Australia | Jun 05 2013
-No bid forthcoming
-Brokers slash valuations
-Likelihood of expensive refinancing
-Asset sales have most potential
By Eva Brocklehurst
Another quarter, another failed bid, another downgrade. Surfwear and accessory manufacturer, Billabong International ((BBG)), is truly in difficulty. The red ink just became a lot redder. As they move to slash forecasts again brokers are asking, just what can be done to rescue the company?
The stock was reinstated on ASX after being in suspension since May 9. The company has ceased change of control discussions without a formal bid proposal. As a result of weaker trading in both Australia and Europe, earnings are now expected to be $67-74 million for FY13, a 9% reduction from the guidance provided in February.
Flagging sales are really not the problem. It's the debt. Unable to agree on a takeover of the company, Billabong is now in discussions with the two main bidding consortia, Altamont Capital Partners and Sycamore Partners, regarding alternative refinancing and asset sales. Around $350m of syndicated debt has to be refinanced, the next refinancing is due in July 2014. Deutsche Bank believes fixed charges cover is the primary concern for this business and it's the off balance sheet lease obligations that pose the biggest problem, as the falling earnings reduce the ability to service lease payments.
Effectively, the way to fix this is to increase the profitability of the stores. Closing some may help but Deutsche Bank sees two problems with this. Some landlords, particularly in the US, may not allow stores to close even if the lease is paid out, while loss-making stores are likely to have been closed already. Reducing the footprint will, therefore, reduce the top line revenue. If the Canada's West 49 stores could be sold, as the company has mooted, that would help generate capital and reduce lease obligations. The company bought West 49 for $110m in June 2010. CIMB believes this sale could provide important breathing space for the company and be a key milestone in the quest for a firmer footing.
Citi thinks the problems are not about the brand but more about the company's retail strategy and capital structure. The core surfing brands remain well regarded. Of the three main brands – Billabong, Dakine and RVCA, RVCA is considered the easiest to sell as it is small and less integrated into the retailing business. Citi envisages a price of around $50 million. Valuation support (book value) has been re-assessed at 23c a share, in Citi's calculations. This compares with $1.19 back in December 2012. Nevertheless, there's still equity value. Net tangible assets are estimated at $56 million and there's another $110m seen in brand value for Billabong, Dakine and RVCA. Credit Suisse calculates that a distressed asset sale for $50m generating $10m in earnings would cause the company to become free cash flow negative through to FY17. Such a sale would reduce the discounted cash flow valuation to 25c, but reducing the net debt burden would be a positive. An asset sale is probably the most feasible option, in Credit Suisse's view.
The private equity consortia may not be putting an offer to shareholders but they've been around for a while. These parties have either bid several times or been conducting due diligence for an extended period. What is of concern to brokers is that operational and financial issues are significant and this could be a key to the absence of a bid during the formal process. It is unlikely Billabong can refinance via traditional bank debt and an equity raising is also unlikely, given the steep discount that would be required.
Innovation is needed. Hence, the former bidders are in the box seat and equity holders are justified in feeling uncomfortable. More stringent demands could be made by financiers such that interest costs are high and security is taken over some of the assets. It all amounts to potentially poor treatment of equity holders and too much uncertainty. CIMB sees it that way, unable to provide a view with any conviction. Having said that, the broker does believe this uncertainty is obscuring the potential value of the business longer term. A trade buyer would likely see value in some brands and, therefore, a partial sale and recapitalisation is still possible.
The most positive aspect is the US business, which is trading well and Billabong's brands are holding market share. The weakness in FY13 also partly relates to an $8 million loss associated with the Surfstitch Europe start-up. While Citi suspects there is a second half loss in FY13 there should be some recovery in FY14. Nevertheless, the business is still deteriorating. Australia and Europe have experienced a sharp decline in earnings while the Americas have held up. Australasian year-to-date comparative sales are down 5.4%. Australian wholesale is bearing up and the weakness is seen largely in bricks and mortar retail. Europe is the main challenge, especially for the Billabong brand, in Deutsche Bank's view. In addition, losses from SurfStitch Europe were $4m higher than the company anticipated. Billabong has a 51% share in SurfStitch Europe.
Brokers have made substantial earnings revisions for FY13 and FY14. These reflect lower operating earnings and higher borrowing costs. On the FNArena database the consensus target price has reduced to 33c, suggesting 44.8% upside to the last share price. This target has halved over recent days – from 66c on May 30 to 33c now. Buy ratings have disappeared. There are three Sell and four Hold ratings on the database.
See also, Troopers Circle Billabong on February 25 2013.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
