Borders Group, Inc. BGP S
January 02, 2008 - 1:56pm EST by
kejag700
2008 2009
Price: 10.85 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 637 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT
Borrow Cost: NA

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Description

Company Overview:
 
Store Base
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 US, 20 in Australia, 4 in New Zealand, 3 in Puerto Rico, and 1 in Singapore.  The Company also operates 521 mall-based and other bookstores, including stores operated under the Waldenbooks, Borders Express and Borders Outlet names, as well as Borders-branded airport stores.  Also, the Company owns and operates 110 Paperchase stores, a designer of stationery, cards and gifts located primarily in the UK.  Barnes & Noble, Borders’ principal competitor, operates approximately 700 stores and generated revenue of $5.4 billion for the last twelve months versus approximately 1,000 stores and $4.1 billion in sales for Borders during the same time.
 
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 Seattle's Best Coffee, a wholly-owned subsidiary of Starbucks Corp, through which the Company will sell Seattle's Best Coffee-branded products in substantially all the Company's existing Borders superstores.
 
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 UK are licensed to and operated by Starbucks (UK). Cafes located in Australia and New Zealand are licensed to and operated by Gloria Jeans Coffees.   
 
Marketing
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. 
 
Thesis:
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 2007 earnings call, CEO George Jones commented on reducing their coupon offering from 30% to 25% or 20% etc…trying to find the balance between promotion and gross margin.  During the weeks leading up to Christmas, Borders has offered members coupons for 25%-40% off. 
 
In addition, the Company has had problems with their Seattle’s Best Cafes and DVD shrinkage in the domestic superstores, citing a $5.5MM gross margin hit in the Q3 2007 vs. Q3 2006.  The CFO addressed this in their latest conference call and has stated they are going to address the inventory waste in their Cafes going forward, but we believe this will still have a negative impact on gross margins in 4Q 2007 and beyond.  Moreover, the Company has experienced shrinkage in DVD sales, which started back in Q1 2006 when the Management decided to unlock all of the DVDs in the stores and eliminated a number of physical inventories.  The new plan is to lock them back up in the stores with cases and with new spider technology.  These changes are not going to affect the continued loss in gross margin in Q4 2007. 
 
We are skeptical of the returns that Management expects from the launch of the website in Q1 2008.  There is significant competition from Amazon.com as well as BarnesandNoble.com, which the Company is going to have to address.  Since Borders’ customers have been automatically directed to Amazon.com for online purchases in the past, many Borders customers automatically navigate to Amazon, and Amazon will not now direct them to the new Borders web site.  Borders will have to spend substantially more capital on advertising or promotions in order to promote their new website and drive traffic, which will negatively impact margins going forward as well.  Essentially, Borders has to win back their own online customers, and many will just stay with Amazon.  
 
Valuation
Borders essentially loses money all year until the critical holiday buying season.  The pressure on gross margin over the past six weeks will likely be very problematic.
 
Historical Financials    FYE 2/3/07
($ in millions)          
    1Q      2Q            3Q 4Q FY
   4/29/06     7/29/06  10/28/2006 2/3/2007 2/3/2007
 
Total Revenue $867.8 $866.3 $860.4 $1,519.0 $4,113.5
COGS 667.1 661.5 675.3 1,061.3 3,065.2
Gross Profit $200.7 $204.8 $185.1 $457.7 $1,048.3
SG&A  225.4 223.3 235.2 303.7 987.6
 
Operating Income (loss) ($27.2) ($22.8) ($54.9) ($31.9) ($136.8)
Interest Expense 5.4 7.7 9.3 10.0 32.4
Income(loss) before Income Tax ($32.6) ($30.5) ($64.2) ($41.9) ($169.2)
Income Tax Provision (12.4) (12.1) (25.1) 31.7 (17.9)
Net Income(Loss) ($20.2) ($18.4) ($39.1) ($73.6) ($151.3)
EPS (Diluted) ($0.31) ($0.29) ($0.64) ($1.25) ($2.44)
EBITDA $3.4 $10.3 ($21.6) $187.3 $179.4
 
Gross Margin % 23.1% 23.6% 21.5% 30.1% 25.5%
EBITDA Margin % 0.4% 1.2% (2.5%) 12.3% 4.4%
SG&A & Other as % of Sales 26.0% 25.8% 27.3% 20.0% 24.0%
 
In our model, we have made the following assumptions for Case 1:
  1. Increase of 4 new Domestic Borders Stores bringing Total Domestic Borders stores to 514 in 4Q 2007.
  2. Domestic Revenue per store of $1.89MM quarterly which is the average increase from 3Q to 4Q of the last 3 fiscal years experienced by Borders Domestic stores.
  3. Decrease Waldenbook Stores by the targeted 50 store count by management bringing the total to 471 stores in 4Q 2007.
  4. Waldenbook revenue per store of $0.47MM quarterly which is the average increase from 3Q to 4Q of the last 3 fiscal years experienced by Waldenbook Stores.
  5. 28 International Stores remain.
  6. International Revenue per store of $4.07MM quarterly which is the average increase form 3Q to 4Q over the last 3 fiscal years.
  7. We have assumed a 1% decrease in Gross Margin from Q4 2006 to Q4 2008.
  8. We have assumed SG&A to be the same 20% of Sales in Q4 2007 as it was in Q4 2006.

FYE 2/3/08

($ in millions)          
Q1 Q2 Q3 Q4(E) FY(E)
   5/5/2007  8/4/2007 11/3/2007 2/3/2008 2/3/2008
   
Total Revenue $885.8 $956.7 $813.6 $1,329.5 $3,985.6
COGS 689.0 729.9 637.4 929.3 2,985.6
Gross Profit $196.8 $226.8 $176.2 $400.2 $1,000.0
SG&A  243.6 254.9 229.4 265.9 993.8
   
Operating Income (loss) ($48.9) ($30.3) ($56.2) $130.5 ($4.9)
Interest Expense 9.9 11.5 12.3 11.0 44.7
Income(loss) before Income Tax ($58.8) ($41.8) ($68.5) $119.5 ($49.6)
Income Tax Provision (22.9) (16.7) (26.8) 46.6 (19.8)
Net Income(Loss) ($35.9) ($25.1) ($41.7) $72.9 ($29.8)
EPS (Diluted) ($0.61) ($0.43) ($0.71) $1.23 ($0.51)
EBITDA ($20.1) ($1.3) ($27.8) $163.4 $114.2
   
Gross Margin % 22.2% 23.7% 21.7% 30.1% 25.1%
EBITDA Margin % (2.3%) (0.1%) (3.4%) 12.3% 2.9%
SG&A & Other as % of Sales 27.5% 26.6% 28.2% 20.0% 24.9%
 
Case 2 Model Assumptions are the same except we decrease Gross Margin to 29.6%
($ in millions)          
Q1 Q2 Q3 Q4(E) FY(E)
   5/5/2007  8/4/2007 11/3/2007 2/3/2008 2/3/2008
   
Total Revenue $885.8 $956.7 $813.6 $1,329.5 $3,985.6
COGS 689.0 729.9 637.4 936.0 2,992.3
Gross Profit $196.8 $226.8 $176.2 $393.5 $993.3
SG&A  243.6 254.9 229.4 265.9 993.8
   
Operating Income (loss) ($48.9) ($30.3) ($56.2) $123.8 ($11.6)
Interest Expense 9.9 11.5 12.3 11.0 44.7
Income(loss) before Income Tax ($58.8) ($41.8) ($68.5) $112.8 ($56.3)
Income Tax Provision (22.9) (16.7) (26.8) 44.0 (22.4)
Net Income(Loss) ($35.9) ($25.1) ($41.7) $68.8 ($33.9)
EPS (Diluted) ($0.61) ($0.43) ($0.71) $1.17 ($0.58)
EBITDA ($20.1) ($1.3) ($27.8) $156.8 $107.6
   
Gross Margin % 22.2% 23.7% 21.7% 29.6% 24.9%
EBITDA Margin % (2.3%) (0.1%) (3.4%) 11.8% 2.7%
SG&A & Other as % of Sales 27.5% 26.6% 28.2% 20.0% 24.9%
 
Case 3 Model Assumptions are the same except we decrease Gross Margin to 29.1%
($ in millions)          
Q1 Q2 Q3 Q4(E) FY(E)
   5/5/2007  8/4/2007 11/3/2007 2/3/2008 2/3/2008
   
Total Revenue $885.8 $956.7 $813.6 $1,329.5 $3,985.6
COGS 689.0 729.9 637.4 942.6 2,998.9
Gross Profit $196.8 $226.8 $176.2 $386.9 $986.7
SG&A  243.6 254.9 229.4 265.9 993.8
   
Operating Income (loss) ($48.9) ($30.3) ($56.2) $117.2 ($18.2)
Interest Expense 9.9 11.5 12.3 11.0 44.7
Income(loss) before Income Tax ($58.8) ($41.8) ($68.5) $106.2 ($62.9)
Income Tax Provision (22.9) (16.7) (26.8) 41.4 (25.0)
Net Income(Loss) ($35.9) ($25.1) ($41.7) $64.8 ($37.9)
EPS (Diluted) ($0.61) ($0.43) ($0.71) $1.10 ($0.64)
EBITDA ($20.1) ($1.3) ($27.8) $150.1 $100.9
   
Gross Margin % 22.2% 23.7% 21.7% 29.1% 24.8%
EBITDA Margin % (2.3%) (0.1%) (3.4%) 11.3% 2.5%
SG&A & Other as % of Sales 27.5% 26.6% 28.2% 20.0% 24.9%
 
Currently, BGP is trading at 10.0x EV/LTM 11/3/07 EBITDA while BKS is trading at 5.2x EV/LTM 11/3/07 EBITDA and BAMM is trading at 4.9x EBITDA.    
 
           BGP         BKS     BAMM
Share price $10.85 $34.17 $11.96
Diluted shares 58.752 61.679 15.916
Market cap $637.5 $2,107.6 $190.4
Cash and equiv $65.5 $20.2 $8.1
Long-term debt $798.5 $24.6 $58.1
Enterprise value $1,370.5 $2,112.0 $240.4
LTM EBITDA $138.1 $415.8 $47.2
EV / EBITDA 9.9x 5.1x 5.1x
 
($ in millions)
       Q1 06      Q2 06       Q3 06      Q4 06      FY 06      Q1 07      Q2 07       Q3 07
Borders Group
Sales $867.8 $866.3 $860.4 $1,519.0 $4,113.5 $885.8 $956.7 $813.6
Gross Profit 200.7 204.8 185.1 457.7 1,048.3 196.8 226.8 176.2
Gross Margin % 23.1% 23.6% 21.5% 30.1% 25.5% 22.2% 23.7% 21.7%
EBITDA 3.4 10.3 (21.6) 187.3 179.4 (20.1) (1.3) (27.8)
EBITDA Margin % 0.4% 1.2% (2.5%) 12.3% 4.4% (2.3%) (0.1%) (3.4%)
     
Barnes & Noble
Sales  $1,114.7 $1,156.2 $1,112.0 $1,878.4 $5,261.3 $1,145.4 $1,244.2 $1,175.5
Gross Profit 338.8 349.5 331.0 619.0 1,638.3 335.7 361.7 355.0
Gross Margin %  30.4% 30.2% 29.8% 33.0% 31.1% 29.3% 29.1% 30.2%
EBITDA  54.3 68.1 36.1 265.1 423.7 49.3 55.1 46.2
EBITDA Margin %   4.9% 5.9% 3.2% 14.1% 8.1% 4.3% 4.4% 3.9%
                 
 
Comparing BGP vs. BKS operating metrics, it is apparent that Borders Group has a way to go to achieve operating metrics comparable to BKS.     
 
Assuming Borders Group achieves EBITDA of $150MM in the 4Q 2007, they will have $101MM EBITDA for their fiscal year end.  This assumes they are able to achieve the same margins as they did back in Q4 2006, which is generous considering the change in economic climate and challenging conditions in the retail market.  Giving them a generous valuation of 6-8x EBITDA, we believe the appropriate value for the share price is in the $6.97 - $8.91 range providing a 36.6%-19.0% discount to the current share price of $11.00.    
 
            Low            Mid         High
Projected FY07 EBITDA $114.2
EBITDA Multiple 8.0x 8.5x 9.0x
Enterprise Value $913.6 $970.7 $1,027.8
Shares Outstanding 58.752 58.752 58.752
Projected FY07 Net Debt $504.0 $504.0 $504.0
EV/Share   $6.97 $7.94 $8.92
Note: BGP is currently trading at $11.00 per share.

Catalyst

-Tremendous competition from Barnes & Noble stores and BarnesandNobles.com and Amazon.com will continue
-Promotions and Coupons in the 4Q 07 are going to continue to impact gross margins negatively
-Café waste will also hit 4Q 07 margins
-DVD sales will not recover and shrinkage will persist
-Continued spending on internet launch will negatively affect gross margins
-Weak US Domestic consumer trends / poor retail environment will decrease mall traffic and have a negative impact on 4Q 07
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    Description

    Company Overview:
     
    Store Base
    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 US, 20 in Australia, 4 in New Zealand, 3 in Puerto Rico, and 1 in Singapore.  The Company also operates 521 mall-based and other bookstores, including stores operated under the Waldenbooks, Borders Express and Borders Outlet names, as well as Borders-branded airport stores.  Also, the Company owns and operates 110 Paperchase stores, a designer of stationery, cards and gifts located primarily in the UK.  Barnes & Noble, Borders’ principal competitor, operates approximately 700 stores and generated revenue of $5.4 billion for the last twelve months versus approximately 1,000 stores and $4.1 billion in sales for Borders during the same time.
     
    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 Seattle's Best Coffee, a wholly-owned subsidiary of Starbucks Corp, through which the Company will sell Seattle's Best Coffee-branded products in substantially all the Company's existing Borders superstores.
     
    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 UK are licensed to and operated by Starbucks (UK). Cafes located in Australia and New Zealand are licensed to and operated by Gloria Jeans Coffees.   
     
    Marketing
    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. 
     
    Thesis:
    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 2007 earnings call, CEO George Jones commented on reducing their coupon offering from 30% to 25% or 20% etc…trying to find the balance between promotion and gross margin.  During the weeks leading up to Christmas, Borders has offered members coupons for 25%-40% off. 
     
    In addition, the Company has had problems with their Seattle’s Best Cafes and DVD shrinkage in the domestic superstores, citing a $5.5MM gross margin hit in the Q3 2007 vs. Q3 2006.  The CFO addressed this in their latest conference call and has stated they are going to address the inventory waste in their Cafes going forward, but we believe this will still have a negative impact on gross margins in 4Q 2007 and beyond.  Moreover, the Company has experienced shrinkage in DVD sales, which started back in Q1 2006 when the Management decided to unlock all of the DVDs in the stores and eliminated a number of physical inventories.  The new plan is to lock them back up in the stores with cases and with new spider technology.  These changes are not going to affect the continued loss in gross margin in Q4 2007. 
     
    We are skeptical of the returns that Management expects from the launch of the website in Q1 2008.  There is significant competition from Amazon.com as well as BarnesandNoble.com, which the Company is going to have to address.  Since Borders’ customers have been automatically directed to Amazon.com for online purchases in the past, many Borders customers automatically navigate to Amazon, and Amazon will not now direct them to the new Borders web site.  Borders will have to spend substantially more capital on advertising or promotions in order to promote their new website and drive traffic, which will negatively impact margins going forward as well.  Essentially, Borders has to win back their own online customers, and many will just stay with Amazon.  
     
    Valuation
    Borders essentially loses money all year until the critical holiday buying season.  The pressure on gross margin over the past six weeks will likely be very problematic.
     
    Historical Financials    FYE 2/3/07
    ($ in millions)          
        1Q      2Q            3Q 4Q FY
       4/29/06     7/29/06  10/28/2006 2/3/2007 2/3/2007
     
    Total Revenue $867.8 $866.3 $860.4 $1,519.0 $4,113.5
    COGS 667.1 661.5 675.3 1,061.3 3,065.2
    Gross Profit $200.7 $204.8 $185.1 $457.7 $1,048.3
    SG&A  225.4 223.3 235.2 303.7 987.6
     
    Operating Income (loss) ($27.2) ($22.8) ($54.9) ($31.9) ($136.8)
    Interest Expense 5.4 7.7 9.3 10.0 32.4
    Income(loss) before Income Tax ($32.6) ($30.5) ($64.2) ($41.9) ($169.2)
    Income Tax Provision (12.4) (12.1) (25.1) 31.7 (17.9)
    Net Income(Loss) ($20.2) ($18.4) ($39.1) ($73.6) ($151.3)
    EPS (Diluted) ($0.31) ($0.29) ($0.64) ($1.25) ($2.44)
    EBITDA $3.4 $10.3 ($21.6) $187.3 $179.4
     
    Gross Margin % 23.1% 23.6% 21.5% 30.1% 25.5%
    EBITDA Margin % 0.4% 1.2% (2.5%) 12.3% 4.4%
    SG&A & Other as % of Sales 26.0% 25.8% 27.3% 20.0% 24.0%
     
    In our model, we have made the following assumptions for Case 1:
    1. Increase of 4 new Domestic Borders Stores bringing Total Domestic Borders stores to 514 in 4Q 2007.
    2. Domestic Revenue per store of $1.89MM quarterly which is the average increase from 3Q to 4Q of the last 3 fiscal years experienced by Borders Domestic stores.
    3. Decrease Waldenbook Stores by the targeted 50 store count by management bringing the total to 471 stores in 4Q 2007.
    4. Waldenbook revenue per store of $0.47MM quarterly which is the average increase from 3Q to 4Q of the last 3 fiscal years experienced by Waldenbook Stores.
    5. 28 International Stores remain.
    6. International Revenue per store of $4.07MM quarterly which is the average increase form 3Q to 4Q over the last 3 fiscal years.
    7. We have assumed a 1% decrease in Gross Margin from Q4 2006 to Q4 2008.
    8. We have assumed SG&A to be the same 20% of Sales in Q4 2007 as it was in Q4 2006.

    FYE 2/3/08

    ($ in millions)          
    Q1 Q2 Q3 Q4(E) FY(E)
       5/5/2007  8/4/2007 11/3/2007 2/3/2008 2/3/2008
       
    Total Revenue $885.8 $956.7 $813.6 $1,329.5 $3,985.6
    COGS 689.0 729.9 637.4 929.3 2,985.6
    Gross Profit $196.8 $226.8 $176.2 $400.2 $1,000.0
    SG&A  243.6 254.9 229.4 265.9 993.8
       
    Operating Income (loss) ($48.9) ($30.3) ($56.2) $130.5 ($4.9)
    Interest Expense 9.9 11.5 12.3 11.0 44.7
    Income(loss) before Income Tax ($58.8) ($41.8) ($68.5) $119.5 ($49.6)
    Income Tax Provision (22.9) (16.7) (26.8) 46.6 (19.8)
    Net Income(Loss) ($35.9) ($25.1) ($41.7) $72.9 ($29.8)
    EPS (Diluted) ($0.61) ($0.43) ($0.71) $1.23 ($0.51)
    EBITDA ($20.1) ($1.3) ($27.8) $163.4 $114.2
       
    Gross Margin % 22.2% 23.7% 21.7% 30.1% 25.1%
    EBITDA Margin % (2.3%) (0.1%) (3.4%) 12.3% 2.9%
    SG&A & Other as % of Sales 27.5% 26.6% 28.2% 20.0% 24.9%
     
    Case 2 Model Assumptions are the same except we decrease Gross Margin to 29.6%
    ($ in millions)          
    Q1 Q2 Q3 Q4(E) FY(E)
       5/5/2007  8/4/2007 11/3/2007 2/3/2008 2/3/2008
       
    Total Revenue $885.8 $956.7 $813.6 $1,329.5 $3,985.6
    COGS 689.0 729.9 637.4 936.0 2,992.3
    Gross Profit $196.8 $226.8 $176.2 $393.5 $993.3
    SG&A  243.6 254.9 229.4 265.9 993.8
       
    Operating Income (loss) ($48.9) ($30.3) ($56.2) $123.8 ($11.6)
    Interest Expense 9.9 11.5 12.3 11.0 44.7
    Income(loss) before Income Tax ($58.8) ($41.8) ($68.5) $112.8 ($56.3)
    Income Tax Provision (22.9) (16.7) (26.8) 44.0 (22.4)
    Net Income(Loss) ($35.9) ($25.1) ($41.7) $68.8 ($33.9)
    EPS (Diluted) ($0.61) ($0.43) ($0.71) $1.17 ($0.58)
    EBITDA ($20.1) ($1.3) ($27.8) $156.8 $107.6
       
    Gross Margin % 22.2% 23.7% 21.7% 29.6% 24.9%
    EBITDA Margin % (2.3%) (0.1%) (3.4%) 11.8% 2.7%
    SG&A & Other as % of Sales 27.5% 26.6% 28.2% 20.0% 24.9%
     
    Case 3 Model Assumptions are the same except we decrease Gross Margin to 29.1%
    ($ in millions)          
    Q1 Q2 Q3 Q4(E) FY(E)
       5/5/2007  8/4/2007 11/3/2007 2/3/2008 2/3/2008
       
    Total Revenue $885.8 $956.7 $813.6 $1,329.5 $3,985.6
    COGS 689.0 729.9 637.4 942.6 2,998.9
    Gross Profit $196.8 $226.8 $176.2 $386.9 $986.7
    SG&A  243.6 254.9 229.4 265.9 993.8
       
    Operating Income (loss) ($48.9) ($30.3) ($56.2) $117.2 ($18.2)
    Interest Expense 9.9 11.5 12.3 11.0 44.7
    Income(loss) before Income Tax ($58.8) ($41.8) ($68.5) $106.2 ($62.9)
    Income Tax Provision (22.9) (16.7) (26.8) 41.4 (25.0)
    Net Income(Loss) ($35.9) ($25.1) ($41.7) $64.8 ($37.9)
    EPS (Diluted) ($0.61) ($0.43) ($0.71) $1.10 ($0.64)
    EBITDA ($20.1) ($1.3) ($27.8) $150.1 $100.9
       
    Gross Margin % 22.2% 23.7% 21.7% 29.1% 24.8%
    EBITDA Margin % (2.3%) (0.1%) (3.4%) 11.3% 2.5%
    SG&A & Other as % of Sales 27.5% 26.6% 28.2% 20.0% 24.9%
     
    Currently, BGP is trading at 10.0x EV/LTM 11/3/07 EBITDA while BKS is trading at 5.2x EV/LTM 11/3/07 EBITDA and BAMM is trading at 4.9x EBITDA.    
     
               BGP         BKS     BAMM
    Share price $10.85 $34.17 $11.96
    Diluted shares 58.752 61.679 15.916
    Market cap $637.5 $2,107.6 $190.4
    Cash and equiv $65.5 $20.2 $8.1
    Long-term debt $798.5 $24.6 $58.1
    Enterprise value $1,370.5 $2,112.0 $240.4
    LTM EBITDA $138.1 $415.8 $47.2
    EV / EBITDA 9.9x 5.1x 5.1x
     
    ($ in millions)
           Q1 06      Q2 06       Q3 06      Q4 06      FY 06      Q1 07      Q2 07       Q3 07
    Borders Group
    Sales $867.8 $866.3 $860.4 $1,519.0 $4,113.5 $885.8 $956.7 $813.6
    Gross Profit 200.7 204.8 185.1 457.7 1,048.3 196.8 226.8 176.2
    Gross Margin % 23.1% 23.6% 21.5% 30.1% 25.5% 22.2% 23.7% 21.7%
    EBITDA 3.4 10.3 (21.6) 187.3 179.4 (20.1) (1.3) (27.8)
    EBITDA Margin % 0.4% 1.2% (2.5%) 12.3% 4.4% (2.3%) (0.1%) (3.4%)
         
    Barnes & Noble
    Sales  $1,114.7 $1,156.2 $1,112.0 $1,878.4 $5,261.3 $1,145.4 $1,244.2 $1,175.5
    Gross Profit 338.8 349.5 331.0 619.0 1,638.3 335.7 361.7 355.0
    Gross Margin %  30.4% 30.2% 29.8% 33.0% 31.1% 29.3% 29.1% 30.2%
    EBITDA  54.3 68.1 36.1 265.1 423.7 49.3 55.1 46.2
    EBITDA Margin %   4.9% 5.9% 3.2% 14.1% 8.1% 4.3% 4.4% 3.9%
                     
     
    Comparing BGP vs. BKS operating metrics, it is apparent that Borders Group has a way to go to achieve operating metrics comparable to BKS.     
     
    Assuming Borders Group achieves EBITDA of $150MM in the 4Q 2007, they will have $101MM EBITDA for their fiscal year end.  This assumes they are able to achieve the same margins as they did back in Q4 2006, which is generous considering the change in economic climate and challenging conditions in the retail market.  Giving them a generous valuation of 6-8x EBITDA, we believe the appropriate value for the share price is in the $6.97 - $8.91 range providing a 36.6%-19.0% discount to the current share price of $11.00.    
     
                Low            Mid         High
    Projected FY07 EBITDA $114.2
    EBITDA Multiple 8.0x 8.5x 9.0x
    Enterprise Value $913.6 $970.7 $1,027.8
    Shares Outstanding 58.752 58.752 58.752
    Projected FY07 Net Debt $504.0 $504.0 $504.0
    EV/Share   $6.97 $7.94 $8.92
    Note: BGP is currently trading at $11.00 per share.

    Catalyst

    -Tremendous competition from Barnes & Noble stores and BarnesandNobles.com and Amazon.com will continue
    -Promotions and Coupons in the 4Q 07 are going to continue to impact gross margins negatively
    -Café waste will also hit 4Q 07 margins
    -DVD sales will not recover and shrinkage will persist
    -Continued spending on internet launch will negatively affect gross margins
    -Weak US Domestic consumer trends / poor retail environment will decrease mall traffic and have a negative impact on 4Q 07

    Messages


    SubjectMerger/buy-out from BKS?
    Entry01/02/2008 03:24 PM
    Membernatey1015
    I completely agree with the short thesis and that on a stand-alone basis this company is in deep trouble. However, you didn't mention the possibility of a merger or buy-out from BKS, which there is a very good possibility of happening. Investors such as Bill Ackman's Pershing Square and other activist types like Citadel own stock in both BGP and BKS. Don't you think there is a decent chance they will agitate for a combo--especially if BGP continues to go down?

    I just ran the back of the envelope math on a merger pro forma for synergies and this is what I come up with. Much of the cost savings would come from DC consolidation, which would in turn bring up inventory turns (due to holding less inventory) at BGP (1.9x) in-line with BKS (2.6x). Thus it appears that about $439mm of working capital could be pulled out of the business. Let's just say that if BKS were to buy BGP today and pay a 15% premium today then BKS would buy the enterprise for about $1.45 billion. If you back out the working capital savings then you get a net purchase price of about $1.0 billion.

    At the same time there will be SG&A cost savings (~200 bps) as well as some gross margin expansion (~200 bps) due to better inventory management. If BKS can raise BGP's operating margins from 0.3% (TTM) to 4.2% (BKS TTM) then BGP would do about $167mm of operating income. BKS has a very clean balance sheet with bascially no net debt so I'm guessing it could finance this transaction with 7-8% average cost of debt. If the pre-tax return on buying BGP is 16.7% and the cost of doing the transaction is 7-8% then BKS would do the deal in a heart beat. Now granted these assumptions could be way off, but there's still a decent margin of safety that if BKS were to get just half of these synergies the deal would still make sense. Plus over time as leases come up for renewal the combined company could close down a store in a market that has 3 stores within relatively close distance to one another, taking it down to 2 stores. As we know with retail, it's all about leveraging that square foot of real estate and consolidating sales from 3 stores to 2 could be a huge benefit. Also, let's not forget BKS used to have operating margins in the 5-6% range and I was just using 4.2% so the operating income for a combined company could be better than what I was using.

    Now let's see what the EPS would be for the combined company using TTM sales, 4.2% operating margins, 40% tax rate and 7.5% cost of debt on a $1.0 billion net purchase price. I get total sales of about $9.4 billion, EBIT of $396mm, net interest expense of $75mm, net income of $192.8mm and EPS of $2.92. If we use a 15x P/E multiple I guess the stock could go to $44, which is downside of about 30% on shorting BKS.

    I think you're better off buying a put option on BGP because if a merger or buy-out doesn't happen then BGP could be in deep doo doo; the company could go bankrupt and you'd make a decent amount on the short thesis playing out. You could buy a January 2010 $10 strike put option for 3.10 (at the ask) plus say a $0.05 commission. Your upside would be $6.85 and downside is $3.15. The reward/risk is about 2.2x. The premium is definitely pricey so I wouldn't do that one. The $5 strike offers a better reward/risk (based on the ask)--upside of 3.9 and downside of 1.1 or about 3.6x.

    I know this sounds complicated, but here's how I'd play a short on BGP. I'd short the stock, sell the January 2010 $10 put for $2.70 (net of commission) and buy the $5 put for $1.10 (including commission). This way if BKS buys BGP at a 15% premium from here you're some what protected because you got a net $1.60 of protection. If BGP goes down to say $8, you make about a 20% return. If BGP goes bankrupt then you make a 67% return.

    Let me know what your thoughts are on a BKS/BGP combo.

    SubjectNo anti-trust concerns
    Entry01/02/2008 06:41 PM
    Membernatey1015
    Our understanding is that there would be no anti-trust concerns regarding a merger.

    Subjectno anti-trust concerns
    Entry01/02/2008 08:47 PM
    Memberthistle933
    Could you expand on your confidence that a deal would fly, given:
    1. Staples/Office Depot
    2. Consent decree over the past several years affecting BKS and BGP and their pricing vs. independent sellers

    Is your confidence dependent on a Republican administration?

    Thanks

    SubjectAnti-trust concerns
    Entry01/02/2008 10:07 PM
    Membernatey1015
    I looked at BGP as a short due to the deterioration of the business and initially had the exact same read as kejag700. I then wanted to get the bull case, which I got initially from reading jwilliam903's VIC long write-up on BGP posted 11/22/07. After that I simply pulled up the holders list for BGP and BKS. It was obvious to see where this was going.

    The guys who I spoke to that are long BGP or both BGP and BKS have hired high-priced legal experts that have given them their "expert" opinion that there would be no anti-trust issues regarding a merger. This stems from the fact that there is plenty of other competition from the likes of Amazon.com, Wal-mart, Costco, mom and pop shops, etc. This is what I went off of and the logic seems reasonable enough to me.

    There is no way I'd go long BGP (or BKS for that matter)--not cheap enough, not enough upside, no real downside protection, no real competitive advantage and certainly not a great business. I wanted to short BGP, but the potential combo of the 2 companies was enough to keep me on the sidelines (for now) given who the holders of BKS and BGP are. I hope this helps.

    Subjectjim
    Entry01/05/2008 01:41 PM
    Memberbedrock346
    funny, i had the exact same thought. i used to be short this on some of the same thesis posted here but never thought it was a zero. i dont think it is a long when so much best in breed retail is hitting new lows but borders better file ch 11 given the carnage. that said, amzn has the sales tax advantage dvd and cds are challenged and bks is better run so i dont love the company just think it better file soon

    Subjectoops
    Entry01/10/2008 09:37 PM
    Memberjim211
    You might have a very crowded short here with long BKS against it. Think that might unwind for a little while after today?
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