Billabong Low Value Prompts Wonder What TPG Bid Knows: Real M&A

Feb. 24 (Bloomberg) -- Billabong International Ltd. is so beaten down that potential buyers could top TPG Capital’s offer for the Australian surf-wear company and still pay the lowest valuation for an apparel deal on record.

TPG, the buyout firm run by David Bonderman, has offered A$765 million ($819 million) for Billabong, valuing the Gold Coast, Australia-based company at 12 times projected fiscal 2012 net income, according to data compiled by Bloomberg. That’s half the median 24 times paid in takeovers of apparel makers in developed markets worth more than $500 million, the data show.

Even after Billabong rose 54 percent in a week, TPG or a rival suitor could offer A$3.85 a share, 39 percent more than yesterday’s close, and still pay the lowest multiple relative to earnings since at least 1998, data compiled by Bloomberg show. While Billabong is selling control of accessory-maker Nixon, considered its most lucrative unit, buyout firms may still seek to revive the company as it cuts jobs and shuts stores, according to Tribeca Investment Partners and UBS AG.

“Private equity sees the opportunity to turn Billabong around,” said Sean Fenton, who manages about A$900 million at Tribeca Investment in Sydney. TPG’s bid will “flush out anyone who is interested to run the numbers and have a look,” he said.

Billabong announced the TPG approach on Feb. 17, the same day it disclosed the planned sale of a majority stake in Nixon. The offer, which was conditional on Billabong not selling any brands including Nixon, was revised three days later to allow for the sale without a change to the price.

Surf Shorts

Billabong, which rose as much as 7.6 percent today, ended trading in Sydney at A$2.91, its highest price in ten weeks.

A spokeswoman for TPG declined to comment on its bid. John Mossop, a spokesman for Billabong, said he couldn’t immediately comment on when Billabong would respond to TPG’s bid.

Formed in 1973 when Gordon Merchant, who is still the largest shareholder with a 13 percent stake, stitched together surf shorts in his apartment on Australia’s Gold Coast, Billabong’s market value reached A$3.84 billion in May 2007, according to data compiled by Bloomberg.

Billabong’s shares then slid 90 percent before TPG’s approach was disclosed, the biggest drop for any consumer discretionary stock in Australia’s benchmark S&P/ASX 200 Index during that period. Profits tumbled as consumer spending slumped in the U.S., Europe and Australia and major stores introduced their own brands to compete with independent surf labels.

“Billabong has a strong portfolio of brands and a wide retail distribution network,” said Michael Simotas, an analyst at Deutsche Bank AG in Sydney. “The thing to do is to manage that retail business better.”

Acquisition Spree

With a rise in the Australian dollar pressuring the 65 percent of revenue the company generates from the Americas and Europe, Billabong last week reported a 72 percent slump in profit to A$16 million for the six months ended Dec. 31. That was the lowest for any half year since its August 2000 initial public offering, according to data compiled by Bloomberg.

Billabong said last week that it will close as many as 150 of its 677 stores worldwide by June 2013, and cut about 400 jobs. It also agreed to sell 51.5 percent of its Nixon accessory and clothing business to buyout firm Trilantic Capital Partners and management to raise $285 million and reduce borrowings by more than one-third.

The company’s debt load increased after a series of acquisitions made as it sought to reduce reliance on its namesake brand, which generated almost all of Billabong’s sales at the time of its IPO. Billabong has closed 18 purchases since 1999, acquiring labels such as Nixon and retailers including Canadian chain West 49 Inc., data compiled by Bloomberg show.

Squeezed by Retailers

The Billabong label now accounts for 48 percent of wholesale revenue, compared with 15 percent for Element, and 14 percent for Nixon, according to Citigroup Inc.

Over the past decade, larger retailers have squeezed Billabong by establishing their own lower-priced, surf-themed brands such as Abercrombie & Fitch Co.’s Hollister. Since 2004, the Australian company has tried to compete by setting up its own store network to push its brands to customers.

That approach often causes problems for apparel companies, and undoing it may improve Billabong’s prospects, said George Svinos, lead retail partner at KPMG in Melbourne.

“You can probably count on one hand how many people are successful in both retail and wholesale,” he said. “There are many examples of people that have struggled with that model and many who’ve absolutely improved their business by either deleting one or the other.”

‘Management Have Failed’

Excluding extraordinary items, analysts now estimate Billabong will earn A$64.5 million in the year ending June 2012, according to data compiled by Bloomberg. TPG’s offer is worth almost 12 times that forecast, compared with the median bid of 24 times profit for takeovers of apparel makers greater than $500 million in the U.S., western Europe, and developed markets in the Asia-Pacific region, the data show.

Private equity firm Permira Advisers LP, paid the lowest multiple so far when it acquired Valentino Fashion Group SpA for 15.3 times net income before extraordinary and one-time items in 2007. A rival could top TPG’s offer for Billabong by 28 percent and still pay a lower multiple, data compiled by Bloomberg show.

“What we’ve seen in the last two years is that management have failed to maximize the value of these assets,” said Andrew McLennan, an analyst at Commonwealth Bank of Australia in Sydney who recommends investors sell the stock. “Clearly the assets are worth more in the hands of a private equity player now.”

Higher Margins

As much as 20 percent of Billabong’s stores are “underperformers,” while those that are profitable had average earnings before interest, taxes, depreciation and amortization margins of 18 percent in the six months through December, Chief Executive Officer Derek O’Neill said on Feb. 17.

That’s higher than the median Ebitda margin of 13 percent among a group of 17 apparel designers that includes Coach Inc. and Asics Corp., data compiled by Bloomberg show. Billabong’s rival Quiksilver Inc. generated an Ebitda margin of 9.4 percent in the twelve months through October, the data show.

If Billabong meets projections for an Ebitda margin of 9 percent this year, a buyer paying A$3.50 a share will generate an internal rate of return of 12 percent, according to Citigroup’s Craig Woolford. Restoring the company’s profitability to the 11 percent Ebitda margin Billabong reported in the financial year ended in June raises the return closer to 23 percent, Woolford’s analysis showed.

“Any buyer needs to have conviction that they can turn around those margins,” said Sydney-based Woolford, who has a “neutral” rating on Billabong. “They know what it has earned historically, so the potential to earn profits remains quite strong.”

Private Equity Returns

Australian private equity and venture capital funds formed in 2002 generated a median internal rate of return of 6.7 percent through September, the best performance among funds created between that year and 2008, according to an analysis by Cambridge Associates LLC. Funds formed since 2008 are too young to have produced meaningful results, Cambridge Associates said.

Private equity buyers will be drawn by the chance to shrink the business and trim costs, according to Tribeca’s Fenton.

Reviving past profits will be harder to do without the full contribution from Nixon, which sells sports watches, women’s handbags and casual clothing. The unit contributed about one- third of Billabong’s Ebitda in the year through June and is growing at 20 percent a year, Nomura Holdings Inc. said in a Feb. 18 report. That compares with three years of Ebitda declines at the group.

‘An Excellent Purchase’

The proposed transaction values Nixon at approximately $464 million, representing about 9.2 times the last 12 months’ Ebitda, Billabong said. TPG’s offer for the rest of the company values it at almost 6 times Ebitda, excluding Nixon.

Still, the sale of Nixon won’t necessarily turn private equity buyers off given that Billabong “remains undervalued,” UBS analysts wrote in a Feb. 17 note. The Zurich-based firm has a ’’buy’’ rating on Billabong.

“TPG came back pretty quickly and dropped the Nixon condition,” said John Maysles, event-driven senior analyst at Los Angeles-based Elevation LLC. “That tells you they must be pretty happy about the deal. If you can turn the thing around, it would be an excellent purchase for a private equity guy.”

--With assistance from Anjelica Tan and Sarah Rabil in New York and Brett Foley in Melbourne. Editors: Robert Fenner, Mohammed Hadi

To contact the reporters on this story: Angus Whitley in Sydney at awhitley1@bloomberg.net; David Fickling in Sydney at dfickling@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Philip Lagerkranser at lagerkranser@bloomberg.net; Neil Denslow at ndenslow@bloomberg.net.

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