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’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):
In 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:
- We think the discounted values are more likely to be right; and
- 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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