turned out to be worse that Billabong management expected.
 
Third (and this is true for most of us) there was an expectation of more of a global recovery than happened.  One consequence is that the acquisitions they have made start to look expensive in light of our current economic reality. That is, the prices are harder to justify because the future cash flows don’t look as strong. This impacts the company’s value as Billabong looks for solutions to its debt/cash flow problem.
 
And finally there’s the issue of whether or not the strategy of putting owned brands into an expanded, owned, retail base made sense.  I thought it did (though I wasn’t particularly happy about the implied impact on specialty retailers).
 
But, as I discussed a long time ago, the devil of that strategy’s implementation was in the details. How much of your owned brands can you put in a retailer before it’s perceived as a Billabong store regardless of the name on the front? How do you handle the other brands those owned stores carry when you’re trying to make room for your own higher margins brands?   How do they feel, as one of those non-owned brands, about being in those stores and the way your brand may be merchandised? I am sure Billabong management spent, and is spending, time on those issues every day.
 
If the economy hadn’t gone quite so far south or had recovered a bit quicker and the Australian dollar wasn’t through the moon would things be okay? That would depend on facts I don’t have. When we get Billabong’s numbers, we aren’t going to be able to conclude that the strategy was “good” or “bad.” All we’ll know and I guess we know it right now, is that they ran out of time to pursue it as their balance sheet weakened.
 
I’ll be all over Billabong’s report the minute it comes out, but I do like to read stuff slowly and take some time to think about it, so be patient with me.

 

 

Billabong Reports Deteriorating Sales Growth Trend; The Strategy or the Economy?

/0 Comments/in /by

Billabong’s announcement about sales trends since the end of October and the actions it’s taking may portend issues for other companies as well as for Billabong. Let’s take a look at what they announced, what actions they are taking, how they found themselves in this position, and how it relates to the global economic environment.

Here’s what they said (you can go here to read the announcement and the transcript of the conference call):

“Following receipt and finalization of management accounts reflecting actual trading results for the month of November and receipt of preliminary retail sales data for company owned stores for the period ended 11 December, the sales growth trend has deteriorated significantly in this critical retail period.”
 
They report that constant currency sales revenue growth for the three months ended September 30 was 24.7%. For the four months through October 31 it was 17.2% and for the five months ended November 30, 11.7%. If you exclude acquisitions, the numbers were 6.2%, 2.8% and 0.4%. Remember these are constant currency numbers. I don’t know what the “as reported” numbers will look like.
 
For a single month, and then two months, to pull the numbers down this hard means that things went south pretty quickly, and apparently so far they aren’t looking good in December. Remember that a lot of business is done during the holiday season, so these percentage declines translate into a whole lot more dollars than they would at other times of the year.
 
“Based on preliminary sales data to 11 December and assuming a continuation of current trends, it is now anticipated that sales revenue for the six months to 31 December will be approximately 5% higher than the pcp [prior calendar period] in constant currency terms (down approximately 3% adjusting for the impact of acquisitions).”
 
 They say this “…reflects the European sovereign debt issues and the ensuing fears of global recession which are impacting consumer confidence and spending patterns significantly.” You can read their description of conditions in each region in the announcement. Weather has made a difference in both Europe and Australia. Billabong reports seeing “very low” sell through at retail, and poor reorders. CEO Derek O’Neill notes that reorders “…must be at reduced prices due to large amounts of unsold inventory washing through the marketplace therefore impacting gross margins.”
 
Basically, Europe is the toughest market followed by Australia and then the U.S. But whatever strength there was in the U.S. apparently dissipated in the first two weeks of December “…on growing global concerns about Europe. Challenging trading conditions remain in Canada, in both wholesale and retail.” 
 
In discussing the U.S., CEO O’Neill refers to some weakness from PacSun orders related to their accelerated store closing. He estimated Billabong had lost a “couple of million’ in business over the last four weeks as a result. I had highlighted this issue when I reviewed PacSun’s results.  I’m sure other brands will experience similar impacts consistent with their exposure to PacSun.
 
The good news is that Asia continues to perform well and Japan has rebounded. They also note that they have a “low double digit forward order book for late Spring and Summer in the USA in the wholesale business.” They had noted, however, that some orders (not just in the U.S.) had slipped from first half to the second half, and I wonder how that might impact those comparisons.
 
The result of all this is that Billabong expects their EBITDA for the six months ending December 31 to be between $70 and $75 million Australian dollars compared to $94.6 million in the same period the prior year.
 
Remember, so far the other public companies have reported just their end of quarter results- typically for October 31. None have felt an obligation to stand up and announce that conditions have gotten tough since then. But they report earnings every quarter where Billabong reports only every six months. I suppose these conditions could be unique to Billabong, but that seems improbable. It’s my belief that the on again, off again meetings about European sovereign debt and the growing realization that nothing has actually been done to solve the issue is creating a global caution among consumers.
 
What’s Billabong Doing?
 
I have the sense from the conference call that Billabong was a bit caught by surprise by the extent of the decline, but they seem to be acting decisively. The first thing they are doing is working to move inventory. This is in contrast to the position they took when the financial crisis hit in 2008. At that time, they indicated they were more concerned with holding margins and brand position than with losing some sales. They choose to be less promotional than others as a matter of brand positioning. Not so much this time I guess.
 
They are also undertaking a complete operational review to see where they can take costs out of the company. I expect that will reverberate through all their brands and locations.
 
Next, and most intriguing, a “strategic capital structure review” is under way with Goldman Sachs, the company’s advisor. What they indicated was that nothing was off the table, but raising more equity was pretty much the last choice. That makes sense when you note that their stock closed today (Tuesday) at AUD $1.77.
 
So that means that besides reducing expenses there’s at least the possibility of selling a brand, accelerating the closing of underperforming stores, maybe raising some kind of convertible debt, or, I guess, even selling the company.
 
They are doing this because their balance sheet position may require it, especially if business conditions deteriorate further. They noted that they were not in violation of any of their banking covenants as of December 19, but would not speculate on where their debt coverage ratio would be at the end of December. CEO O’Neill said the poor business conditions were “…expected to result in a deteriorating leverage position [at December 31].” Here’s how CFO Craig White puts it:
 
“The fact is that we’ve gone from a position where I could say that we were comfortably within covenants to a position that’s less comfortable, but I’m not going to speculate on where we’ll end up at the end of December. There’s a lot of things that can move around in that time.” 
 
It’s reasonable of them to say that they don’t know yet where they will be at the end of December. December, as they point out, is a big month. But they are concerned enough that they’ve got Goldman Sachs looking at their choices. How did they get to this position?
 
Good Strategy, Bad Timing?
 
During the conference call, CEO O’Neill continued to support the company’s overall strategy of retail growth. He discussed the systems they have in place to manage it, and the progress they are making of getting better product to market faster in a more coordinated, efficient way.  The more or less unspoken question during the call was “Hey, if this strategy is so hot, how come you got Goldman Sachs helping you figure out how to strengthen your balance sheet?!”
 
It’s not a bad question. As you recall, the West 49 acquisition was a big one. And it came along not necessarily at the time Billabong wanted it to. But there it was looking too good to pass up and fitting the company’s strategic criteria. You may remember they borrowed a bunch of money to pay for it, and I noted at the time it was a good thing they’d raised some capital earlier when they could even though they didn’t need it or the deal probably couldn’t have happened.
 
The other thing I emphasized was that buying a turnaround, which West 49 clearly was, was a whole different story from buying a solid brand or retail chain with a history of profitable growth and strong management in place. If they’d asked me at the time (they didn’t) I would have told them that whenever I’ve walked into a turnaround, it’s always been worse than I expected before I got there.
 
In a stronger economy, that might be an inconvenience. In a lousy one, it’s a problem. I’m not suggesting that the West 49 deal is the basis of all Billabong’s issues. The economy would still suck even without it. But if they didn’t have the debt they used to pay for the company, and hadn’t had to invest management time and some money into integrating and cleaning it up and stocking it with more of their owned brands, maybe they wouldn’t need Goldman Sachs to help them work through their potential balance sheet issues.
 
This is a tough situation that’s come on Billabong pretty suddenly. There were some concerns over the inventory and balance sheet at the last review but clearly they’ve accelerated due to deteriorating business conditions. There appears to be a not trivial chance that Billabong will violate some of its bank covenants at the end of the year.
 
The thing is, if it’s a small violation and you can see how it’s going to work its way out over a quarter or two, you don’t necessarily need Goldman Sachs to help fix the problem. What I might do (what I have done) is go to the bank and have a conversation about a soft quarter, and cash flow, and how it’s just a temporary thing, and about how I’m going to fix it, and couldn’t they see their way clear to waive the covenant for may six months, and yes, of course I’d be thrilled to pay them a fee to do that. Grovel, grovel, grovel.
 
Banks are a little more gun shy than they use to be (10 years too late may I point out), so maybe it’s not that simple. I still think the Billabong strategy makes sense as long as they exercise some caution as to how much of their owned brands end up in their owned stores. I also continue to think that tough times create opportunities, but only for those with strong balance sheets. Billabong apparently needs to shore their balance sheet up. We’ll find out in February if not before by how much and what they do.