Insights on the Sale of Billabong to Boardriders

On February 14^th, Billabong released a 194 page document explaining the deal under which Boardriders (formerly Quiksilver and owned by Oaktree) will buy it for $1.00 a share (all number in Australian dollars unless otherwise noted).  You can go to this page and click on “Court Orders Convening of Scheme Meeting” to download the document as a PDF.  It includes the independent expert’s report prepared by Grant Samuel & Associates Pty Ltd (“Samuel”) explaining and justifying the purchase price.

Perhaps the best way to start is to review a little industry history.  I posted a link to “Subcultural enterprises, brand value, and limits to financialized growth: The rise and fall of corporate surfing brands” last year.  Here’s the link again.  Those of you who didn’t read this study ought to take the time.

We learn that the deal is expected to close on April 24^th.  In a strategic sense, despite the length of the document we don’t learn much that’s new.  Some of the comments on possible synergies from the combination are interesting and there are some new facts/opinions we’ll get to.  Let’s get started.

The report values Billabong between a range of $190 and $239 million, or $0.96 to $1.20 a share.  The Samuel report says, “The valuation assumes Billabong has the funding in place to continue to execute its turnaround strategy.” Prior to the proposal, “…Billabong had a market capitalization of approximately $133 million.”

As part of the deal, Boardriders has a commitment for a US$450 million term loan facility.  Of that amount, the most that can be needed to fund the purchase would be $159,973,809.  That’s about US$126.4 million right now.  The rest will be used, “(ii) to refinance certain existing debt of the Billabong Group and Boardriders Group; (iii) to pay the fees, premiums, expenses and other transaction costs incurred in connection with the Scheme; and (iv) for working capital and general corporate purposes.”

We already knew that cash was getting tight at Billabong and that the term debt to Centerbridge and Oaktree (maturing September 2019) will not be repayable from cash flow, so a deal had to happen.  Focus on what Samuel is saying; the valuation is only $190 to $239 million if that term loan is in place.  If it’s not in place, it’s lower.  How much?

If this deal didn’t happen, what else could Billabong do?  It could sell more equity.  Let’s say the term loan amount of US$450 million represents the amount Billabong needs to put its house in order.  Billabong shares were trading around $0.75 before the announcement of the deal.  The current exchange rate is $0.79 Australian dollars to each U.S. dollar.  To raise US$450 million (equivalent to $570 million Australian dollars), Billabong would have to sell, at $0.75 a share, around 760 million new shares.   But who’s going to want to buy those shares and why would they pay $0.75 a share?  Samuel puts it a little more delicately than I do, but we agree that the answer is nobody, and certainly not at a price close to $1.00.

Billabong’s next choice is to sell one or more of their brands.  Here’s what Billabong management says about that option.

“A sale of one of Billabong’s major brands would not necessarily repay in full the outstanding Centerbridge/Oaktree Senior Secured Term Loan. Such a sale would also require consent of the enders under the Centerbridge/Oaktree Senior Secured Term Loan.”

“• The sale of one of the Company’s three major brands would also mean that the scale of the remaining business would not be viable to allow the Company to fulfil its strategy of building global brands on global platforms.”

The senior secured term loan is for $221 million- US$172 million.  It’s interesting to note that Billabong isn’t sure that even the Billabong brand is worth that much.  We should recognize, however, that they would be selling it under conditions when they had to have a deal.  That’s never when you get the best price.

Anyway, I agree with Billabong and Samuel that selling a brand doesn’t solve the problem.  I might go further and suggest that the sale of one brand implies the eventual sale of the others.

I suppose you can also ask the question, “Isn’t there another buyer out there who will pay more?”  The discussion above is enough to convince me that there probably isn’t.  Samuel seems to feel the same way.

“While the synergy benefits (net of costs) may be significant, they are to a degree unique to Boardriders. There are only two businesses that compete (globally at similar scale) directly with Billabong in terms of product lines, Quiksilver and Rip Curl and Rip Curl is understood to not be in a position to acquire Billabong. Normal valuation practice is only to include synergies common to several acquirers in fair value. Synergies unique to one party are excluded.”

Something had to happen.  Selling equity wasn’t going to work.  Selling a brand wouldn’t solve the problem.  There was no other buyer at a price that would make sense if only because they couldn’t benefit from the synergies Boardriders can (hopefully) benefit from.

Like Monty Hall used to say, “Oaktree, come on down!”

As I’ve been writing for a couple of years now, Billabong CEO Neil Fiske has pursued a strategy I largely agreed with. Some benefits have been recognized, but more slowly and at a higher cost than anticipated.  A difficult market which, at best isn’t improving, hasn’t helped.  This paragraph in the document from Billabong’s board of directors to shareholders in a section called, “KEY CONSIDERATIONS RELEVANT TO YOUR VOTE” lays out just how big and long term the challenge is.

“The prerequisites to Billabong’s EBITDA margin improvement ambitions include revenue growth, gross margin improvement and improved efficiency in cost of doing business, to be achieved by transforming the Billabong Group from a predominately standalone regional model to an integrated global business. While Billabong has generally described these improvements as long-term goals, they would need to be achieved on a sustainable basis across all brands, in all markets, and at the same time in the inherently risky fashion sector. Having regard to expected market conditions and other risk factors… the achievement of the Company’s long-term goal of double digit EBITDA margins is inherently uncertain and highly unlikely to occur in the foreseeable future.”

So a lot has to go right in a coordinated way in a risky market (anybody ever been in a  business where things worked out that well?) and it’s going to take an indefinite, but not short, amount of time. Samuel confirms this and adds some details.

They tell us that Billabong, RVCA and Element together are “just under” 80% of Billabong’s revenues.  “Billabong’s other owned brands account for approximately 7% of total sales revenue and third-party brands represent the remaining 13% of total sales revenue.”  I imagine we’ll see those other owned brands sold.  RVCA is about 13% of sales revenue and Element 14%.  Samuel expects RVCA and Element to have “limited impact on overall results.”  The report characterizes Billabong’s other brands as “…extremely small but add complexity to management of the business.”

“The three key brands, Billabong, Element and RVCA have leading or very strong market positions in their key markets in each region. RVCA and, to a lesser extent, Element, are regarded as having significant growth potential. On the other hand, the Billabong brand, which represents more than 50% of Billabong’s total sales revenue, [ about 52%] is a mature surf brand where growth is more difficult and expensive to achieve.”  (Italics added).

“The turnaround strategy is midway through implementation. While there is upside potential from further cost efficiencies and ongoing benefits from roll out of the global platforms (including the omni-channel platform), [ I agree] progress has been slower than expected and there is no certainty that all elements of the turnaround will be implemented successfully. In any event, it must be recognised that these new global platforms, even if successful:

– are likely to result in incremental rather than dramatic enhancements to sales and margins; and

– will require continued investment in the platforms to maintain their effectiveness”

Boardriders has not provided Samuel with any estimate of synergies.  Let’s remember why we’re interested in synergies- it’s not just about the money that can be saved, but about who has, or does not have, a job, what they are doing and where.

Samuel estimates that Billabong’s expenses from being a public company would decline by $1.7 million in FY17 and by $2.2 million in FY18.  These reductions are included in their valuation.  They make the following additional comments:

“Global Operations and Corporate and Head Office Costs Billabong incurs costs related to running Billabong’s global operations as well as corporate and head office costs, which include the costs of:

 international advertising and promotion costs;

 central sourcing costs;

 certain group shared services (such as human resources, IT etc);

 the Billabong executive office (such as costs associated with the offices of the Chief Executive Officer and the Chief Financial Officer, company secretarial and legal, corporate affairs, treasury, tax etc); and

 being a listed company (such as directors’ fees and insurance, annual reports and shareholder communications and share registry and listing fees).

Any acquirer of 100% of Billabong would be able to save the costs associated with being a publicly listed company. The ability to save other costs is less clear.”

“Boardriders, as owner of the Quiksilver brand (one of the two major competitors to Billabong), has the potential to extract substantial synergies from merging the two businesses. Boardriders has not made any public statements as to its expectations of synergy benefits… nor have these been conveyed to Billabong, so it is not possible to reliably estimate them. However, at the very least, they are likely to include:

 elimination of head office functions and duplicated shared services;

 merging of operations such as sourcing and logistics;

 purchasing power benefits;

 e-commerce fulfillment rationalization; and

 inventory realignment in multi-brand stores.

On the other hand, it would be reasonable to assume each brand would need to maintain its distinctiveness and character so there would be limited savings in marketing, design or retail operations. At the same time, the costs to achieve many of these synergy benefits would be significant (requiring a comprehensive restructure of Billabong’s operations) and would only be able to be achieved over a relatively long-time frame.”

We can’t be specific about the changes and the expense reductions involved but we can, I think, expect them to be extensive.  In a continually difficult market where growth is hard to achieve (as the Samuel report emphasizes) synergies, whatever and wherever they are will be critical to the improving bottom line.

Billabong needs to be private and to get out from under its paralyzing capital structure.  This deal achieves that.  Certainly the synergies matter and there will be some.  The question is whether the opportunities of two companies in the same tough market improve just because you put them together.