Borders: Don't Judge a Book by Its Cover


Borders: Don't Judge a Book by Its Cover

The bookstore turnaround is garnering attention, most recently from the manager of Pershing Square Capital hedge fund.

Wall Street is starting to see signs of a turnaround at Borders, the nation's second-largest book retailer (see our September coverage). William Ackman, who runs Pershing Square Capital, a hedge fund, is also taking notice of the potential success story. The key, he says, is to read beyond the dust jacket.

Book retailing seems like an unattractive industry in this e-commerce age. Border's mall sales (through its Waldenbooks stores) are suffering; bestseller sales are moving to Wal-Mart and Costco; music sales, migrating to the Net, are shrinking. Borders is generating little cash flow. The stock has treaded water for five years. Yet Ackman announced on November 9 that he had purchased an 11% stake in Borders (symbol BGP), news that drove the stock up 6.6% (it closed at $23.46 on November 10, slightly lower for the day).

Ackman has a stellar investment record and a history of buying large stakes in companies, such as McDonald's and Wendy's, and playing the activist shareholder who pressures management to extract more value for shareholders from the company. So what is Ackman thinking with Borders?

He laid out his case at the Value Investing Congress, in New York City. First, he notes that Borders' core business of book superstores is actually still a good business. Yes, the market share of online sales of books has boomed ( is the third largest bookseller), but so have superstore sales. Mall stores (Waldenbooks for Borders, B. Dalton for Barnes Noble) are disaster areas ("worth more dead than alive," quips Ackman) since they depend on bestsellers. But Ackman thinks Borders will rapidly close these stores as mall leases expire.


Borders is remodeling its old stores, shrinking space devoted to the bad business of music sales and devoting more space to high-margin, faster-growing businesses such as coffee shops (Seattle's Best Brand coffee; Barnes Noble, which sells Starbucks coffee, is the country's second-largest coffee retailer, according to Ackman) and stationery (Paperchase brand). Ackman sees the superstores as akin to mini-malls, where people meet, attend events, drink coffee and shop. He says the average shopper is well-educated, earns a high income and, on average, spends an impressive one hour in the store. The brand is strong.

The hedge fund manager is also attracted to the improving financials. Borders will repurchase 14% of outstanding shares by early 2007. Annual depreciation expense, a non-cash charge, is running at $130 million compared with $50 million for maintenance spending, implying improvement in free cash flow. Borders stock is up 14% since we wrote about it in September, but Ackman thinks the shares are headed much higher. He figures they are worth about $36. And he'll do everything he can to make sure new Borders CEO George Jones does what it takes to get the stock there.