|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||680||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
Borders (BGP), the book superstore is a balance sheet improvement plus margin expansion story that should play out in the next two years. During this time, management will generate significant cash from improving working capital, divesting the international business and closing money losing Waldenbooks locations. Additionally, through several initiatives management will improve domestic superstore margins.
The stock has dropped a fair amount since June as turnaround stories fell out of favor. As a result, under very reasonable scenarios there should be 70%+ upside from current levels and little downside. Using even more conservative assumptions than management’s recently announced strategic plan will result in the company trading at 3.5x EBITDA and single digit P/Es in a couple of years.
Management expects about $235MM of cash will be generated by improving inventory turns and liquidating underperforming Waldenbooks stores by the end of 2009. Additionally, management believes that there ultimately could be significant upside from even further working capital progress. BGP’s current systems are clearly dated and inefficient. For example, buyers have no open to buy and can only screen stores 25 at a time – it’s a manual process vs. Barnes and Nobles’ automatic replenishment. This is basic blocking and tackling. Management appears to be making progress on its inventory in the latest two quarters and in our recent conversations seems to be more focused/confident than ever on turning its inventory into cash over the next couple of years. A new CIO was hired in August. It should be noted, that Borders is not trying to “reinvent the wheel,” but rather just to employ the same type of systems that have long been successfully used by Barnes and Noble. For conservatism’s sake, our model is run at $185MM of cash generated from working capital initiatives and Waldenbooks. Beyond the Borders’ working capital initiatives, the company should roughly generate an incremental $100MM in cash from the divestiture of its international unit.
Turning to margins… Domestic superstore EBITDA margins were close to 10% a couple of years ago; now they are in the depressed zone of 6.0%. By way of comparison, Barnes and Noble is currently running at about 8.0%, and expecting to grow margins over time. Borders’ goal is to return domestic superstore margins to 9% by 2009. For conservatism’s sake, our model is run at 8.0%. The margin improvements should come largely from some mix shift initiatives. First, the company is expanding the amount of real estate it devotes in each store to Paperchase, a division of Borders that sells stationary, cards and gifts. Paperchase has high single digit comps and the best margins in the store. Borders’ Cafés are another growing piece of the company with high margins. Helping matters even more, the real estate being turned over to Paperchase and Borders’ Cafés is coming from the struggling music department. Also enhancing margins, the company is planning on doing more self-publishing (could mean as much as 50 bps) and stocking more bargain books. These initiatives are all underway. There is also some level of excess costs (internet site development spending with no earnings offset, which will change in Q1 of next year) and higher than targeted shrinkage/café waste levels that are flowing through the margin line as well.
Borders also has a formidable asset in its rewards program where it has 5x (22MM) the number of members as Barnes and Noble. On average, Borders gains 140,000 new members a week. Borders’ program is free to join while Barnes and Nobles charges $25 annually. Management is considering charging a fee for its reward membership program. We are not modeling any revenues from such a fee, but we do think it is reasonable to believe rewards members will pay something for a Borders membership. If Borders successfully charged half of those members an annual fee of $2.50/year, EBITDA would increase $27.5MM (which would take margins up 90 bps). Most importantly, the rewards program is helping generate traffic and loyalty (traffic has increased in 22 out of the last 23 weeks).
There is a significant international franchising opportunity for Borders and management is ramping up this effort. A hypothetical example of the impact – 50 franchised stores at $5.8MM each of annual sales and a 4% royalty rate could mean $11.6MM of income (this would take the margins up 40 bps). This opportunity is not in our numbers.
Management has recently stated that Borders is on or ahead of plan with its balance sheet and margin initiatives, and the CEO recently bought a decent amount of shares. Furthermore, on the latest conference call he said he plans to buy even more stock. When all is said and done, we think the company should trade for at least 5.5x-6.0x EBITDA, and a reasonable case can be made for a higher multiple. At 5.5x 2009 EBITDA, you would have a $20 stock or 83%+ upside including dividends (there is currently a ~ 3.8% dividend yield) using our 8.0% domestic superstore EBITDA margin.
There are other ways to win. If the private equity market ever restarts, Borders is a solid LBO candidate at much higher prices. Financing high quality inventory that can be put back to publishers is obviously more doable than leveraging other retail situations. Since a lot of the value creation is executing on the inventory front, this is something that a private equity firm should feel more comfortable hanging an investment thesis on vs. hoping for higher multiples and dividend recaps. Also, Borders has strategic value for Barnes and Noble (which could unlock a great deal of the purchase price very quickly by reducing the working capital). The Whole Foods saga ended favorably and there have been rumors in the past about Barnes and Noble being interested in Borders. Finally, Paperchase could be spun-off at a decent price.
|Entry||11/22/2007 10:07 PM|
|1) How'd you calculate the # of B&N members, the company doesn't break out the number. |
2) What do you think of BKS as an investment instead of BGP? When I looked at the situation I thought that BKS was the less risky way to go, although I'd admit that BGP has higher upside potential, I'm just curious on what your thoughts are.
|Entry||11/25/2007 12:39 PM|
|Thanks for the questions. |
BKS doesn’t break down the domestic superstore margins but based on conversations with management about the margins on the other business lines you can back into it. As a result, I’ve estimated the internet business is around a zero margin, B Dalton at around 4%. Basically, BGP is trying to emulate BKS’ overall mix so the overall margins should get to the same place if they execute.
We own BKS too and think its worth at least in the mid 40s in the next two years. With a much cleaner balance sheet, there is definitely less risk than BGP. Given where BGP is trading now relative to the upside and my thoughts on the downside – I think its the more compelling of the two. Especially since BKS has recovered a bit from hitting $30 in early August.
|Subject||Rewards Program, etc|
|Entry||12/10/2007 05:17 PM|
|I'm a bibliophile and also owned a very small publishing company for a while. I frequent Borders and B&N a lot. |
I find that the Borders Rewards program is pretty useless. It is free because it is not worth charging for. The discounts are minimal. The B&N Rewards program, while costing approx $25 annually, is a good deal if you are a heavy book buyer. Thus I direct most of my in-store book purchasing to B&N, not Borders.
Other reasons I mostly go to B&N is because the background music is not obnoxious and the stores (especially the bathrooms) are better maintained.
It's ironic that Borders inventory systems are now so antiquated. I remember that 'back in the day' their inventory systems were leading edge and that was a big competitive plus for them.
Borders almost invented the superstore concept. The first time I shopped at a Borders, it was as if I had stepped into heaven. It is so sad to see how far they have slipped.
|Entry||12/31/2007 09:12 AM|
Borders Inc. is the 2nd largest operator of book, music and movie superstores and the largest operator of mall-based bookstores in the world based upon both sales and number of stores. As of 11/3/07, the Company operates 538 Superstores under the Borders name, including 510 in the
The Company is organized based upon the following operating segments: Domestic Borders Superstores, Waldenbooks Specialty Retail Stores, International Stores (inc. Borders, Books etc. and Paperchase stores), and Corporate. Borders superstores average 24,800 sq ft in size, including approximately 13,000 square feet devoted to books, 2,900 sq ft devoted to music, 800 sq feet devoted to newsstand and 900 sq feet devoted to movie; however, the Company has taken steps to remodel their stores to reduce the space devoted to music. In addition, the Company devotes approximately 1,400 sq feet to a café in virtually all Borders superstores. In 2004, the Company entered into a licensing agreement with
Waldenbooks Specialty Retail operates small format stores in malls, airports and outlet malls, offering customers a convenient source for new releases, hardcover and
paperback bestsellers, periodicals and a standard selection of other titles. Waldenbooks stores average approximately 3,800 sq feet in size, and carry an average of 19.000 titles, ranging from 9,000 in an airport store to 31,500 in a large format store.
International superstores, which operate under the Borders name range between 13,500 and 42,400 sq feet, and are located in both city center as well as suburban locations. All International superstores offer books, music, movies and gifts and stationery merchandise and feature cafes. Cafes located in the
The Company launched Borders Rewards during the 1Q of 2006. Membership in Borders Rewards is free, with no enrollment costs or annual fees. Borders Rewards was a program in which 5% of all qualifying purchases made by members throughout 2006 were credited to personal Holiday Savings accounts, which were used on holiday purchases made from November 15 – January 31. Moreover, on April 12, 2007 the Company replaced the program's previous members benefits with Borders Bucks, 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.
The Company, through its subsidiaries, has agreements with Amazon.com to operate Web sites utilizing the Borders.com and Waldenbooks.com URLs (the Websites). Under these agreements, Amazon is the merchant of record for all sales made through the Web sites, and determines all prices and other terms and conditions applicable to such sales. Amazon is responsible for the fulfillment of all products sold though the Web Sites and retains payments from customers. The Company receives referral fees for products purchased through the Web Sites. This arrangement is being terminated at the end of this fiscal year. The Company plans to launch a proprietary e-commerce site in early 2008.
We believe that Borders Group has not found a balance between promotions and sales / traffic in their domestic superstores and that gross margin will continue to erode significantly in the fourth quarter of fiscal year 2007 and beyond. Management has cited an increase in traffic to their domestic stores because of their growing 22 million Borders Rewards group membership; however, the lack of annual membership or enrollment costs provides no extra revenue, while the discounts that the members redeem continue to impact gross margin. In the 3Q 20