Borders Explores Strategic Options; Receives Special Funding

Borders Group (BGP), the bookstore chain, reported earnings before yesterday morning's open and announced that it had retained JPMorgan (JPM) and Merrill Lynch (MER) to explore strategic alternatives. It has also arranged a special $42.5 million financing arrangement with its largest investor, Dan Ackman’s Pershing Square Capital, a prominent activist hedge fund (BGP 4Q Earnings Release).

Shares had already lost 2/3 of their value over the last year heading into today’s trading and were also got torched yesterday. They were down 40% to around $4.30 on huge volume (BGP 1 Year Chart (pdf file)).

The stock is interesting to me at this point. The company is struggling due to competition from online booksellers like Amazon (AMZN) and Barnes & Noble (BKS), a hefty debt load, a general cultural trend away from reading books, as well as the tough macroeconomic environment.

However, two prominent value investors are its largest shareholders: 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).

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.

Overall, the possibility of a sale and the presence of these well-respected and highly successful value investors piques my interest. I think it's worth nibbling at here, since it is hard to imagine things getting any worse and there could actually be some upside.

Disclosure: Top Gun is long shares of Border’s Group (BGP).

Comments

[bikini_martini]

Ackman (that's Bill not Dan) raped the company. He owns 10.6mm shares which he bought for a total price of about $180mm and in January he also got into a total return swap on 1.8mm shares at $9.72 which expires in Aug-09. If the stock traded at $11 the value of his position would be about $120mm (10.6mm shares x 11 + 1.8mm TRS x $1.18). So his fund would lose $60m mm on this investment, down some 33%. With the warrants, Borders essentially makes him whole, at $11 stock price the 14.7mm warrants struck at $7 are worth around $60mm so Pershing breaks even.

If things turn for the worse from here the company will have no access to liquidity and will have to exercise the put to Ackman on the international operations for $125mm. But thes are worth anywhere between $180mm and $240mm (6x-8x multiple on the $30mm EBITDA from these ops that management disclosed on the earnings call). So if the stock stays at $5, the $7 strike calls will expire worthless but Pershing will make $55-$115mm on the put option.

So it's a heads Pershing wings, tails Borders loses situation. I cannot imagine Dreman and Citadel being too happy about this. And by the way, while you are right that they have significant investments in Borders, if you look at the history of their holdings they got in '06 early '07 with the stock in the low 20s high teens and have actually been reducing their positions in Q4 '07 with the stock in the low teens. When they got into this stock a consumer recession was not in the stars but once the outlook soured they started cutting losses. My bet is that end of Q1 '08 they will be out (unless they want to have a fight with Ackman in court).

[Linda Anne]

'Shares had already lost 2/3 of their value over the last year heading into today’s trading and were also got torched yesterday. They were down 40% to around $4.30 on huge volume --I think you meant to say "AND GOT TORCHED YESTERDAY"

[bikini_martini]

Torched would mean that shareholder value went up in flames. It did not. It simply got transferred from other investors to Pershing. Stock closed 2 bucks lower on Thursday which is about $115mm value - this is probably how much Ackman's options were worth at grant.

[DanielJacome]

"Torched would mean that shareholder value went up in flames. It did not. It simply got transferred from other investors to Pershing"

Excellent and savvy point - thanks.

[Greg Feirman]

"Were also got torched" - LOL. Editing!!!

My original said "and are getting torched today as well" (www.topgunfp.com/borde.../).

Uhhh..... not using torched literally!!!!