Thursday, March 20, 2008

Borders Seeks "Strategic Review"

The long wait is over. Borders has announced they are seeking advice from Merrill Lynch and J.P. Morgan to seek alternatives that will "maximize shareholder value." The company has been preparing itself for this moment for the past year or so since George Jones became CEO and began dismantling the international operations and conducting a wholesale review of the Borders and Walden operations. Over the past year, Pershing Capital Advisors, an investment firm, has purchased 18% of the shares of the company and with today's announcement they are also bailing out Borders with a loan of $42.5million to shore up the company's finances. Earlier this month, the company announced that they had failed to agree terms with Pacific Equity Partners to sell the Australian and New Zealand store operations. The sale was widely expected to generate over $100mm in purchase price.

This capital commitment comes at quite a price. Firstly, they will be paying 12.5% interest. Secondly, Borders has agreed to sell them the Paperchase and Australia and New Zealand operations and the 17% interest they hold in the UK operation if Borders is unsucessful in selling them to a third party. CEO Jones has been consistent in viewing Paperchase as important to the growth of Borders and a key component of their evolving merchandising strategy. To consider selling it appears a sign of desperation. As mentioned the A/NZ operations may have been worth $100mm but there was only one real buyer. Without competition how much is this operation worth? The UK interest is essentially worthless given the sale price of the whole business. If worse comes to worse and Pershing ends up buying these assets for $125mm they will appear to have gained a bargain since even Borders management state that they believe the value of the assets is far in excess of the $125mm. (If I read the press release correctly, on receiving the $125mm Borders immediately must pay back the $42.5mm loan: that nets to $82.5mm). Pershing is likely to prefer the whole company rather than the parts.

In addition to the capital commitment Pershing is also gaining warrants that equate to 19% of the company's shares. This amount plus the shares they already own (and Jones' shares) must mean they will effectively control the company once the deal is finalized on or before April 4th. (They would have to exercise the warrants).

Shares in the company closed just above $7 which values the company at $400mm. Pennies really considering managements belief in the value of the pledged assets (Paperchase etc.). Investors are expecting something to happen to the stock as it has ticked up $1 in pre-open trading.

The company also announced full year results with total consolidated sales from continuing operations of $3.8 billion for the full year 2007. On an operating basis, Borders Group posted full-year consolidated income from continuing operations of $9.2 million, or $0.16 per share, compared to $33.0 million, or $0.53 per share a year ago. The company has previously noted write-offs associated with the sale of the UK operation and non-operating investments in their web relaunch that total $125mm and $28mm respectively. On a GAAP basis the full year net income loss was $157.4mm.

Their fourth quarter numbers with revenue up almost 3% and net income flat with last year should give investors some belief that operating changes put in place by CEO Jones may be working. However, it is early in his term and he has only recently filled all his key executive positions. With a volatile economic situation it remains to be seen how successful the company will be over the medium to long term. Certainly operating outside the glare of the financial markets will help turn Border's around and it seems to me that that is where the company is headed.

More from the press release.

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