Thesis

Current price represents an amazing opportunity to own a cyclical business with strong brands with a short term catalyst that can unlock value (two groups bidding $1.10/share).  Even if the LBO fell through, Billabong as a going concern should provide significant upside to equity holders.

Market Perception

• The business is in structural/secular decline.
• There are hidden problems as two buyout firms (Bain and TPG) withdrew their bids last year after due diligence.
• VF Corp/Altamont and Sycamore may withdraw their $1.10/share offer this week after due diligence.

Variant View

• The portfolio of brands, especially the namesake Billabong brand still has significant brand equity left.
• Surf/Skate apparel is currently out of favor, but it will come back.
• Private equity unlikely to withdraw their bids this time.  $1.10 is a really good price.

Why would the buyout offers stick this time?

1. 1.       On 3/21/2013, the stock dropped to as low as $0.63 after ending the previous day at $0.81 due to speculation that the offers will be withdrawn.  Trading was suspended early.  Billabong issued a regulatory filing that states clearly both bids are still ongoing.  It’s highly unlikely Billabong will issue such statement without verifying with the bidders or that they will lie to the company.
2. 2.       The best way to make money in private equity is to buy at distressed price (more on this later).  The broken auction of last year has provided a rare opportunity and both groups know this.
3. 3.       Paul Naude, who partners with Sycamore, is the head of Americas and has worked at the company for over a decade.  His interest in the company is purely financial as he has no reputational/ego issues with the Billabong name.  He is an insider who knows the math.  Due diligence will not scare his group away.
4. 4.       Billabong would fit nicely if acquired by VFC, who has the same business model.  VFC can realize huge synergies and improve operational efficiency.  Most importantly, VFC knows how to run brands.  Base case for VFC is the acquisition should bring in at least $190mm EBITDA annually (LTM Billabong revenue x VFC long term EBITDA margin = $1.29B x 14.7%).  Again, this offer is very attractive to VFC.

The Math

Billabong has $86.6mm cash, 479mm shares outstanding, and $286.3mm of debt.  Current EV = 0.73 * 479 +286.3- 86.6 = $549.4mm.  Buyout EV = $726.6mm.

Historically, from FY 2001 – 2012, EBITDA margin has averaged 17.3%.  Before the business turn south in the last two years, EBITDA margin averaged 20.6%.  Assuming the new owners can stabilize sales and restore margins, Billabong is a $223mm to $266mm EBITDA business.

Scenario 1, Buyout bids are real

I do not have any insider knowledge about the buyout offers.

I believe, the private equity guys are assuming $190 – 240mm of EBITDA in the transaction which implies buying out Billabong at an EV/EBITDA multiple of 3.8x based on $190mm.  This is ridiculously favorable for the buyers. 

If both parties make final offers, I can see a bidding war.  VFC can be more aggressive as they can partly fund the transaction with stock trading at 17x P/E.  Upside in a bidding auction scenario could top out at 6x EBITDA, implying EV of $1.14B (6 *$190mm) and $1.96/share.

Scenario 2, Both buyers withdraw

In this case, the key question is the intrinsic value of the business.  The new management team is already closing stores, cutting costs, eliminating weaker brands and refocusing on stronger brands.

A conservative base case of $1.2B sales, 12% EBITDA margins and 6x EV/EBITDA suggests the stock should be worth $1.39.  For reference, average retailers trade at 6 – 8x EBITDA; strong ones trade at 11 – 16x.

Can the business be turnaround?

I don’t know but I can name a few examples such as Gap, Olay, and Swatch that did.  Unlike Blockbuster, Billabong does not face existential threats.  Unlike Sears, there is still enough brand equity for it to be saved.  The point is with the right strategy, I am a believer because surf wear is just temporarily out of style.

Downside Risk

The price action on 3/21/2013 provides anecdotal evidence of where the stock will go if there are no offers.  $0.63 seems resonable.

BestBuy Analogy

Both companies share some similarities:

• Market perception is extremely poor
• Sales and margins decline
• New management recently onboard
• Receive offers to be taken private

BestBuy was and is in a worse situation than Billabong 

• BestBuy has a bigger problem: it is fighting against “showrooming” and there is no sign of it winning the battle.
• Schulze is more than a financial buyer.  He was motivated to protect his legacy.  The buyout price reflected more than objective value
• The bid failed even with Schulze being the largest equity holder

Anyone who purchased BBY stocks in the last 4 months are sitting on some hefty gains.  I believe similar dynamics is at work for BBG.  Current price is depressed and the stock could go up just because of investor sentiment change.