Billabong’s bad tidings

When you think of the industries that Australia is truly world class in, a few sectors bob up. Beer would be one (even if our biggest brewers are no longer Australian-owned). Blood products would be another (thanks to CSL). Wine and even retail and media could be on the list.

But the one that always stuck out to me was the surfwear sector. Australian companies Rip Curl, Quiksilver and Billabong may have been born in garages in surfing towns, but they became iconic names in an industry worth billions of dollars.

But for how much longer?

Yesterday’s shock profit downgrade from Billabong (coming as it did less than three months after the pretty positive outlook given at the company’s annual general meeting) sent the company’s shares down a staggering 44% to just over $2. They’ve fallen another 15% today and now sit at $1.72.

That the company’s shares have fallen below the price they were issued at when Billabong floated in 2000 is well known. But what deserves more attention is the speed at which the value of the company has been destroyed.

Less than two years ago, Billabong had a market capitalisation of $2.97 billion. Even 12 months ago, the company was worth $2.1 billion.

Today, Billabong is worth a bit over $470 million. That is great symbol of how rapidly the company’s fortunes – and the state of the retail sector – has changed.

Yesterday, Billabong’s management went to great lengths to paint this as a perfect storm of cyclical problems – the slowdown in Europe, fragile consumer conditions and unseasonal weather in Australia, a fresh slowdown in Europe.

But Billabong knows this is not just cyclical. At its most basic level, the internet is driving down prices and compressing margins around the world and big brand companies are being forced to react.

Billabong, to its credit, has moved to essentially cut out the middleman by buying and opening its own retail outlets. While this is a move that should pay off in the long-term, it also makes Billabong more vulnerable to shifts in the market.

When sales fall at a retail level, now it is Billabong itself that is left with inventory problems. When prices fall at a retail level, now it is Billabong’s margins that get squeezed, rather than some surf shop in a shopping mall.

The foray into retail has also added to Billabong’s debt levels, which are now at $600 million. And after yesterday’s sharemarket rout, the company is now in some danger of breaching its debt covenants.

Remember, the company is still planning to make an operating profit of $70-75 million for the six months to December 31, but in a business where losing tens of millions from its value every day, it wouldn’t take much for Billabong’s managers to end up with the banks breathing down their necks.

And to avoid that, CEO Derek O’Neill is going to need to take some evasive action. Working with long-term advisor Goldman Sachs, the company is now looking for ways to shore up its balance sheet.

Asset sales are most likely and a capital raising remains an outside possibility – although Billabong yesterday stated that is not its preference as it would dilute the heck out of existing shareholders.

But there are two more options worth considering.

The first is a takeover of the entire company. While most companies in the retail sector are being buffeted by the same conditions slamming Billabong, surely there would be some buyers out there willing to snap up a bargain.

French group PPR SA bought rival skate brand Volcom earlier this year for $607.5 million – surely Billabong looks like great buying compared to that?

The final option revolves around Billabong founder and rich list member Gordon Merchant, who saw the value of his stake in the company fall by $53 million to $70 million yesterday. Merchant is still thought to hold a fair bit of cash from selling shares in the company over the past decade – could he turn white knight and take the group private again? There’s no indication that would be the case, but certainly the opportunity is there.