herald sun article

A customer looks at bikinis in an Australian Billabong store. Picture: AFP

MUCH of the commentary on private equity group TPG walking away from troubled surfwear icon Billabong, and the subsequent exaggerated selling of the stock, has missed one important point.

Simply, that whether or not private equity players are actually as smart as they and many others think, the one thing they most certainly are, without qualification, is greedy.

That exactly the same applies to their first cousins - hedge funds - also helps in understanding the dynamics around the Nine Network.

Nine of course provides a fascinating link between these two iterations of greed. It was the cocktail of private equity greed and stupidity that created the opportunity for their cousins in greed to then pounce on the Nine carcase.

First Billabong. There are two things to understand.

First, TPG has walked away from bidding $1.45 cash for the company. Not from bidding, say, $1.10, or yesterday's yet further depressed closing price of 78c. But $1.45 and only $1.45.





TPG gained the right to do due diligence on Billabong by making an "indicative, non-binding and conditional" proposal to bid at that price.

It was all or nothing. It could not, after doing that due diligence, offer to bid, instead $1.10 or even $1.40.

It would have had to start a new conversation with the company, if it wanted to do that. And that would raise interesting legal questions, after having had the opportunity to look in every Billabong cupboard and under every bed, so to speak.

So the only conclusion that could be drawn from TPG walking is that it was not prepared to buy Billabong at $1.45 a share. And then you have to factor in TPG greed. TPG would have wanted to see a return of around 25 per cent a year on its investment.

That's what private equity demands - itself a very interesting broader question in this post-GFC world of very low single-digit interest rates and lower combined costs of equity and debt capital in general.

It's impossible to know what mix of equity and debt, both within Billabong and in funding its own equity component of the Billabong balance sheet, that TPG could achieve.

But it's reasonable to assume that TPG would have wanted to be confident it could get to grow the overall value of the Billabong business by at least 10 per cent a year, every year, to give it a 25 per cent-plus return on its equity.

Broadly translating that to the Billabong share price would require a reasonable prospect of it going to $1.70 or so after one year, to north of $2.26 after two years, and to approaching $4 after five years.

Clearly it did not see those sorts of numbers. What it did see, we don't know. But the fact that it walked away from paying $1.45 most definitely does not say it saw some dark disaster inside Billabong or in its future.

Indeed, it could very easily have seen upside in Billabong, from a starting price of $1.45. But the upside of more normal investment returns.

What it would be very interesting to discover is the price that TPG would be prepared to pay. Because that would tell us, what a revived Billabong could be worth in a few years.

Of course, the value a private equity group thinks it can build is not quite the same thing as reality.

Its fellow club-member CVC thought it could build value for Nine off a $5.5 billion starting base. Six years on, the value of Nine was 'built' backwards to $3 billion tops (including the magazines now sold).

There are two elements to rebuilding value in Billabong. The first would be shared between TPG and new Billabong CEO Launa Inman.

It's the no-brainer, of removing those elements of the business that don't generate any or at least not sufficient returns.

Dramatically reducing the product offer to the high-volume/high margin products. Doing the same with stores. And taking the axe to costs - both internal and supplier.

After that is where private equity usually, or hopes to, exit. It's the second stage which is the tricky one. Building a long-term growth and value franchise.

But right now that's beyond the long-term so far as Billabong is concerned. It should be able to harvest the low hanging fruit. The question is what value you can put on that.

Over at Nine the greed equation is simple, The hedge funds are most definitely not satisfied with getting 100c in the dollar. They want at least 125c and hopefully an option on more.

Two hedge funds have bought around 40 per cent of Nine's $2.25 billion of senior debt at around 80c in the dollar. That means if they get fully repaid they will pocket 125c in the dollar.

If they also emerged with 100 per cent of Nine's ongoing equity of $1.25 billion, in what would then be a conservatively geared balance sheet, they would have a further potential upside.

So any equity they cede to the Goldman Sachs-led mezzanine lenders tests their greed twice. It cuts the upfront 125c in the dollar; and it reduces the further upside from any equity appreciation.

The upside could vanish though if they pushed the cliff-top poker table too close to the edge. And they could lose some or all of that extra 25c in the dollar.

They'd be wise to trade some of their greed for the certainty of a reduced profit.