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Mike Arnold, Indievestments (270 clicks)
CFA, value, growth at reasonable price, event-driven
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I first profiled Billabong (OTCPK:BLLAY) in the summer of 2012, arguing that the business had strong brands, but was undergoing considerable transformation. Fortunately, at the time, I passed on investing as I found better opportunities elsewhere in the market.

Almost a year later, the market capitalization of Billabong's equity has dropped from around $450 million AUD ($417 million U.S.) to around $85 million AUD ($78/09 million U.S.), a price decline of over 80%. Therefore, a review of the events in the last year is warranted to see if this cigar butt has upside.

Since the article, a number of key developments have occurred, including:

  1. TPG Capital made a $1.45 AUD ($1.35 U.S.) bid for Billabong's equity in July 2012, only to withdraw from the bidding process in October 2012.
  2. Renewed interest from private equity ("PE") buyers in November 2012, resulting in two potential, but now failed, LBO deals, including one led by Paul Naude. Mr. Naude was a director of Billabong, and suspended his appointment to lead a consortium of buyers (Sycamore Partners, the "cornerstone equity investor" and Bank of America Merrill Lynch as the "lead financier"), offering $1.10 AUD in December 2012.
  3. On January 14, 2013, Billabong received an alternate proposal for $1.10 AUD per share led by former Nike executives at Altamont Partners and VF Corp (VCF), owner of numerous apparel brands, including The North Face, Nautica and Timberland.
  4. In February 2013, Billabong announced a $536 million loss, of which $567 million was non-cash and related to write downs of goodwill and its investment in the Nixon JV it created in the prior year, through a $285 million sale of a 48.5% interest in the brand. Sales for the half year were down 8%, year over year. The company also reported a net debt position of $152 million, not including certain off balance sheet lease obligations. In addition, Billabong was on track to close 160 retail locations as of June 2013, as part of its ill-fated attempt to expand its retail operations through its acquisition of Canadian retailer West 49.
  5. In April, the terms of the Sycamore deal changed to $0.60 AUD per share, with the ability to convert a maximum of 24.9% of shares into "NewCo," the surviving entity owning Billabong's assets. Billabong founder Gordon Merchant who beneficially owns 15% of the company indicated his desire to receive the scrip consideration.
  6. In June, Billabong signaled to the market that the deal to sell the company to either Sycamore or Altamont had changed to asset sales and potential refinancing agreements. Ian Pollard also updated the market with respect to full year guidance, and indicated Billabong expected between $74 and $85 million in EBITDA, and further restructuring activities including the exploration of a sale for its West 49 retail business. Billabong bought West 49 for $99 million CAD in June 2010 and assumed its debt. The WSJ reported that Billabong has hired investment banker Financo to sell West 49.
  7. Later in June, the financial press indicated that the Commonwealth Bank of Australia and HSBC sold bank debt to distressed debt investors at a 15 - 20% discount to par. The share price swooned some 50% as equity investors began to get worried that Billabong would be forcibly taken over by creditors. The news apparently led to Perennial Value, the second largest equity holder to sell half its stake. If Perennial Value dumps its remaining shares, it could cause another drastic drop in the share price.

Debt Covenant

As a result of the large impairment charges incurred from writing down goodwill, Billabong breached its loan covenants. The syndicate of banks amended the debt covenant to protect its loans. The new provisions are as follows:

  • Billabong will grant the financiers the right to take security over at least 80% of the Group's total assets and 85% of EBITDAI in support of the financing facilities.
  • Billabong will not pay an interim dividend for the half-year ended 31 December 2012 or a final dividend for the year ending 30 June 2013 and thereafter restrict dividends to be not more than 50% of Net Profit After Tax (after significant and exceptional items) without majority financier consent.
  • Billabong has classified $269.8 million of borrowings as current liabilities on the balance sheet notwithstanding that at the date of the last quarterly report they are not due to be repaid within twelve months (now the date is getting closer, July 2014).

What Now?

Things look terrible at Billabong. However, as management sells off assets (West 49, etc), closes retail locations and refocuses on its distribution channels and brands, in my opinion, the company will survive, in one way or another.

The question is, will equity shareholders retain ownership in the future operations?

With a net debt position of only $152 million (not including some $350 million in off balance sheet lease commitments), it does not appear like an insurmountable hurdle to sell assets and/or issue a bond to protect shareholders and bank lenders.

In addition, I wouldn't be surprised if a white knight came in to pick up the assets on the cheap and/or for strategic purposes. Nike (NKE), Adidas (OTCQX:ADDYY), Columbia Sportswear (COLM), and Under Armour (UA) come to mind. VF Corp has already expressed interest in the assets.

Conclusion:

I'm placing a small bet on Billabong. I bought ADR shares on June 26 (which represent two ordinary shares per ADR). I think the brands have value, as evidenced by a number of interested strategic/opportunistic buyers. The concern, though, is the continued slide of the offer price and a number of failed transactions. I suspect it's partly because of Gordon Merchant's sizable equity stake and his obstinate unwillingness to give up influence over the business he built.

There is certainly a lot of hair on this investment. But for $80 million, the downside is quite limited in relation to the potential upside of Billabong at this point. Many apparel brands, including the ones mentioned above, trade at price to sales multiples of 1.5 to 2 times sales. Billabong currently trades at 0.07 times sales.

If you think Billabong can satisfy its bank debt due in July 2014, equity investors might be in for substantial upside given very limited downside risk at this point.

Source: Billabong: A Cigar Butt With Upside?