What's Going On At Borders?

Sorry for the delay in getting back to this. Real life--and a contract--intruded.

A year ago, on 3/23, I posted this quote from the then-relatively-new Borders Group CEO, George Jones:

“We need to reinvent our business to exploit the rapid changes taking place in how consumers access information and entertainment,” Jones said. “Our ultimate goal is to make Borders a vital community gathering place where people come together to see, touch, interact, and learn – online and in-store.”

A few months later during an interview in May, Jones outlined five initiatives intended to revitalize Borders:

1) Taking back the Borders website from Amazon.com. Unlike Barnes & Noble, which had built an active and dynamic online presence, previous Borders' executives had turned to Amazon to run their website.

2) Selling off foreign stores. Borders retained Merrill Lynch to help them unload the majority of their 73 superstores overseas. Jones explained that Borders needed to focus its attention and capital on its U.S. superstores. He said the company would likely depend on a franchise model for overseas rather than a proprietary model. (They also decided to close 264 of their 564 Waldenbook stores.)

3) Developing prototype stores. Jones said the amount of the average transaction at Borders was up, but the number of transactions were down. In other words, there were fewer customers in the stores. He wanted to encourage more foot traffic in his stores.

4) Proprietary publications. On June 11, Borders released its first "exclusive and proprietary" title, Slip and Fall by Nick Santora. Jones had plans to do additional proprietary books, believing that if readers could only locate these books at Borders, it would drive traffic to the company.

5) Expanding the loyalty program. Jones said Borders made a mistake by not immediately responding when Barnes & Noble instituted its rewards program in 2000. Borders waited until February, 2006 to follow suit.

In the past year, Jones and his team set about implementing the above strategy. Last year, they closed 75 Waldenbook stores. In September, I reported the company had sold its British and Irish subsidiaries to a private equity firm in London. But, last week, a deal to sell their Australian and New Zealand operations fell through.

The sale of the foreign stores and the closing of the Waldenbook stores were intended to free up needed capital for both restructuring and the building of Borders' new concept stores.

Last month, on February 13, Borders unveiled its new prototype store in Ann Arbor, Michigan: "a store where shoppers can mix and burn CDs, explore their genealogies and even publish their own novels."

Unfortunately, the slowing U.S. economy and the tight credit market has made this a difficult time in which to raise capital. Borders' largest shareholder, Pershing Square Capital Management, stepped forward, agreeing to lend the company $42.5 million.

According to Publishers Weekly (PW), Pershing also "agreed to acquire Borders's Australian, New Zealand, Singapore and Paperchase subsidiaries for $125 million if Borders cannot find another buyer at a better price."

That help didn't come for free. PW reported: "Borders granted Pershing Square 14.7 million warrants to purchase company stock for $7 a share for up to seven and a half years, an amount of stock equal to nearly 20% of full diluted company shares (Borders stock closed yesterday [3/19] at $7.10, a low for the year and in the range of its opening price in 1995."

Warrants are similiar to options. In stock trading, if an investor believes a stock is going to go up in the short-term, he can buy an option. Let's say ABC stock is currently trading at $10 and the investor believes it is going to go up to $16 in the next six months.

Instead of risking the $10 a share (or $1,000 for 100 shares) he would have to pay now on just a hunch, he can buy an option. For simplicity's sake, let's say the option costs him $1/share, so for $100, he gets the right to buy 100 shares of ABC at any time in the next six months for its current price of $10.

If the stock goes up to $16, that means those 100 shares are now worth $1,600. The investor exercises his option and pays $1,000 for the shares. After you subtract the cost of the option, he has an immediate profit of $500 on paper (the current value of $1,600 less the $100 cost of the option).

However, if the hunch proves wrong and the stock goes down instead, the investor allows his options to expire. All he's lost then is the $100 cost of the options.

Options are short-term instruments--usually up to nine months. The main difference between an option and a warrant is that the warrants are longer-term instruments. They can last for years.

So, in exchange for its help, Pershing Square got the right to buy what would be in effect 20% of Borders' stock for the current price of $7/share. They protect their present investment by providing help to the company and, if the stock goes up in the next seven years, they can buy it at its present bargain basement price.

In his press release yesterday morning, CEO Jones said Pershing Square's support "gives us adequate opportunity to implement our plans this year and pursue a range of longer term solutions . . . We believe that consummation of the transactions under the commitment will make us fully funded for 2008, where absent these measures, liquidity issues may otherwise have arisen in the next few months."

And he suspended the company's dividend.

In the meantime, Borders did release its fourth quarter and 2007 results. The good news: in both the fourth quarter and, in the full year 2007, sales rose versus the same periods in 2006. For the fourth quarter, sales were up 2.8% to $1.3 billion. For the year 2007, sales rose 4.2% to $3.8 billion.

I'll talk more about this later . . .