Pershing Square: Buying Up Borders

Well, that didn't take very long. "Ask and ye shall receive" I guess?

On Wednesday, I posed some questions about Borders (BGP) and the next day, answers came piling in.

Bill Ackman's Pershing Square Capital Management, Borders's largest holder, has entered into the following agreement with Borders.

• 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. 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.

The company also reported results for the fourth fiscal quarter and full year 2007, ended February 2, 2008. As detailed below, on an operating basis, fourth quarter income from continuing operations was $84.7 million or $1.44 per share, compared to $87.7 million or $1.45 per share a year ago. Total consolidated sales from continuing operations were $1.3 billion in the fourth quarter. Excluding the impact of the extra week during fiscal 2006, this represents a 2.8% increase over the same period a year ago.

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.

Here is why all the above is good news. The equity stake by Ackman in Borders is a non issue because his interest in the chain is the same as mine. He is "eating his own cooking" when it comes to the company, as Berkshire's (BRK.A) Warren Buffett is fond of saying.

Were this an outside equity stake, we could not be sure what the intent of the holder was. The loan that is issued would take priority over the stock price but with the loan holder being Ackman, and he having an interest in 40% of the shares, the stock price will not be ignored.

Yes, the dividend was eliminated, but let's be honest, 11 cents a share ain't gonna buy a summer home. Keep it and get this going.

The question that was not answered was the online store. But, a look at the results there from Barnes and Noble (BKS) shows that there is definitely growth there (13%) apart from Amazon (AMZN).

All that being said, at $5 and change, time to pick it up...

Disclosure: Long BGP

Comments

[Bob'29]

In looking at the different components of a Border's store, I see: 1. Books, magazines and papers 2. Coffee, beverages and nicely done cakes with a great place to sit and read, and, 3. CD's which take up about a third of a store's floor space. I would guess that the CD aspect of Border's is an area that might be slowing to a greater degree than the rest of the business as time progresses. I would like to be a mouse in the corner as the negotiations of Border's restructuring takes place. Wouldn't it be great to see the nations biggest music seller, Apple, contract space at every Border's for music sales? Imagine: With every music purchase a customer makes, she or he gets a free ipod. This is another way to frame Apple's strategy to give unlimited music for a premium with the purchase of an ipod. Mr. Jobs goes to Border's! How about it Steve?

[warelf]

Hi Todd,

I agree with most of what you have written except that my biggest concern now is that the incentive for Ackman to take Borders private at a share price well below intrinsic value is huge. He more than doubles Pershing's return and halves the potential for small shareholders

[Bob'29]

I saw (somewhere yesterday) that Borders shares would still be reasonably valued at $26. per share. If Pershing picks up the store at half of this; it is double the share price today. Shareholders would do well to avoid a panic sell and hold on untill Borders intrinsic, current and future value reflects in its sale price. The Price to Book Ratio is now drastically discounted so to speak.

[Bob'29]

Mr. Ackman, the mouse in the corner that was carefully listening to the restructuring discussion reported back. As we anticipated and from reading above referenced documents; Borders music business is in need of some creative input. Here it is. My father supported our family with a busy music store which started in the 1940's. It saw the progression from sheet music to 78 rpm, to 33 rpm mono then stereo records. There were listening booths where a customer could take their long playing 33 rpm record, close the door, place it on the turntable and listen to hearts content. Most of the time it would result in a sale. One of the reasons cd's have gone flat in sales (besides iTunes) is that there is really no equivalent to the listening booth. How many times have you purchased a cd and really not liked it? It sits on your music rack lonely and unlistened. Apple could hybridize the iTunes world with the Borders world. Here's the plan: With the purchase of every iPod the buyer would receive six months of free weekly down loads, of say 12 songs or one jazz or classical work per week. The customer would come to Borders where they may or may not have purchased their iPod, to listen to the music that would potentially be downloaded. Many comfortable chairs and quality headphones await. While there, they might buy other music from iTunes, maybe a cd, book or just have coffee and meet friends. This plan would expand Apple's horizons to the 97% of Americans that don't yet have an iPod, increase music sales at Borders while using prime space that is currently languishing and create all important foot traffic in the stores. Borders has now created an incentive to counter the Amazon trend. It gives valued customer service, creates community and of course revenue for Apple and Borders. I'm sure Mr. Jobs and Mr. Ackman can work out the details of the merger.