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Archive for the ‘Borders Group (NYSE:BGP)’ Category

Greenbackd Portfolio Q1 performance and update

March 1, 2009 marked the end of Greenbackd’s first quarter, so we thought we’d take the opportunity to update you on the performance of the Greenbackd Portfolio and the positions in the portfolio, discuss some changes in our valuation methodology since our first post and outline the future direction of Greenbackd.com.

First quarter performance of the Greenbackd Portfolio

We get many questions about the content and performance of the portfolio. We had originally planned to report on a six-monthly basis, but we have now decided to report on a quarterly basis so that we can address these questions on a more frequent basis. Although it is still too early to determine how Greenbackd’s strategy of investing in undervalued asset situations with a catalyst is performing, we’ve set out below a list of all the stocks we’ve included in the Greenbackd Portfolio and the absolute and relative performance of each at the close on the last trading day in our first quarter, Friday, February 28, 2009:

greenbackd-portfolio-performance-2009-q13The absolute total return across the current and former positions as at February 28, 2009 was -3.7%, which was +7.0% higher than the S&P500’s return over the same periods. A negative return for the first period is disappointing, but we are heartened by the fact that we outperformed the market by a small margin.

You may have noticed something odd about our presentation of performance. The S&P500 index declined by 18.0% in our first quarter (from 896.24 to 735.09). Our -3.7% performance might suggest an outperformance over the S&P500 index of +14.3%. We calculate our performance on a slightly different basis, recording the level of the S&P500 index on the day each stock is added to the portfolio and then comparing the performance of each stock against the index for the same holding period. The Total Relative performance, therefore, is the average performance of each stock against the performance of the S&P500 index for the same periods. As we discussed above, the holding period for Greenbackd’s positions has been too short to provide any meaningful information about the likely performance of the strategy over the long term (2 to 5 years), but we believe that the strategy should outperform the market by a small margin.

Greenbackd’s valuation methodology

We started Greenbackd in an effort to extend our understanding of asset-based valuation described by Benjamin Graham in the 1934 Edition of Security Analysis. Through some great discussion with our readers, many of whom work in the fund management industry as experienced analysts or even managing members of hedge funds, we have had the opportunity to refine our process. We believe that what started out as a pretty unsophisticated application of Graham’s liquidation value methodology has evolved into a more realistic analysis of the balance sheet and the relationship of certain disclosures in the financial statements to asset value. We’re not yet ready to send it into space, but we believe our analyses are now qualitatively more robust than when we started and that has manifest itself quantitatively in better performance (more on this below).

The two main differences between our early analyses and our more recent ones are as follows (these are truly cringe-worthy, but that’s why we undertook the exercise):

  1. We didn’t take account of the effect of off-balance sheet arrangements and contractual obligations. This caused us to enter into several positions we should have avoided, including BGP and VVTV.
  2. We were using overly optimistic estimates for the recovery rates of assets in liquidation. For example, we started using 50% of Gross PP&E. We now use 20% of Net PP&E. We now apply Graham’s formula as the base case and deviate only when we believe that Graham’s formulation doesn’t reflect reality.

The effect of these two broad errors in analysis was to create several “false positives,” which is to say that we added stocks to the portfolio that wouldn’t have passed our current, more rigorous standards. The performance of those “false positive” stocks has been almost uniformly negative, and dragged down the performance of the portfolio. As an exercise, we went back through all the positions we have opened since we started the site and applied our current criteria, which are more stringent and dour than our earlier standards. We found that we would not have opened positions in the following eight stocks:

  • BRN (-13.1% on an absolute basis and +4.9% on a relative basis)
  • BGP (-10.8% on an absolute basis and -21.6% on a relative basis)
  • COBR (-17.1% on an absolute basis and +3.6% on a relative basis)
  • HRT (-25.3% on an absolute basis and -9.7% on a relative basis)
  • KONA (+87.8% on an absolute basis and +81.9% on a relative basis)
  • MGAM (-24.2% on an absolute basis and -5.0% on a relative basis)
  • VVTV (-25.0% on an absolute basis and -23.1% on a relative basis)
  • ZLC (-72.0% on an absolute basis and -61.1% on a relative basis)

It seems we got lucky with KONA, but the performance of the balance of the stocks was wholly negative. The performance across all stocks listed above was -12.5% on an absolute basis and -3.9% on a relative basis. Excluding these eight stocks from our portfolio (i.e. treating the portfolio as if we had not entered into these positions) would have resulted in a slightly positive absolute return of +0.7% and a relative performance over the S&P500 of +12.5%. This is a compelling reason to apply the more dour and rigorous standards.

We like to think we’ve now learned out lesson and the more dour and rigorous standards are here to stay. Set out below is an example balance sheet summary (for Chicago Rivet & Machine Co. (AMEX:CVR)) showing our present base case discounts from book value (circled in red):

example-summary-2

Readers will note that these are the same base case discounts from book value suggested by Benjamin Graham in the 1934 Edition of Security Analysis, more fully described in our Valuing long-term and fixed assets post under the heading “Graham’s approach to valuing long-term and fixed assets.” Why we ever deviated from these standards in the first place is beyond us.

Update on the holdings in the Greenbackd Portfolio

Leading on from our discussion above, four of the stocks we picked using the initial, overly optimistic criteria no longer meet our more stringent standards but haven’t yet been removed from the portfolio. We’re going to take our medicine now and do just that. To make it clear, these stocks aren’t being removed because the value has deteriorated, but because we made a mistake adding them to the portfolio in the first place. As much as we’d like to treat these positions as void ab initio (“invalid from the beginning”), we’re not going to do that. We’ve made a full accounting of the impact they’ve had on the portfolio in the First quarter performance of the Greenbackd Portfolio section above, but we don’t want them affecting our future performance. The stocks to be removed from the Greenbackd Portfolio and their absolute and relative returns are as follows:

  • BRN (-13.1% on an absolute basis and +4.9% on a relative basis)
  • HRT (-25.3% on an absolute basis and -9.7% on a relative basis)
  • MGAM (-24.2% on an absolute basis and -5.0% on a relative basis)
  • COBR (-17.1% on an absolute basis and +3.6% on a relative basis)

We’ll provide a more full discussion of where we went wrong with these stocks at a later date, but suffice it to say for present purposes that all were errors from the second bullet point in the Greenbackd’s valuation methodology section above (i.e. overly optimistic estimates for the recovery rates of assets in liquidation).

There are fifteen stocks remaining in the Greenbackd Portfolio:

Eight of these positions (ABTL, ACLS, ARCW, CAPS, CRC, CRGN, NSTR, and VOXX) are trading at or below our nominal purchase price and initial valuations. The remaining seven positions (AVGN, DITC, IKAN, MATH, NENG, NTII, and SOAP) are trading above our intial purchase price but are still at varying discounts to our valuations. We’ll provide a more full update on these positions over the course of this week.

The future of Greenbackd.com

We are going to trial some small changes to the layout of the site over the next few weeks. We’ve already made the first change: the newest comments now appear at the top of the list. We’ll also be amalgamating some pages and adding some new ones, including a page dedicated to tracking the portfolio with links to the analyses. We’re also considering some options for generating income from the site. At the moment, Greenbackd is a labor of love. We try to create new content every week day, and to get the stock analyses up just after midnight Eastern Standard Time, so that they’re available before the markets open the following day. More than 80% of the stocks that are currently trading at a premium to the price at which we originally identified them (NTII, SOAP, IKAN, DITC, NENG, MATH and AVGN) traded for a period at a discount to the price at which we identified them. This means that there are plenty of opportunities to trade on our ideas (not that we suggest you do that). If you find the ideas here compelling and you get some value from them, you can support our efforts by making a donation via PayPal.

We look forward to bringing you the best undervalued asset situations we can dig up in the next quarter.

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Pershing Square Capital Management hosted its Annual Investor Dinner in late January (Dealbreaker has a copy of the presentation (.pdf).) We’ve previously written about Pershing Square in relation to its position in Borders Group Inc (NYSE:BGP). It was not one of our better calls.

Pershing Square’s investment strategy makes for interesting reading:

We seek simple, predictable, free-cash-flow-generative businesses that trade at a large discount to intrinsic value

  • Mid-and large-cap companies
  • Typically not controlled
  • Minimal capital markets dependency
  • Typically low financial leverage and modest economic sensitivity
  • Often hidden value in asset base
  • Catalyst for value creation which we can often effectuate

At the right price, we may waive one or more of the above criteria
Our selection process is designed to help avoid permanent loss of capital while generating attractive long-term returns.

Pershing Square’s investment strategy is more Buffett than Graham (or more Fisher than Graham), but note that they do seek value that may be hidden in assets. Pershing Square’s returns have been extraordinary, as this slide attests:

pershing-square-cumulative-net-returns1

Although not all Pershing Square’s positions were winners:

pershing-square-2008-winners-and-losers

(via Dealbreaker)

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Welcome back to Greenbackd and happy new year for 2009. We hope that you had a good break. There have been a number of positive developments in the companies we discussed last year. Set out below is an update on those positions we had open in the Greenbackd Portfolio at the close of 2008:

  • Trilogy has increased its stake in ABTL to 7.4%. ABTL is up 18.6% since our first post but we are maintaining our position because we think it’s still worth 50% more.
  • BVF has endorsed the MNOV offer for AVGN. AVGN is up 20% since our first post but we are holding on because we think the merger presents an opportunity for AVGN’s stockholders to receive around $1.20 per share in cash (almost 60% higher than AVGN’s $0.78 close Friday) and the possibility of “an extraordinary, uncapped return” if MNOV is successful post-merger.
  • BRN has filed its September 10Q and we believe that its liquidation value has increased from $6.52 per share to $6.91 per share. The stock is up 41% since our initial post. We still see the liquidation value some 40% higher than BRN’s Friday close of $4.95, so we will maintain our position.
  • CRC is down 6.3% from our initial post. Other than the retirement of the CFO, we have no other news to report. With CRC in a liquidity crisis, the retirement of the CFO is a worrying development. That said, we see CRC’s liquidation value at around $2.45 per share, which is more than 450% higher than its Friday close of $0.43, so we propose to maintain our position.
  • A group of “high-powered executives” plan to save INFS from “New York sharks.” The stock is up 15.9% to $0.73 since our initial post. Its liquidating value is still some 58% higher at $1.15 per share and so we are maintaining the position.
  • We’ve closed our position in KONA for an 88% gain in 18 days.
  • A new activist investor has filed a 13D for MATH and is lobbying the company to liquidate. MATH is up 17.7% since our first post but it’s still trading at half its liquidating value and a little more than half its net cash backing, so we’re maintaining our position.
  • ZLC is off 16.8% from our initial post. We’ve estimated its liquidation value at $7.63 per share, which is still 90% higher than its $4.01 close Friday, so we are maintaining our position in ZLC.

Although it is still too early to determine how Greenbackd’s strategy of investing in undervalued asset situations with a catalyst is performing, we’ve set out below a list of all the stocks we’ve included in the Greenbackd Portfolio and the absolute and relative performance of each. This is the standardized format we propose to adopt to track Greenbackd’s performance at 6-monthly intervals:

Current holdings (As at January 5, 2009)

greenbackd-portfolio-current-holdings-performance

Former holdings (As at date of our closure of the position)greenbackd-portfolio-former-holdings-performance

The absolute total return across the current and former positions as at January 5, 2009 is 14.2%, which is 8.4% higher than the S&P500’s return over the same periods. As we discussed above, the holding periods for Greenbackd’s positions has been too short to provide any meaningful information about the likely performance of the strategy over the long term (2 to 5 years), but we believe that the strategy should outperform the market by a small margin.

We look forward to bringing you the best undervalued asset situations we can dig up in 2009.

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Borders Group, Inc. (NYSE:BGP) has released its 10Q for the third quarter. We’ve previously posted about BGP here. When we first looked at it, we said that it presented 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. At that time, BGP’s market capitalization was $39.4M (at the previous day’s close of $0.65) and we estimated that its liquidation value was some 250% higher at $135M or $2.23 per share. Well, we’ve now had an opportunity to review the 10Q for the third quarter and the results aren’t pretty. In fact, we now believe that there is a risk that the assets may have no value in a liquidation and we’re out.

The updated value proposition

BGP has made a $175M loss for the quarter, operating cash flow was negative in the amount of $51M and the company has taken on $55M in new debt. By way of contrast, in the last quarter to August, while the company made a loss of $9M, operating cash flow was positive in the amount of $77M and the company retired $129M in debt. Our summary analysis of the balance she

et is set out below (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-q3-summaryBGP’s value remains concentrated in its inventory and property, plant and equipment, both of which are up slightly on the last quarter. Compared to $18.01 per share in Q2, inventory is now $20.75 per share, which we’ve written down by two-thirds to $13.91 per share (written down value of $12.07 in Q2). Property, plant and equipment is now carried at $27.18 per share compared to $27.04 per share in Q2. We have written it down the by half to $13.59 per share (slightly higher than the written down value of $13.52 per share in Q2). While its assets have increased slightly, the real problem for BGP is the growth in its substantial liabilities. Total liabilities now stand at $29.83 per share, up from $25.92 per share, the debt portion of which is up from $7.69 per share to $8.68 per share.

Our previous estimate for the liquidating value of BGP was around $2.23 per share. We now estimate that its liquidating value is -$9.6M or $-0.16 per share. This is on the basis of a very conservative treatment of its tangible assets and does not take into account BGP’s intangibles, like consumer brand recognition, which must have some residual value. We also note that BGP has a seasonal business, and this most recent quarter sees BGP in a much better position than the same quarter last year, at which time we estimate that its liquidating value was closer to -$4.87 per share. We think there’s a good chance that BGP will have some substantial asset value next year, and that it’s worth more than its liquidation value, but on our very conservative treatment of its assets, it has a negative liquidating value at this point in time.

As a brief diversion, set out below is a summary financial analysis of BGP without any discount applied to the assets (both the “Carrying” and “Liquidating” columns shows the assets as they are carried in the financial statements):

bgp-q3-summary-carrying-valueIn this analysis, with no discount applied to the carrying value of the assets, BGP appears wildly undervalued. We prefer our much more conservative estimate of liquidating value for two reasons:

  1. We think the discounted values are more likely to be right; and
  2. If we’re wrong in our estimate, we hope that we’ve applied a sufficient discount that we’re wrong on the upside, and not the down side. Valuing assets in liquidation is not an exact science. Prior to the actual sale, we don’t know with any certainty how much any given asset might yield. If we were to value assets at close to their carrying values, we think that more often than not we’d be disappointed.

You can read more about our undervalued asset situations philosophy on our About Greenbackd page and our rationale and method for calculating values on our About liquidation value investing page.

Conclusion

Our overly optimistic conclusion when we first wrote about BGP deserves repeating here (if only to stop us doing it again). We said, “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.” We even bolded that last part, which, in retrospect, we regret. While we still agree that BGP has a well-known brand, Will Ackman is one of the best activist investors in the US, and BGP will be worth much more than its liquidation value, it’s no longer trading at a third of its liquidation value, so the downside protection is gone. Our focus here is undervalued asset situations, and BGP is not an undervalued asset situation at this time. So that mean we’re out for now. We are, however, going to keep an eye on it for its next few quarters to see if the value returns.

BGP closed yesterday at $0.58. We liked it at $0.65, so we’re down 9.83% on an absolute basis.

The S&P 500 closed yesterday at 904.42 and closed at 816.21 (+10.81%) when we liked BGP, so we’re down 20.64% on a relative basis.

[Disclosure: We have a holding in BGP but we plan to exit it soon. We may acquire it again in the future. 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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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-summary

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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