Warning: We updated this post on December 18, 2008.
Borders Group, Inc. (NYSE:BGP) presents a rare opportunity to invest in a stock with a well-known brand alongside one of the best activist investors in the US, William A. Ackman of Pershing Square Capital Management, L.P. Want more? With a market capitalization of $39.4M at today’s close ($0.65) and a liquidation value we estimate at $135M, BGP is available right now at an astonishing 61% discount to that value.
About BGP
According to its website, BGP “operates over 509 Borders superstores in the U.S.; 32 Borders stores outside the U.S., in Australia, New Zealand, Singapore and Puerto Rico; and approximately 485 stores in the Waldenbooks Specialty Retail segment, including Waldenbooks, Borders Express, Borders airport stores, and Borders Outlet. Borders Group owns London-based Paperchase Products Limited, a retailer of stationery, cards and gifts with approximately 120 locations outside the U.S., including stand-alone stores and concessions. There are also more than 317 Paperchase shops located within U.S. Borders superstores and the company opened its first stand-alone Paperchase shop in the U.S. on Boston’s Newbury Street in 2007.”
The value proposition
While the company has been loss making for the last few years it maintained positive Cash Flow from Operating Activities of $94.1M last year, $46.9M in the 2007 year and, encouragingly, $76.6M in the most recent quarter to August 2008 (see the most recent 10Q here). There real value is in the balance sheet. Set out below is our summary analysis (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):
BGP’s value is concentrated in its Inventory ($18.01 per share) and Property, Plant and Equipment ($27.04 per share). We have written down the Inventory by two-thirds to $12.07 per share and the Property, Plant and Equipment by half to $13.52 per share. The company has substantial liabilities of $25.92 per share, of which $7.69 is debt. We estimate the liquidating value of BGP to be around $2.23 per share. With the stock at $0.65, BGP is at an astonishing 29% of its liquidating value. Note that the liquidating value does not take into account BGP’s intangibles, like consumer brand recognition, which must have some residual value. At $0.65, we think BGP is a bargain.
The catalyst
William A. Ackman of Pershing Square Capital Management is perhaps one of the best – and best known – activist investors in the US. Pershing Square first disclosed its holding in BGP in a 13D notice filed October 9, 2007 and now controls around 33.6% of BGP’s stock (see the most recent 13D here).
Pershing Square has pushed the company to undertake certain strategies to enhance the value of its investment and BGP seems to be making progress in executing these measures. According to the 10Q, on March 20, 2008, the company announced that it would “undergo a strategic alternative review process.”
“J.P. Morgan Securities Inc. and Merrill Lynch & Co. have been retained as the Company’s financial advisors to assist in this process. The review will include the investigation of a wide range of alternatives including the sale of the Company and/or certain divisions for the purpose of maximizing shareholder value.”
On April 9, 2008, the company completed a financing agreement with Pershing Square, which “will allow the Company to be fully funded during fiscal 2008, where absent these measures, liquidity issues may otherwise have arisen during the year.” According to the company’s most recent quarterly report, the financing agreement with Pershing Square consists of three main components:
“1. A $42.5 senior secured term loan maturing January 15, 2009 with an interest rate of 9.8% per annum. The term loan is secured by an indirect pledge of approximately 65% of the stock of Paperchase pursuant to a Deed of Charge Over Shares. In the event that Paperchase is sold, all proceeds from the sale are required to be used to prepay the term loan. The representations, covenants and events of default therein are otherwise substantially identical to the Company’s existing Multicurrency Revolving Credit Agreement (as amended, the “Credit Agreement”), other than some relating to Paperchase. Such exceptions are not expected to interfere with the operations of Paperchase or the Company in the ordinary course of business.
2. A backstop purchase offer that gave the Company the right but not the obligation, until January 15, 2009, to require Pershing Square to purchase its Paperchase, Australia, New Zealand and Singapore subsidiaries, as well as its interest in Bookshop Acquisitions, Inc. (Borders U.K.) after the Company has pursued a sale process to maximize the value of those assets. Pursuant to this sale process, the Company sold its Australia, New Zealand and Singapore subsidiaries during the second quarter of 2008 to companies affiliated with A&R Whitcoulls Group Holdings Pty Limited. Pershing Square’s remaining obligation to purchase the Company’s remaining U.K. subsidiaries remains in effect until January 15, 2009. Pershing Square’s purchase obligation for the U.K. subsidiaries is at a price of $65.0 (less any debt attributable to those assets) and on customary terms to be negotiated. Proceeds of any such purchase by Pershing Square are to be first applied to repay amounts outstanding under the $42.5 term loan. Although the Company believes that these businesses are worth substantially more than the backstop purchase offer price, the relative certainty of this arrangement provides the Company with valuable flexibility to pursue strategic alternatives. The Company has retained the right, in its sole discretion, to forego the sale of these assets or to require Pershing Square to consummate the transaction. Pershing Square has no right of first refusal or other preemptive right with respect to the sale of these businesses by the Company to other parties.
3. The issuance to Pershing Square of 9.55 million warrants to purchase the Company’s common stock at $7.00 per share. The Company is also required to issue an additional 5.15 million warrants to Pershing Square if any of the following three conditions occurs: the Company requires Pershing Square to purchase its international subsidiaries as described in (2) above, a definitive agreement relating to certain business combinations involving the Company is not signed by October 1, 2008, or the Company terminates the strategic alternatives process. The warrants will be cash-settled in certain circumstances and have a term of 6.5 years.
The warrants feature full anti-dilution protection, including preservation of the right to convert into the same percentage of the fully-diluted shares of the Company’s common stock that would be outstanding on a pro forma basis giving effect to the issuance of the shares underlying the warrants at all times, and “full-ratchet” adjustment to the exercise price for future issuances (in each case, subject to certain exceptions), and adjustments to compensate for all dividends and distributions.”
On October 1, 2008, Pershing Square exercised the right in paragraph 3 above to require the company to issue further warrants to purchase 5.15M shares at $7.00 per share, which means Pershing Square controls warrants covering an additional 14,700,000 shares.
Conclusion
It seems to us that this is one of the better opportunities out there at the moment. It’s not often that the stars align like this: a stock with a well-known brand selling at less than a third of its value in a liquidation with one of the best activist investors in the US controlling almost a third of its outstanding stock. BGP has already embarked on its value enhancing transformation. We believe that, given time, BGP will be worth more than its liquidation value, but, if we’re wrong, it’s still trading at a third of that value, which is a bargain.
BGP closed yesterday at $0.65.
The S&P 500 closed yesterday at 816.21.
[Disclosure: We do not presently have a holding in BGP. UPDATE: We have now acquired a holding in BGP. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.]
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