Billabong’s tough call

You knew it was coming. Private equity loves a wounded animal, particularly one with a strong brand and market position, and in surfwear giant Billabong they’ve found an ideal target.

According to a report in the Australian Financial Review, private equity firm TPG has lobbed a bid of around $766 million for Billabong, which is battling a perfect storm of problems, including anaemic retail sales around the world, the high Australian dollar and a debt load of $600 million.

The offer is pitched at about $3 a share, which sounds good when you consider the shares have languished at around $1.75 since the company released a shock profit warning in December, just three months after presenting a pretty rosy outlook at its annual general meeting.

But that 70% premium won’t make a takeover any easier to swallow for long-term investors. About two years ago, the company was worth $2.97 billion, or as much as $12 a share. An offer of $3 a share still represents an incredible destruction of wealth.

Billabong’s board and its major investors will now be faced with a stark choice between fresh memories (knocking back any takeover) and a new reality (accepting the deal).

The fresh memories will tell them the bid is an opportunistic bit of bargain hunting. This is a company with an iconic global brand, a strong retail footprint and before the last 18 to 24 months, a strong track record of growth and financial performance. If conditions change, surely Billabong can return to something like its former glories.

But the new reality is stark. The retail sector is being hit by structural change, as shoppers reduce the spending and shift this lower spending online. Prices and margins have shrunk. The high Australian dollar seems unlikely to retreat any time soon. Perhaps it would be better to take the money, cut your losses and let someone else tackle this perfect storm.

The investor wrestling most with this is likely to be company founder Gordon Merchant, a man who has seen his fortune shrink from more than $900 million to around $300 million because of Billabong’s decline.

He still retains 15% of the company, and according to his rich list valuation, some spare cash, having sold about $200 million of stock back in 2006 when the shares were worth almost $15.

Merchant has made no signals about re-taking control of the company, but it’s natural for a founder and major shareholder to bristle at the idea of someone buying his company on the cheap. Whether Merchant has the financial firepower to make a bid would be an issue, but he could probably find a supportive investment partner is he wanted to.

If these takeover battles go as they usually do, Billabong’s board will make all the right noises about this being an opportunistic bid and press for a higher price.

But chairman Ted Kunkel will have to seriously entertain the offer from TPG and look for other interested parties in the hope of sparking a mini bidding war. French group PPR SA, which bought rival skate brand Volcom in early 2010 for $607.5 million could be one bidder.

But could the most likely interested party be sitting down at the board table in the form of Gordon Merchant? Time will tell.

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