Borders Group (BGP)

Pershing owns 10.6 million or 18% of outstanding shares, and David Dreman’s Value Management owns 4.8 million or 8% of outstanding shares. Citadel Investment Group also owns 3.2 million or 5.4% of outstanding shares (WSJ BGP Institutional Holdings)(subscription only). As on March 23rd 2008, Bill Ackman's Pershing Square Capital Management, Borders's largest holder, has entered into the following agreement with Borders.

If Pershing executes its 14.7 million warrants, it would own 25.3 million shares, or 33.6% of the total.

• A $42.5 million secured term loan to Borders at a 12.5% annual interest rate; the loan matures January 15, 2009.
• Pershing committed to a "backstop purchase offer" that gives Borders the option until January 15, 2009, to sell its Paperchase, Australia, New Zealand and Singapore units, and its 17% interest in Borders U.K. to Pershing for $125 million, "after the company has pursued a sale process to maximize the value of those assets."
• Borders will issue to Pershing 14.7 million warrants to buy shares at $7 each. That would be just under a 20% stake in Borders. The stake would be protected against dilution if Borders were to issue more equity, except for shares issued for employee stock options.

The proposal is binding on Pershing Square until April 4 2008. Borders has the right until then to seek better financing deals. If Borders finds a better deal, it can end the Pershing agreement with no break-up fee, although Pershing can request reimbursement of "reasonable expenses," Borders said.

That’s quite a list of value investors and turnaround specialists who combined own about one-third of Border’s outstanding shares. Furthermore, these holdings are as of the beginning of the year - before yesterday’s 40% haircut.

Fundamentally, the company isn’t making any money and it has a lot of debt: about $500 million net. On the other hand, same store sales have stabilized and been positive for three straight quarters.

More importantly, After Ackman exercises the warrants, his ownership of the chain will be 40% when you take into consideration his economic interest being held in "total return swaps." This ownership percentage will effectively give him total control of the chain. This is very good for shareholders. Let's not forget, Ackman began buying at $24, doubled down at $12 and now will pick up another chunk at $7. A key here is the dilution protection. Buying shares here can be done with as reasonable as can be expected assumption of no further dilution. That is important. One could probably assume that Ackman may be buying more now with the stock hovering around $5.50 a share. Overall, the possibility of a sale and the presence of these well-respected and highly successful value investors piques interest.

Borders filed its 8-K for Q4 this am.

Highlights:

• On a full-year basis, cash flow from operations improved by $128.6 million at year-end as SG&A expenses were reduced by $96.5 million and inventory was reduced by $326.8 million.

• Debt at year-end was reduced by $217.8 million to $336.2 million—a 39.3% reduction.

• Total consolidated 2008 sales were $3.2 billion, down 8.8% from 2007. For the fourth quarter, total consolidated sales were $1.1 billion, down 12.9% from a year ago.

• Comparable store sales for the fourth quarter at Borders superstores declined by 15.3% and declined by 4.7% at Waldenbooks Specialty Retail stores. For the full year, same-store sales declined by 10.8% at Borders and declined by 5.1% at Waldenbooks.

• On an operating basis, the company generated fourth-quarter income from continuing operations of $63.8 million or $1.05 per share compared to income of $74.3 million or $1.26 cents per share for the same period a year ago. On a GAAP basis, including non-operating charges, fourth quarter income from continuing operations was $28.9 million or $0.48 per share compared to income of $67.3 million or $1.14 per share a year ago.

“Our top priority is getting our financial house in order by continuing to reduce expenses, pay down debt and improve cash flow,” said Borders Group Chief Executive Officer Ron Marshall. “We are working with vendors and others to enhance cooperation and are pleased to have the continued support of our largest shareholder with the recently announced extension of our financing agreement with Pershing Square. At the same time, we are focused on driving sales through improved execution and by re-engaging with our customers. Borders is a strong brand with millions of loyal customers. I am confident that by shoring up our financial foundation and reclaiming our position as the bookseller for serious readers, we will ultimately secure a viable future.”

Fourth quarter consolidated sales were $1.1 billion, down 12.9% from a year ago. For the full year, consolidated sales were $3.2 billion, an 8.8% decrease from 2007. On an operating basis, Borders Group generated fourth-quarter income of $63.8 million or $1.05 per share compared to income of $74.3 million or $1.26 per share for the same period last year. On a GAAP basis, fourth-quarter income was $28.9 million or $0.48 per share compared to GAAP income of $67.3 million or $1.14 per share a year ago. The fourth quarter GAAP income includes non-operating charges—primarily non-cash—totaling $34.9 million. For the full year, on an operating basis, the company posted a consolidated loss of $16.2 million or $0.27 per share in 2008 compared to a loss of $0.4 million or $0.01 per share in 2007. On a GAAP basis, the full-year loss was $184.7 million or $3.07 per share, compared to a loss of $19.9 million or $0.34 per share in 2007. The GAAP full-year loss includes an after-tax, non-operating charge of $168.5 million, also primarily non-cash.

Excluding non-operating charges, SG&A as a percent of sales improved in the fourth quarter by 1.8% from 20.7% to 18.9% due to the company’s aggressive expense reduction initiatives, which were offset by de-leveraging due to negative sales trends. Expense reduction initiatives helped reduce SG&A dollar expenses by $52.1 million in the quarter. On a GAAP basis, SG&A as a percent of sales decreased in the fourth quarter by 0.3% from 20.6% to 20.3%. For the full year, SG&A as a percent of sales on an operating basis improved by 0.6% from 25.4% to 24.8% due to expense reductions, which drove an SG&A dollar decline of $96.5 million. On a GAAP basis, SG&A as a percent of sales for the full year increased by 0.4% to 25.9% compared to 25.5% in 2007. Operating cash flow improved in the fourth quarter by $18.3 million to $219.6 million compared to $201.3 million for the period in the prior year. For the full-year, operating cash flow improved by $128.6 million to $233.6 million from $105.0 million in 2007.

Full-year capital expenditures were $79.9 million compared to $131.3 million in 2007 as management took aggressive action to reduce capital expenditures. In the fourth quarter, capital expenditures totaled $6.2 million and further reduction is planned. Year-end debt totaled $336.2 million compared to debt at the end of 2007 of $554.0 million, a decrease of 39.3%. Inventory productivity improved as the company reduced its 2008 year-end inventory investment to $915.2 million compared to 2007 year-end inventory of $1.24 billion, a 26.3% reduction.

Borders Superstores

Total sales at Borders superstores in the fourth quarter were $816.1 million, down 14.8% from a year ago. For the full year, total sales were $2.6 billion, down 9.4% from 2007. In the fourth quarter, comparable store-sales decreased by 15.3% at Borders superstores with books generating same-store sales of -11.7% and non-book categories generating same store sales of -21.1% for the period. For the full year, comparable store sales at Borders stores decreased by 10.8% with books generating same-store sales of -8.2% and non-book categories generating same store-sales of -16.1%. Borders.com sales were $26.4 million in the fourth quarter and $45.7 million for 2008, which included eight months of operation.

Operating income on an operating basis in the fourth quarter was $86.5 million compared to $102.1 million for the same period a year ago. On a GAAP basis, operating income in the fourth quarter was $17.1 million compared to $87.4 million the prior year. For the full year, operating income on an operating basis was $17.7 million compared to $56.9 million in 2007. On a GAAP basis, there was an operating loss of $100.9 million compared to income of $30.6 million in 2007.

The company opened one new Borders superstore in the U.S. during the fourth quarter and closed five, ending fiscal 2008 with a total of 515 superstore locations.

Waldenbooks Specialty Retail

Total sales in the fourth quarter at Waldenbooks Specialty Retail stores were $195.6 million, a 14.3% decline compared to the same period in 2007. For the full-year, total segment sales were $480 million, a decline of 14.7% from the prior year. Comparable store sales in the fourth quarter decreased by 4.7% and decreased by 5.1% for the full year.

In the fourth quarter, on an operating basis, operating income was $16.0 million compared to operating income of $26.5 million for the same period in 2007. On a GAAP basis, operating income was $11.5 million compared to $25.5 million for the same period in 2007. For the full year, on an operating basis, the operating loss was $16.7 million compared to an operating loss of $17.3 million for the same period in 2007. On a GAAP basis, the full year operating loss was $27.5 million compared to an operating loss of $21.4 million for the same period in 2007.

The company closed 84 Waldenbooks Specialty Retail locations in the fourth quarter, bringing the fiscal 2008 closure total to 112. Borders Group ended fiscal 2008 with a total of 386 locations in this segment.

International

Total sales within the International segment (which consists primarily of Paperchase) totaled $43.2 million in the fourth quarter, which is down by 21.7% compared to a year ago. Excluding the impact of foreign currency translation, segment sales would have increased by 0.2% for the period. For the full-year, International sales were $136.7 million, down by 5.8% compared to 2007. Excluding the impact of foreign currency translation, sales would have increased by 4.7% for the year.

On an operating basis, operating income for the fourth quarter was $6.0 million compared to income of $7.0 million a year ago. On a GAAP basis, operating income in the fourth quarter was $5.5 million compared to income of $6.6 million the prior year. For the full-year, operating income on an operating basis was $4.5 million compared to $8.4 million in 2007. On a GAAP basis, full-year operating income was $3.7 million compared to $8.0 million in 2007.

When you look the results, it makes sense for Borders to keep Paperchase rather than put it to Ackman as was agreed to yesterday. It is a stable and profitable segment.

Yesterday I said I was looking for increased cash flow and cost cutting.debt reduction. All three have been accomplished and when one consider the environment out there, the near 40% reduction in debt and quite impressive.

Borders is on its way. Engineering a turnaround in the worst economic climate in 30 years in not easy. Clear progress is being made. It won't happen overnight, but, when the economy does rebound, a very lean and a far less debt laden Borders will turn results quickly.

Perhaps better marketing

Stock is oversold