Last week we had former market darling JB Hi-Fi (ASX: JBH) warning on profits. Today, Billabong International (ASX: BBG) wiped out, its shares plunging over 40 per cent after the company revealed a significant deterioration in the critical pre-Christmas trading period.

We labelled Billabong as a purely speculative investment opportunity, with some justification. I’m currently deep-diving into the Billabong trading update and accounts. Although some investors may be tempted to buy Billabong shares after the massive collapse in their share price, experience tells me there is no need to rush. As ever, patience is key.

How low can it go?

The current share price of $2.15 is low enough to merit further investigation. That said, with a heavy debt load and high interest payments, Billabong is definitely not a safe investment.

A large write-down of intangibles could easily send earnings into the red.

With $1.3 billion in intangible assets, and less than $1.2 billion in equity, Billabong shareholders don’t own any tangible assets. Is the Billabong brand alone worth close to half a billion dollars? Then again, at $2.15, Billabong has a market cap of $540 million and an enterprise value — market cap plus net debt —of just over one billion. So it’s worth digging deeper.

Could debt wipe Billabong shareholders out?

With a heavy debt load and high interest payments it is no wonder Billabong has engaged Goldman Sachs for a strategic capital structure review.

This review includes an assessment of all potential alternatives to strengthen the Company’s capital structure in light of the existing operating environment and the risk for further deterioration … while nothing has been ruled out, raising equity is not the preferred path at this time as the Company is reviewing other options.

Of course an equity raising is not the favourite path!

No-one ever wants to admit failure. No-one wants to go cap in hand to the owners, especially at the worst possible time to raise equity — right now as the share price is hitting lows not seen in 11 years!

Are the cash flows and management strong?

No. Over the last six years the business has consumed $174 million more than operations have produced. And key management performance statistics have been in free-fall.

Foolish bottom-line

Billabong’s board and management chose a poor time to leverage the balance sheet and expand in to bricks and mortar retailing. They have significantly increased shareholders risk without a commensurate increase in the potential rewards. Bad capital management is a corporate sin and red flag.

A clear view of its debt, and its duration and covenants, is the next step. Then an examination of if it’s cheap enough to risk getting into bed with poor management.

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