Pacific Brands Limited The Burst Bubble

Background Information and Industry Overview

Effects of the Global Recession

Balance Sheet Movements

In a perfect marketplace, such as the one championed by the proponents of the efficient market hypothesis, assets would be automatically priced correctly by the magic of the market place. However, in the real world, corporate assets often are overvalued or undervalued based on speculative pressure or possibly asymmetric information. The global recession caused havoc with its extensive intrusiveness into a plethora of unrelated industries. The common denominator that plagued seemingly unrelated industries is that consumer confidence fell through the floor.

Pacific Brands Limited was by not immune by any measure to the pressures placed upon them by the faltering market. In fact, it was quite the opposite. Since Pacific Brands claimed a holding that included an enormous amount of value in regards to its intangible assets it was more exposed than firms in most other industries. When intangible assets represent a sizable portion of a firms holding, then it inherently maintains significant exposure to fluctuations in the overall health of the marketplace.

Therefore, the idea that the intangible assets were not properly priced before the market crash may not be entirely accurate. When consumers had considerably more consumer confidence and disposable income to engage in retail shopping, then the value of the individual brands and the product mix could have been accurate based on this set of conditions. However, once the market took a turn for the worst, the value added segment that the brand image commanded from consumer perceptions was diminished or possibly even eliminated.

Thus the products would only be demanded at values that were closer to the actual economic value of the products without any value added portion for intangible branding efforts. Therefore, the stock price fluctuations were consistent with the fluctuations in the market conditions and the only flaw that could be identified was that in the stock price's peak in was probably overvalued because it did not account for the large amounts of risk that were somewhat hidden.

Background Information and Industry Overview

Pacific Brands Limited (PBG) manufactures, outsources, markets and sells a portfolio of consumer garment brands and various other household products. It has based much of its recent growth strategy on the acquisition of new brands and products. In 2000, the organization went through a series of acquisitions including the Clarkes (children) and Hush Puppies footwear brands. Through to its listing in 2004, the group acquired licences for a number of other brands, including Kolotex, Razzamataz, Sachi, King Gee, Stubbies and Playtex. Other notable brand acquisitions have included Esprit, Sheridan, Mossimo, Yakka, Wrangler, King Gee, Mooks and Stussy.

PBG operates within a highly fragmented apparel industry with one larger competitor as well as several smaller organizations however given the fact that it operates within a fragmented niche market the direct competition is fairly limited. Its product mix is composed of plethora of different branded products that are all targeted toward a specific niche. Thus PBG is able to leverage it risk to some extent by its product offerings through the differentiated channels. For example, during an economic downturn there might be less luxury good sales but one could reasonably expect that inferior goods sales would increase.

Figure 1 - Industry Peer Comparison[footnoteRef:1] [1: (Aegis Equities Research Pty Limited 2011)]

Effects of the Global Recession

Before the economic downturn began to really settle into the Australian markets, Pacific Brands was breaking records in terms of sales and profits. One news article boosted that PBG was predicting a 15 to 20% growth on its financial measures in the 2008 fiscal year, noting that the strengthening Australian dollar was predicted to boost sales (O'brien 2007). However, PBG did not meet these predictions. In fact, after the stock price peaked in shortly after the article was written, PBG started a downward spiral...

In hindsight, it is easy to say that PBG was more exposed to a systemic problem, such as a recession, than many of the other players in the market. The following chart represents the five-year stock price graph that illustrates the volatility in share price that PBG had to endure.
Figure 2 - PBG 5Y Stock History[footnoteRef:2] [2: (Bloomberg 2011)]

Balance Sheet Movements

One of the primary reasons that PBG was so exposed to the global recession, even more so than other Australian firms, was that a considerable portion of its asset holdings were in intangible assets. When the organization purchased a new brand or license through an acquisition it was in essence purchasing a brand that was more intangible than tangible. Thus this would be recorded in the financial statements under the assets section of the balance sheet just like any other asset. In 2008, PMG accounted for 1.5 billion dollars in intangible assets due to the various holdings of its branding efforts (see figure 3).

Figure 3 - Balance Sheet Section June 2008[footnoteRef:3] [3: (Pacific Brands 2008)]

Though there is a necessity to value intangible assets, it is suspect that PBG may have gone overboard with the practice. Apparently, during the initial public offering of the company, Pacific Brands hired a consultant named Interbrand to help bundle up these intangible assets and present them in a coherent manner to investors (Interbrands 2011). There stated mission in the endeavor was to "optimize and justify the maximum value of its trademarks to the investment community." However, with the advantage of hindsight, the consultant may have been too efficient with their practice.

Between the fiscal year end statements of 2008 and 2009 PBG accounted for nearly two hundred million dollars in the intangible asset account (Figures 3 & 4). In 2008, when Pacific Brands was suffering its greatest decreases in share price it actually wrote the Australian Treasury and requested that they be allowed to amortize their intangible and goodwill assets similar to other forms of intellectual property (Thackray 2008). This letter stated that of all the OECD countries that Australia was one of the few left that would not allow them to allocate their resources in this manner.

Figure 4 - Balance Sheet Section June 2009[footnoteRef:4] [4: (Pacific Brands Limited 2009)]

The argument basically followed that if other tangible assets were allowed to be amortized among specific schedules then so should be intangible assets. The argument although reasonable, does not take into account that brands do not necessarily have an equivalent to a useful life cycle. For example, brand names such as Ford for example, have had brands that maintained a very high goodwill account for nearly a century. They are not subject to the predictable amount of wear and tear that may be found on machinery or equipment for example. Therefore a strict amortization schedule would not correctly account for all of the variability in brand lifetimes.

The valuation of goodwill and intangible assets impacts PBG more than firms in other industries do to the nature of their product offerings. For example, in 2009 the amount of intangibles were valued at roughly one point three billion dollars while the total of the shareholders' funds were only valued at one point one billion dollars (Martin 2009). It is also apparent that Australia's tax officials did not grant PBG much flexibility in this matter after the letter was presented to them since there holdings in intangible assets remained fairly constant through 2010 (Figure 5).

Figure 5 - Balance Sheet Section June 2010[footnoteRef:5] [5: (Pacific Brands Limited 2010)]

The PBG brands are facing more competition from unbranded sources (Newcombe 2007). Thus it may seem that some kind of tax relief would be warranted in regards to intangible and goodwill assets. The problem however is that since you can use a straight line amortization schedule there are few reliable valuation schemes left. Additionally, it is incredibly difficult to determine exactly how much a brand image…