Australia | Dec 20 2012
-Earnings downgrade disappoints
-Brokers pessimistic over latest bid
-Company may be better privatised
-Regional difficulties continue
By Eva Brocklehurst
Action clothing retailer Billabong International ((BBG)) is between a rock and a hard place. As the company issued a further downgrade to earnings estimates for FY13 it received a fresh takeover offer at $1.10 per share, from a consortium including director Paul Naude. The difficulties faced by the company raise questions over whether this new bid can proceed. Citi gives it just a 20% probability. Billabong's board is yet to respond to the proposal and the bid is substantially lower than the $1.45 conditional bid offered by private equity firm TPG earlier this year.
Meanwhile, Billabong revised down its FY13 guidance for earnings to $85m-92m, below the previous guidance of $100m-110m. In addition, the company identified $29m in significant items. This throws up the question of just what is the value of Billabong stock. Credit Suisse has not been able to build a sufficient case for forecasting significant brand improvements. Its valuation would move to $1.10 per share with the addition of $50m more in earnings over the forecast horizon. So, the bid price incorporates a substantial turnaround premium. Also, debt is "uncomfortably high" according to the broker. Credit Suisse's target of 38c per share is based on average earnings growth of 6.5% per annum over the next five years. That forecast assumes continuing weakness in Europe, offset by store closure benefits and normal seasons in Australasia and the Americas. On FNArena's database the consensus target price is 91c within a range of 38c (Credit Suisse) to $1.50 (CIMB).
Billabong estimated that its turnaround strategy would generate $155mn in incremental earnings, however, Credit Suisse does not support the assumptions made in generating that forecast. Billabong has deferred payment obligations associated with past acquisitions of $64m current and $68m non-current. These liabilities are incorporated in Credit Suisse's valuations.The broker's Sell rating is keeping company with that of JP Morgan. JP Morgan has lowered the rating to Sell, also noting the asset impairment risk is heightened and gearing issues return. The broker believes Sycamore Partners, one of the players in the consortium, is well positioned to turn around Billabong but has been a disciplined acquirer, having reduced the offer price for Talbots after due diligence. Despite the fall in the share price after the trading update, JP Morgan also believes the risk/reward is not attractive. In summary, the broker says, while there are company-specific factors at play for Billabong, the company is facing an exposure to markets with challenging macroeconomic dynamics, namely Europe and Canada.
UBS has cut its rating to Hold, also noting the stock does not look compelling from a risk-reward perspective, given considerable downside risk should a bid not proceed, a low prospect of alternative bids and high probability of any final bid being lower than the current one. The broker says the downgrade implies a 33-42% decline in underlying earnings, a disappointing result in light of recent re-structuring and the low base from which it comes. As a result, UBS has cut its FY13 earnings estimates by 14%. Moreover, in this broker's view, the company's cut to guidance further highlights its lack of agility and raises concerns over its ability to achieve the FY16 earnings target of over $210m, albeit UBS is already around 20% below this figure. UBS suggests the turnaround of Billabong may be best handled in private hands and believes any reasonable proposal by the consortium should be seriously considered by the board.
For Deutsche Bank too, the company would be better off privatised. The broker has little confidence that earnings have bottomed and balance sheet concerns are re-emerging given the diminishing ability to cover fixed lease and interest costs. The broker notes the interest from an insider at $1.10 prevents a Sell recommendation but a completed deal is far from certain. A Hold is retained with a price target of 85c. Following the trading update, Deutsche has reduced earnings estimates for the group by around 21% in FY13 and 26% in FY14, forecasting earnings of $82.2m or $84m on a constant currency basis for FY13. The downgrade in FY14 is larger because the broker has reduced expectations for a recovery from the problematic regions. The valuation implies there is a 45% probability that a $1.10 deal is successful.
Citi sees the whole affair as awkward, as the board felt $1.45 undervalued the company only a few months ago. Valuation support exists, the broker maintains, as global peers trade at an FY13 enterprise value to earnings estimate of 8.5 times compared with Billabong's 9.4 times. However, Billabong's margin is roughly half these global peers and thus offers room for improvement. While there is a margin recovery opportunity, Citi expects the sales base needs to shrink. The broker suspects the board will have difficulty supporting the private equity approach but the business conditions continue to deteriorate and a turnaround away from equity market scrutiny may be required. Citi has downgraded its recommendation to Hold with a price target of 90c.
CIMB has taken a different tack, expecting the bid to be rejected by the board on the basis that it overlooks long-term valuation potential. However, the broker said the bids highlight the inherent long-term value in the business. In its view, the consortium is attempting to take advantage of near-term earnings softness. By CIMB's numbers the offer values Billabong at 8.5 times revised earnings guidance, similar to the TPG bid, which valued it at 8.8 times previous guidance. The recent offer therefore seems to reflect the outlook rather than a genuine assessment of longer-term value. The broker retains a Buy rating, reflecting the turnaround opportunity under new management. However, CIMB expects the share price to trade lower in coming weeks as expectations of a successful bid subside. CIMB has a price target of $1.50 and retains a Buy rating.
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