Rocket Bomber - article - retail - commentary - Borders Redux.

RocketBomber: “We Read Boring Corporate Reports SEC Filings so you don’t have to!“ [sm]

It came up in the last post, as an issue it will likely linger into 2009 (or ’10); their struggles weigh heavily on many publishers (manga, comic, or otherwise), and the cloud hanging over the company is no doubt worrisome to the 30,000 or so employed there — some of them just kids in college working nights and weekends for beer-and-comic-book money, but also a significant fraction of “lifers” who have been booksellers for years (decades, even) and who will be lost, distraught, & dismayed not even if the company goes down, but merely if their store, their home away from home, is one of the outlets that closes.

I’m talking about Borders, and we all know the company has its problems, but it’s been 9 months or so since I last visited the issue in depth, over on Comicsnob.com

…oh wait. The ‘snob is in deep cold-stasis at the moment (the SQL database has been saved—or so Bob assures me—but there’s no website front end to serve up those pages) so let me port the requisite articles over to my mysql — Links:

In mid-February, I looked at their new website [then in beta] and the new concept stores, while also making a little fun at their expense

And then toward the end of March, I looked much deeper into financial reports, possible mergers, debt mitigation strategies, and where the money to keep them afloat through the summer would be coming from. Indeed, I made so many predictions that I will end up being right no matter what happens. It’s a nice position to argue from.

[ ahh… antedated blog posts, where would my archives be without you? I’ve a couple hundred more of these, just waiting for that week off when I can spend my vacation working on the blog… ]

So let’s review, shall we?

• Borders has since reduced their debt by a third.
• …mostly by selling off sizable chunks — not a sustainable model, but still a good move.
• The new Borders.com website went live on May 31st
• They managed to get just enough money in loans to get by [at a price, see below]
• William Ackerman (the hedge fund manager of Pershing Square Capital Management, which owns a sixth of Borders outstanding shares) has been dropping hints right, left, and center that anyone and everyone should buy Borders; anyone except Pershing Square, of course, since he doesn’t want to actually run a business (that would be work) he’s just looking to cash out.
• …but no one was biting, and Borders has since taken themselves off the market

Per SEC filings dated 13 Nov, Pershing Square owns — wait. ok, so some explanation:

here’s some whys and wherefores of the form 13F [pdf] — which is basically a quarterly statement of what a hedge fund owns, if the fund manages more than $100MM in assets, and only for those stakes worth more than $200K or amounting to at least 10,000 shares, and SEC filings in general make my brain hurt, which is why I’m a bookseller whose usual investment decisions break down to blue-box macaroni vs. styro-cup noodles — but anyway the 13F is a listing of big chunks of companies owned by hedge funds.

The double line items for each co. owned are because of the two types of hedge fund “ownership”: stakes for which the fund manager has sole discretion (she bought it on her own say-so and can vote the shares or sell them without asking permission) and those with so-called “shared” discretion: a circumstance resulting from a large stakeholder (someone giving the fund money: an insurance co., bank holding co., or pension fund perhaps, given the huge honking loads of cash we’re talking about) placing strings on how the money is used or in providing direction for the initial investment to begin with. But we should all be able to add 1+1 to get 2, I hope, unless the proceeding paragraphs prompted your brain to jump out of your ear to escape.

— so anyway, according to the previously linked SEC filing, Pershing Square owns 6,540,451 shares of B&N (11.9%) and 10,597,880 shares of Borders (17.5%) —

They also own other stuff, like chunks of Visa, Mastercard, Sears, Target, Wendy’s/Arby’s and Dr. Pepper. (I’m not analyzing the whole of it, just trying to grok the books, OK?) Pershing is also a Borders creditor, having loaned them $42.5MM — an amount secured by, among other things, the right to buy up to 9.55 million shares at a price that seemed reasonable back in April ($7 a share, and warrants redeemable anytime in the next 5 years so Pershing may be able to wait long enough for the price to go higher than $7; and bringing their total ownership up to 28% or so). So Pershing is invested in more than one sense of the term.

True to form (as a hedge fund manager) Ackman has hedged his bet: If Borders fails, B&N is worth more. If Borders sells, well, who knows what that will do to the stock price but any drama for Borders likely means B&N is worth more. If B&N buys Borders (not gonna happen, but I’ll throw it out there) then at current stock prices (Market close 12/18: BKS at 14.61, BGP at 0.51 — Yes, 51¢ a share) then Pershing would get somewhere in the neighborhood of 37,000 more shares of B&N (an additional .07% if it was a stock swap, or a half mil in cash)

—prospects look better at $3 a share (six times better, & $3 is an average analyst estimated ‘target’ at the mo, at least according to one site) and almost rapturous at $7 a share — but at even 7 bucks it’s a far cry from the 25 May 2007 price of $23.41 a share, the last high point before a long, long fall. Borders may have slid too far down the slippery slope for buyouts of any sort, from anyone, to make sense.

Unless you’re that guy in Ohio who just won the lottery. I mean, at 51¢ per, one could buy all outstanding shares for about $30MM. (If everyone was selling; most folks would hold at current prices — oh, and you’d also be assuming $525MM in debt, and a company still operating at a loss: “Borders superstores reported an operating loss of $37.8 million in the third quarter” — an amount close to 8 million above their current market capitalization — but does the guy next door own a Bookstore? Well, does he? Eat that, Dinkleberg! )

In October, Borders did in fact issue 5.15 warrants @$7 per to Pershing, pursuant to terms previously agreed upon. That still leaves the $42MM debt on the table (coupons aren’t payments) and in fact the warrants are just an agreement to sell stock at the given price: to exercise these rights Pershing (or anyone they sell the warrants to) would have to spend $36 million for something that, at least according to the traders on the NYSE, is only worth one-fifteenth of that price. (6.6% of that estimated value for the folks playing along at home but not doing math in their head.)

IN OTHER WORDS, IT’S A GAMBLE; an even bigger gamble now compared to when Ackman/Pershing accepted the bet in April. It may still pay off, as the bet is on a company, not a horse. And it’s only interest on the debt as Borders is still on the hook for that $42mil. And five years is a nice long time, in stock market terms: since WWII, for every five year period except one (1971-76) your typical stock market investment (as gauged by the S&P500, that is to say the 500 largest companies traded) has at least broken even; gains typically exceeded 5-10% [of course I know nothing of investment, past mac&cheese vs. ramen as previously stated, but someone else is posting pretty charts and math-y numbers for your perusal — they may also be trying to sell you something though (I didn’t read too deeply) so pack your grains of salt]

Setting my questionable linking to consumer advice aside for a moment: Pershing is betting on Borders. Borders is also betting on Borders; while they tried to find a buyer (as folks who happen to own large chunks of their own stock of course will when times are tough) in the absence of a decent offer they are just as willing to roll up sleeves, hunker down, and do the hard work.

Said Work:
1. Get through the holidays.
2. Sincerely wish that the news at the end of January isn’t catastrophic. I mean, good news isn’t forthcoming from any retailer, but Borders has to hope against hope that all those emailed coupons and 40% off sales and in-store-only offers and previous reductions in inventory, when reconciled with whatever the holiday sales happen to be (minus January returns, provided they will honor such) all amount to merely bad news for the 4th quarter.
3. …and maybe they can secure new financing. (don’t hold your breath)

I think of the 6 options I presented earlier, Borders is going to be stuck with #5, Plain Vanilla Bankrupcy. (with chunks of #4 to make it all go down easier)

That is to say, a Chapter 11 court-supervised reorganization.

If I were doing it:

• The Web Site just might be your future. Even in the midst of financial distress, make arrangements to continue investments in Borders.com. Hell, work up some sort of legal blind to separate the website from the rest of the company so that in the worst-case scenario — the rest of the company is sold for parts and shut down — the .com would be insulated and still carries the Borders brand name into the future
• Waldenbooks. So. Um. Well, Waldenbooks is a great brand, well known, been in malls for decades, has a certain amount of customer goodwill — but in the face of competition (including, ironically, Borders Superstores) the old mall locations with their scant 600-1500 sq.ft. of retail don’t quite cut it with the customer base anymore. Borders was already looking to close 45% of the Waldenbooks outlets by next March, and that decision was made 18 months ago before the multiple meltdowns. If I couldn’t find a buyer for Waldenbooks, I might try to spin the division off into it’s own company (maybe it’ll find a buyer later?) or just write off the smaller stores at a loss. If it came down to a decision to amputate a limb to save the patient: Waldenbooks has to go.
• A Waldenbooks sale would be superior by far to the kill option. Maybe sell it at a substantial discount but offer continuing supply-chain support (books & returns via the established Borders warehouses) for some time period—5 years minimum—and with the option to continue to do so with the consent of both parties?
• Paperchase is also a nice brand. It is doing nothing for your core business, though. Sell it off too, at 50 cents on the dollar if you have to.
• Any store older than 10 years old is on the block. Make them prove their worth; no one gets out alive unless comp sales year to year have grown 1%. So very little, that 1% — but in retail (particularly recently) any comp gains year-to-year from a pre-existing store is worth rewarding
• Any store older than 15 years is going to have to close, too. Most of these are smaller outlets anyway: no coffee shop, no room for full music&DVD departments, no room to expand or shift anything really —
• OK, so call it at 20,000 sq.ft. (2000 m² for most of the world.) In American terms, that’s a chunk equal to a football field from the goal post to the 40 yard line. 20K is about the size of an anchor location in the mall, it easily fits on the pad sites outside most malls (or along most highways), it’s almost a default size for the new mall-replacement lifesyle retail developments and anything less than half a football field is going to seem small. (20K is only 80% of optimal given that stated goal, but if you have been doing business in the same location for at least five years and have established yourself in the local market then it is worthwhile to remodel and continue on, even if it means making do inside the smaller footprint.) Older, but still big enough, retool and remodel; everything else will have to close. Find a new site close by if you can… but two years from now. Or three.

• With all of that, I figure Borders-minus-Waldenbooks-minus-smaller-outlets will be a company consisting of only 500 or so superstores — if only considering the superstores, about 5/6 it current size, and as stated with no smaller outlets. You’d be fronting a single brand supported by the stronger, proven retail locations — and hopefully, with a substantially (like, 50-fold) increased percentage of these “new concept” stores.

The shift will require write-offs and investment in store upgrades …so even to get to what I might call “fighting weight,” Borders will have to spend more money that it doesn’t have. Money that in the current business climate it can’t even borrow at usurious rates. And some changes (closing stores, primarily, which requires breaking leases) can only be done under the auspices of the bankruptcy courts. And there are a lot of parties involved; this kind of reorganization may be impossible.

But I didn’t say it was possible, it’s just what I would do.

Borders may continue to muddle through. They may declare bankruptcy if only to have the option to close stores (I doubt they’ll do any of the more radical things on my list) while also attempting to get better terms on their current half-billion-dollar debt. And that may be enough.

The good news (if there is any) is that wrapped inside that debt and the legacy stores and the dross of 12 years of bad business decisions there is likely a core of at least 300 (& my guess is closer to 500) quality bookstores that make money and are vital parts of their communities.

It make take us a while to find them (and they may end up belonging to someone else when all is said and done) but for at least 50% of Borders customers the future will be just fine.

[disclaimer: in addition to his volunteer blogger duties in the service of fandom, the manga industry, and of the greater internet community — Matt also collects a paycheck from a company that competes with Borders. So there. Yeah. Grain of salt, and all that.]