Billabong: Don't sell this board short

Billabong's founder is either dead keen to keep the company public, or he is playing a high-stakes game of brinkmanship to deliver a higher offer

a woman

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Billabong International Limited (ASX: BBG) shareholders have been on a ride that might rival the rush surfers get as they surf at Kurrawa, Bells or Margaret River wearing some of the company's wares .

I've never been a board-rider – body-surfing is more my thing. Perhaps the more appropriate analogy is the fear-induced rush as you get dumped by a wave, given the recent share price fall.

A long-falling knife

Just under five years ago, Billabong's share price almost touched $18. Twenty-two months ago, the shares changed hands for $12. Almost one year ago to the day, Billabong traded at $8.50, and two months ago the price fell from $4 to $1.77 in the space of two weeks.

At each of those points, investors might have looked at the previous high, and started to salivate at the value that seemed to be on offer. Each time, the perceived value evaporated as the shares hit a new low.

Shareholder salvation?

Two weeks ago, possible salvation arrived in the form of a proposal from private equity firm TPG Capital. A bid of $3 per share was put on the table, but the company decided to sell just over half of one of its brands into a joint-venture, effectively breaking a condition of the TPG offer.

Undeterred, TPG came back with an amended offer removing the condition preventing brand sales. Yesterday, February 27, the Billabong board once again sent the suitor away empty handed, with the target announcing its founder and 15 per cent shareholder Gordon Merchant would not accept the offer.

Merchant is clearly not happy with the offer, nor with the Board continuing talks with TPG. Just as the market opened this morning, Billabong released a statement that TPG would be prepared to increase its bid to $3.30 but it also released a letter from Merchant's solicitors stating that Merchant would not support a due diligence process even if the offer was for $4.00, which he still believes would undervalue Billabong.

Time for the auction

Merchant is either dead keen to hang onto his shares, and keep the company public, or he is playing a high-stakes game of brinkmanship with the aim of getting the offer price up to a price per share with a 4 in front of it.

Short of a competing offer, which is becoming more unlikely each passing day, the Billabong board has a fine line to tread. If Merchant and the board ask for too much and TPG walks away, the share price may well sink back to somewhere near its pre-bid price of under $2.00.

If they don't extract enough value, they'll be selling shareholders well short – and that seems to be Merchant's current gambit. It is a very gutsy call, and Merchant is obviously confident in Billabong's business, its management and brands.

The company's future – in either public or private hands – depends on how well it can produce and market products that its target market find attractive. Those of us that grew up with Billabong remember its heyday – the question is whether kids today share the same affinity with the brands it now sells.

At the same time, Billabong is still to see any fruits (if any are to come) of its strategic shift into retail. I still believe it was the right strategic direction, but the jury is still out on the execution and the pile of debt it took on to accomplish the change. As is often the case, even the best strategies count for naught when the bills can't be paid.

I have a sneaking suspicion that TPG could be getting a very good deal if it can pay a low enough price and if – and it's a big if – Billabong can continue to make its brands relevant to teenagers and make its retail strategy a success. Equally, the same outcome could be achieved in public hands, to the benefit of shareholders.

Foolish take-away

Unfortunately, sneaking suspicions don't make for solid investment cases. Forecasting likely outcomes is a game of probabilities, but for most shareholders this will be a case of a bird in the hand being worth two in the bush.

Selling now might mean forgoing some possible upside in the share price, but a failed bid might see up to one-third wiped off the current price – even after the bid was rejected. If the bid fails and the share price does fall, Billabong at under $2.00 might be worth another look.

I'm not saying the current price is the best on offer, but one thing is for sure – this price won't be on offer for long. It will either go higher with an increased bid or it will fall in the absence of on. Heads, shareholders win, tails, they probably lose. Unless you particularly enjoy two-up, my suggestion would be to simply take the money off the table, and go in search of another company where the odds are clearer and stacked more in your favour.

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Scott Phillips Is The Motley Fool's feature columnist. Scott owns shares in Berkshire Hathaway. You can follow him on Twitter @TMFGilla. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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