What Will It Take To Save Borders Group Inc.?

When I was in law school, Borders Books in Ann Arbor, Michigan had a reputation as one of the nation's most fabulous independent book stores in the nation, with a headquarters on State Street near the independent movie theater and close to the University of Michigan campus, and a small number of other locations nearby.

Borders was then what the Tattered Cover bookstore in Denver is now.

Meanwhile, discount retailer Kmart, founded in 1962 to fill roughly the niche that Wal-Mart has right now, as the lowest priced big box retailer in the market offering half decent goods, acquired the mall based Waldenbooks chain in 1984. Waldenbooks was a bookstore for people who don't like to read. Almost nothing they sold was written at above then 10th grade reading level. It was like the pharmacy book rack, but bigger.

In 1992, Kmart bought the very dissimilar (by geographically local) Borders Books, on the theory that Kmart could provide the capital for Borders to expand, and Borders could provided books store operating experience that Kmart lacked. Borders expanded dramatically, Borders and Waldenbooks were merged in 1994, and neither chain was a good fit with Kmart so they were spun off in 1995. Kmart did half a dozen similar deals in other areas (e.g. Office Max. Sports Authority and Payless Drugs) at roughly the same time.

Kmart's deteriorating (and still shabby) core business fell into a Chapter 11 bankruptcy in 2002, left bankruptcy in 2003, and merged with Sears in 2004. Both the Kmart and Sears brands continue to operate struggling big box retail store operations, although market watchers suspect that the real value in the companies may be in their vast real estate holdings which have slowly been converted to other uses (including store within a store Land's End outlets at Sears stores).

Anyway, Borders Group has continued on its merry way for more than 13 years, painstakingly moving Waldenbooks upmarket so that they are smaller but nice mall based mini-Borders stores with a focus on popular titles, while expanding the Borders model to most metro areas in the United States until it has become the number two brick and mortar bookseller in the United States with the entire group having 27,000 employees.

But, the 2009 financial crisis was not kind to Borders group. Its sales covered only about 80% of its expenses. Its full speed ahead expansion has never really been tested either, until now. From shopping there, online and off, I know that its prices are competitive with competitors Barnes & Noble and Amazon.com, although sometimes ever so slightly higher. Anyway, the bottom line is that it has no real room to improve the bottom line by increasing prices. It has spent early 2009 slashing management costs and unprofitable operations, like a marquee downtown Chicago store, and has so far held onto enough financing to keep it afloat.

But, investors have lost faith. The current stock price of 58 cents a share is down from a 52 week high of $10.66 a share. This collapse basically has taken place from September of 2008 until January of this year. The company's market capitalization is now about $36 million.

This is despite the fact that the balance sheet of the company doesn't look all that bad. Its inventory of books and other media to sell are mostly financed with trade credit. Its plant and equipment are almost completely financed with short term debt and capital leases. It has almost no long term debt, and it does have some cash on hand. Still, if you make a loss of 25% of the sale price on everything you sell, you've got a problem.

It looks to me like the losses are basically a case of (1) stores that are too large and have too much overhead to support their sales, and somewhat related (2) too little focus on titles that sell.

Recent experience has also shown a very poor track record for retail companies trying to emerge successfully reorganized from Chapter 11 bankruptcy. So, unless Borders can slash costs, maintain cash flow until the 2009 Christmas season, and have much better sales in 2009 than it did in 2008, it is doomed. This is a shame because Borders really is the best non-independent brick and mortar book seller in the market.