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:
- Increase of 4 new Domestic Borders Stores bringing Total Domestic Borders stores to 514 in 4Q 2007.
- 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.
- Decrease Waldenbook Stores by the targeted 50 store count by management bringing the total to 471 stores in 4Q 2007.
- 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.
- 28 International Stores remain.
- International Revenue per store of $4.07MM quarterly which is the average increase form 3Q to 4Q over the last 3 fiscal years.
- We have assumed a 1% decrease in Gross Margin from Q4 2006 to Q4 2008.
- We have assumed SG&A to be the same 20% of Sales in Q4 2007 as it was in Q4 2006.
FYE 2/3/08
| ($ 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