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Paul Naude Offers AUD 1.10, Billabong Reduces Full Year Forecast

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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 Subsequently, Bain and TPG withdraw offers of $1.45 after some due diligence (The TPG offer was made on July 24 and withdrawn on October 12.).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. 

Paul Naude Explores Billabong Leveraged Buyout

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I suppose you have all heard that Billabong Director and President of the Americas Paul Naude has stepped aside from his duties for six weeks to try and pull together a leveraged buyout of Billabong. You can see the Billabong announcement and the conditions under which he is working here at Billabong’s investor web site. It’s the first link under Recent News called Company Update. 

To be clear, I have no information that’s not public. However, I thought it might be useful to review just what a leveraged buyout is and how it works. And, I’ve got a couple of questions.
 
In a leveraged buyout, the buyer (or buyers) purchases the target company by using some of their own money (the equity portion) and borrowing the rest. The loan amount is secured by the assets of the target company.
 
You might reasonably ask, “How much of the purchase price is equity and how much is debt?” It used to be that you could borrow most of the purchase price, but that was back in the good old days. I’m not close to the leveraged buyout market, but I’m guessing you have to put up more equity now. That’s both because lenders are a bit more cautious then they use to be and because it’s harder in this economy (in general- I can’t speak to the specifics of Billabong) to put together a plausible business model that shows fast revenue growth to be used in paying off the debt.
 
On the other hand, interest rates have come down to historically low levels even, or maybe I should say especially, for lower rated debt. People seem to be forgetting again that there is an inevitable relationship between risk and return. You may recall that’s what got us into our current economic/financial mess in the first place.
 
Anyway, the point is that lower interest rates make it easier to make a deal pencil out. Once a leveraged buyout is complete, the new owners have to pay down the debt. They typically try to do that by some combination of asset sales, expense reductions, improved efficiencies and revenue growth.
 
You remember that Billabong had to sell half of Nixon and then a few months later raise additional equity to address concerns about their balance sheet. By definition, in a leveraged buyout, their balance sheet would deteriorate again as they added the debt used to purchase the company to it. The former owners and banks won’t care, because they will get their cash and be gone. The new owners will understand that they are taking higher risk but hey, that’s the business they are in and their plan will have convinced them that the risk is justified by the potential return.
 
We also remember, of course, that a couple of potential buyers evaluated Billabong to see if they might be interested in buying it and choose not to. Why? Well, we don’t know specifically but I think it’s fair to say that they didn’t see the risk as justifying the potential return.
 
Below is a chart of Billabong’s stock price from an article in The Australian that will remind you of the series of events.
 

       
 
One would assume that Paul Naude knows why Bain and TPG pulled out, but on the other hand maybe they had no obligation to explain it to the Billabong Board of Directors.
 
That doesn’t really matter anyway. When I evaluate a company, as you know, I do my own analysis and don’t pay attention to anybody else’s conclusions. Perhaps after I did that with Billabong I’d:
 
–          See the risks and returns a bit differently than Bain and TPG.
–          Think I could get it for a lower price because of the performance of the stock since the October 12th withdrawal of TPG.
–          Believe that the transformational strategy had the potential to drop a lot of Australian dollars to the bottom line pretty quickly.
–          Be prepared to be more aggressive in selling assets to pay down debt.
–          Think that the Australian dollar was going to depreciate a bunch over the next year.
 
Paul didn’t take this step without thinking it through. His experience with the company, reputation in the industry and, I assume, willingness to be CEO and put up some of his own money, is at least going to get him listened to. His agreement with Billabong keeps him from disclosing any confidential information, so I wonder if he won’t go back to TPG and/or Bain and show them a different vision of reality. They’ve already got the confidential information.