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BGP AT A GLANCE

P/E ► -0.725   EV/EBITDA ► 21.1 HIGH ROA ► -12.4% LOW ROE ► -99.2% VERY LOW Debt to Equity ► 9.98 VERY HIGH Current Ratio ► 1.04 LOW Interest Coverage Ratio ► -2.53 LOW

 

 

 

 

 

 

Borders Group Inc. (NYSE:BGP) is the second largest U.S. based book retailer and the largest mall-based bookseller in the country. At November 1, 2008, the Company operated 522 superstores under the Borders name, including 519 in the United States and three in Puerto Rico. The Company also operated 467 mall-based and other bookstores, including stores operated under the Waldenbooks, Borders Express and Borders Outlet names, as well as Borders-branded airport stores. In addition, the Company owned and operated United Kingdom-based Paperchase Products Limited (“Paperchase”), a designer and retailer of stationery, cards and gifts. As of November 1, 2008, Paperchase operated 117 stores, primarily in the United Kingdom, and Paperchase shops exist in 333 domestic Borders Superstores. In addition, the Company operated a proprietary e-commerce Web site, Borders.com, which was launched in May of 2008. ^[1] The company looks to close about half of its mall-based stores and all but a few of its international outlets in 2008 and 2009 to concentrate on its core U.S. superstore business.

In recent years, the company has been in the crossroads of several potent negative trends:

• Younger generations of Americans are increasingly adopting digital media such as MP3s, online video, and video games, which have both direct impacts on the sales of traditional media such as CDs and DVDs, and indirect effects as well (more distractions means less time for reading books).
• Compounding this digital effect is the onslaught from e-commerce companies such as Amazon.com (AMZN), which have the ability to significantly undercut brick and mortar retailers' prices on books, CDs, DVDs and other offerings. Borders will be launching its own e-commerce offering in 2008, many years behind its key competitors.
• Finally, Borders is the largest mall-based book retailer in the U.S. at a time when mall-based retail is slowing down in the face of one-stop-shopping at stores such as Wal-Mart Stores (WMT) and Target (TGT)

Business Financials

Borders makes money through the sale of books and CDs as well as its in-store Seattle's Best Coffee brand cafes and Paperchase gift and stationery shops. As seen in the pie chart, two-thirds of its sales came from its flagship Borders retail outlets, with the remaining one-third split evenly between its specialty Waldenbooks retail stores and international sales, both of which took operating losses in FY 2006.

Borders 2008 showing

Borders posted a loss of 53 cents per share vs a 63 cent loss last year. Same-store sales at Borders U.S. superstores, or sales at stores open at least a year, fell 4.1 percent. Total consolidated sales, at $784.7 million, were down 1.0% over a year ago. At Borders domestic superstores, comparable store sales for the period decreased by 4.1%. Without the impact of music, same-store sales at Borders domestic superstores decreased by 1.7% for the quarter. The music decline was expected as Borders has made the decision to dramatically scale back operations there.

The debt was reduced to $591.9 million at the end of the first quarter from $722.8 million at the end of the year-earlier quarter and cash flow improved by $133 million.

Borders 2007 showing

Some information from the just-released Borders (BGP) 10-K.

• Achieved average sales per square foot of $228 and average sales per superstore of $9.6 million.
• International superstores, which operate under the Borders name, achieved average sales per square foot of $381 and average sales per superstore of $8.3 million in 2007.
• Waldenbooks Specialty Retail operates stores under the Waldenbooks, Borders Express and Borders Outlet names, as well as Borders-branded airport stores. Average sales per square foot were $277 and average sales per store were $1.1 million for 2007
• Borders leases all of its stores. Borders store leases generally have an average initial term of 15 to 20 years with multiple three- to five-year renewal options. At February 2, 2008, the average unexpired term under Borders existing store leases in the United States was 9.8 years prior to the exercise of any options. The expiration of Borders leases for stores open at February 2, 2008 are as follows:
• Waldenbooks Specialty Retail store leases generally have an initial term of five to 10 years, and in certain cases posses renewal terms of one to three years. At present, the average unexpired term under Waldenbooks Specialty Retail existing store leases is approximately 1.7 years.
• Borders has $92.2 million remaining on a share repurchase authorization but cannot repurchase them if borrowings under credit agreement exceed 90%.
• Borders Rewards has grown to over 25 million members.

Again, nothing earth shattering which is a nice disclosure sign.^[2]

Flagging 2006 Strategies

Over the past few years Borders strategy has been to invest in domestic expansion and superstore remodeling, moving floor space away from the weaker music segment, though this strategy failed to boost store traffic and transactions sufficiently to meet projected sales targets in 2006^[3].

The international segment lost money in 2006, and as a result, in 2007, the company Borders is paring down their international and Waldenbooks segments and reducing investments in domestic expansion and remodeling to focus on their core superstore business^[4]. The company reported negative income in FY 2006 because Borders took a charge to write down the value of some of their U.K. investments and specialty retail stores as well as some of the Borders superstore assets^[5].

Trends and Forces

Increasing Online Competition

Part of the reason for declining sales growth in brick and mortar stores is the continuing increase in competition from online retailers, which take business (and margin) from brick and mortar sales. In the past, Borders has partnered with Amazon.com (AMZN), letting Amazon operate the websites of its subsidiaries in return for referral fees^[6]. In 2008, however, Borders is planning to take control of its own online store, Borders.com, ending the relationship with Amazon.com (AMZN)^[7]. Revenue from online sales accounted for a tiny portion sales under the partnerhip, as Amazon's online referral fees accounted for 1.2% of total revenue in 2006.

Borders (BGP) has turned on its website today after a seven year absence. The central feature at Borders.com is called the "Magic Shelf". Borders says the shelf captures the essence of shopping in one of its stores. Books are placed cover out and side by side on the shelf. Shoppers can move up or down and from side to side. Roll the cursor over a book and a box with details about it pops up. The shelf can be customized by the user and can show 20 shelves of titles and offers "just for you" picks based on past purchases.

Dependence on Bestsellers

Widespread availability of popular products online, at mass merchants (e.g., Wal-Mart Stores (WMT), at wholesale clubs (e.g., Costco Wholesale (COST) and elsewhere has forced traditional booksellers like Borders to cut prices significantly (up to 40% off suggested retail price for hardcovers) to keep customers coming into their stores. This price slashing has led to diminished margins in an important area of the book selling business. The impact of a single bestseller can greatly affect sales growth; for example, Waldenbooks comparable store sales declined 7.5% from 2005 to 2006 due primarily to the 2005 release of a popular Harry Potter title^[8].

This dependence on bestsellers is much more significant at mall-based stores compared to their superstore counterparts and Borders has a much greater exposure in to mall-based retailing compared to main competitor Barnes & Noble (BKS), which sold off most of its B. Dalton mall locations.

Digital Media Adoption

Younger generations of Americans are less interested in reading books than their older counterparts, having grown up in an era with more entertainment options. The advent of new digital distractions such as mp3s, online video and video games has led to decreased interest in more traditional forms of entertainment such as CDs and books. Borders saw comparable same store sales of CDs decline 15.1% from 2005 to 2006^[9].

Increasing Sales and Profitability

Borders continues to focus on improving key retailing practices at its domestic superstores, including increasing effectiveness of merchandise presentation, improving assortment planning, replenishment and supply chain effectiveness, and ensuring consistency of execution across the chain. A key component in this strategy is the development of a concept store, 14 of which opened during fiscal 2008, which included 12 new stores and two relocations. The concept store includes the implementation of “destination businesses” within certain of the company’s most popular categories, which will help to distinguish the company’s domestic superstores from competitors. To address declining sales in the music category, as well as increasing space available for improved merchandising presentation and expansion of higher margin categories, Borders has reduced inventories and reallocated floor space in its stores and will continue to do so as appropriate. ^[10]

Member Programs Increase Consumer Loyalty

Started in 2006, the Borders Rewards program has over 30 million members^[11]. Discounts for buying Borders products incentivizes customers to make Borders their destination, increasing brand loyalty. Members can earn Borders Bucks in increments of $5 for each cumulative $150 they spend on qualifying purchases in a calendar year at Borders and Waldenbooks stores nationwide. Borders Bucks expire 30 days after receipt by the member if not redeemed. The Borders Rewards program is free, with no enrollment costs or annual fee, and has been reworked to provide more frequent payouts to a wider variety of customers. On the other hand, competitor Barnes & Noble's member program is not free and charges an annual fee. ^[12]

Competition

Borders faces its main competition from other retail superstores as well as online booksellers. Retail giants like Wal-Mart and Target also compete with Borders in the market for books. Despite underlying negative industry trends, Borders (and competitor Barnes & Noble) have been gaining marketshare through the superstore format, and Borders is continuing to focus on this area by re-branding some of its Waldenbooks stores under the Borders Express name and closing the under performing Waldenbooks locations. In regards to offline book sales, Borders commanded a market share of about 21% and competitor Barnes & Noble had a market share of about 28% as of the 3rd quarter of 2005,

Traditional Retailers

Barnes & Noble (BKS): Barnes & Noble is the largest U.S. book retailer, operating almost 700 superstores. Borders' main competitor, Barnes & Noble may have a chance to expand its lead as Borders focuses on closing certain Waldenbooks stores and disposing of its international business. Barnes & Noble is less exposed to the decline in mall-based retailing than BGP, as it sold off most of its B. Dalton mall-based stores. BGP, on the other hand, is the largest mall-based book retailer in the U.S.

Books-A-Million (BAMM): Book retailer primarily in the southeastern U.S. operating 179 superstores.

E-Commerce

Amazon.com's huge bookselling arm partnered with Borders using an affiliate model, which contributed 1.2% of sales in 2006. Amazon was the merchant of record for all sales made through their web site, and determined all prices and other terms and conditions applicable to such sales. Amazon was responsible for the fulfillment of all products sold through the Web Sites and retained all payments from customers. Borders received referral fees for products purchased through the Amazon website. ^[13]

Borders e-commerce web site launched in May of 2008, terminating their Amazon agreement, and the in-store e-commerce kiosks were introduced into Borders stores during the fourth quarter of 2008. This strategy allows the Borders to engage in key partnerships that are expected to build incremental revenues and margins, connect e-commerce sales to the Company’s Borders Rewards loyalty program and integrate Borders.com and its domestic Borders Superstores, creating a cross-channel experience for customers. ^[14]

Retail Megastores

Wal-Mart Stores (WMT) and Target (TGT) are the main retail megastores that sell everything from books and CDs to groceries. These retail giants have had an impact on the market for books. Bookselling is not a part of these companies' core business, but the increased availability of popular titles at these stores has led in part to the diminished margin on bestsellers.

Pershing Square Capital Management

On April 9, 2008, Borders completed a financing agreement with Pershing Square on behalf of certain of its affiliated investment funds. Under the terms of the agreement, Pershing Square has loaned $42.5 million to the company and will purchase, at the Borders discretion, certain of the company’s international businesses pursuant to an initial $135.0 million backstop purchase commitment. ^[18]

The financing agreements consists of the following components:

1. A $42.5 million senior secured term loan maturing January 15, 2009 with an interest rate of 9.8% per annum. The term loan is secured by an indirect pledge of approximately 65% of the stock of Paperchase pursuant to a Deed of Charge Over Shares. ^[19]

2. A backstop purchase offer that gives Borders the right but not the obligation, until January 15, 2009, to require Pershing Square to purchase its Paperchase, Australia, New Zealand and Singapore subsidiaries, as well as its interest in Bookshop Acquisitions, Inc. (Borders U.K.) after the Company has pursued a sale process to maximize the value of those assets. Pursuant to this sale process, the Company sold its Australia, New Zealand and Singapore subsidiaries during the second quarter of 2008 to companies affiliated with A&R Whitcoulls Group Holdings Pty Limited. Pershing Square’s remaining obligation to purchase the Borders remaining U.K. subsidiaries remains in effect until January 15, 2009. Pershing Square’s purchase obligation for the U.K. subsidiaries is at a price of $65 million. Proceeds from the purchase by Pershing Square are to be first applied to repay amounts outstanding under the $42.5 million term loan. ^[20]

3. The issuance to Pershing Square of 14.7 million warrants to purchase the Company’s common stock at $7.00 per share. The warrants will be cash-settled in certain circumstances and have a term of 6.5 years. ^[21]

On December 22, 2008 Borders announced that they had reached an agreement with Pershing Square to extend the expiration date of the previously announced Borders option to buy its U.K.-based Paperchase gifts and stationery business for $65 million, subject to certain conditions. The "put" option was due to expire January 15, 2009, but has been extended until February 16, 2009. Consequently, the deadline for repayment of the $42.5 million senior secured term loan, which was originally payable to Pershing Square on January 15, 2009, has also been extended to February 16, 2009. Other terms of the "put" option and the term loan remain unchanged except that the approximately $1 million loan repayment premium that Borders is required to pay Pershing upon repayment of the $42.5 million loan remains due no later than January 15, 2009. ^[22]

Footnotes

1. ↑ Sec Filing
2. ↑ ValuePlays Research
3. ↑ Borders Group (BGP) Annual Report, Fiscal year 2006, "Shareholders' Letter", p. 2
4. ↑ Borders Group (BGP) Annual Report, Fiscal year 2006, "Shareholders' Letter", p. 2
5. ↑ Borders Group (BGP) Annual Report, Fiscal year 2006, "Shareholders' Letter", p. 2
6. ↑ Borders Group (BGP) Form 10-k, Fiscal year 2005, "Selected Financial Data", p. 20
7. ↑ >Borders Group (BGP) Annual Report, Fiscal year 2006, "Shareholders' Letter", p. 4
8. ↑ Borders Group (BGP) Form 10-k, Fiscal year 2006, "Selected Financial Data", p. 21
9. ↑ Borders Group (BGP) Form 10-k, Fiscal year 2006, "Selected Financial Data", p. 21
10. ↑ Sec Filing
11. ↑ Borders Group (BGP) Quarterly Report, Third Quarter 2008, "Shareholders' Letter", p. 3
12. ↑ Sec Filing
13. ↑ Sec Filing
14. ↑ Sec Filing
15. ↑ Barnes & Noble (BKS) Form 10-k, Fiscal year 2006, "Selected Financial Data", p. 43
16. ↑ Borders Group (BGP) Form 10-k, Fiscal year 2006, "Selected Financial Data", p. 21
17. ↑ Books-A-Million (BAMM) Form 10-k, Fiscal year 2006, "Selected Financial Data", pp. 6-8
18. ↑ Sec Filing
19. ↑ Sec Filing
20. ↑ Sec Filing
21. ↑ Sec Filing
22. ↑ Press Release