Back when one of us worked at Dun and Bradstreet, the term negative net worth was deemed to be very, very bad. So when you pass your eye over the balance sheet of both Barnes and Noble, the biggest book store in the US, and its rival the Borders Group, the combination of low net worth (assets less liabilities), the fact that some of the assets are still ephemeral (goodwill) and that the results of both are largely cash negative, makes it easy to understand why both of them are valued at such lowly levels on the US stock market.
But when companies like these, with brands that are inherently valuable, begin to have a potential upside in the digital future, then both begin to take on a value that can only be appreciated by adventurer investors. This week we can see that the two organizations have perhaps found their white knight and are launching plans, visible only in the fine print of SEC filings for Borders, to take the sudden increase in sales at Barnes and Noble and the heightened interest in its digital strategy, as depicted by the arrival of the NookColor, and its effrontery to take on Apple’s iPad tablet at half its price, and turn it all into far higher share prices.
Ever since 2008 Barnes and Noble (B&N) has been harassed by the corporate adventurer Ronald Burkle through a group called the Yucaipa Funds. It has built a stock position that has forced the company to adopt a poison pill, set to expire during 2012, to keep the Yucaipa holding under 20% of the group. Yucaipa was buying in an environment that sees B&N valued at under $1 billion, but with revenues heading for $6 billion, and growing at 43% over the first half of its current financial year to around $3.3 billion.
While Burkle says it wants to seek mergers and eliminate assets, there really is only one way to get shareholder benefit out of B&N, and that’s to continue to trade it under that brand and make the most of the Nook strategy. That could mean staying as it is or merging it and to do that someone has to put up some cash.
Now another corporate adventurer in the name of young hedge fund entrepreneur
William Ackman, and his investment fund Pershing Square Capital Management, which has already built a 38% position in Borders, has offered to buy out B&N and merge it with Borders for $16 a share. That offer has not yet been formally made and what happened this week is that the paperwork was being done on buying more shares in Borders for the purposes of putting in $1 billion ready to make an offer. The offer is described as ‘mutually acceptable’ so Ackman is only interested in being a white knight, and will not try to bully B&N, and anyway the poison pill would apply equally to him as it does currently to Buckle.
The deal that it plans to put on the table will allow shareholders to take stock or cash, which could mean that the powerful backer of B&N, Leonard Riggio, who bought the company back in 1971, could opt to keep his stock in the combined entity, while giving Buckle a chance to cut his losses and leave with a profit.
Naturally interested bystanders have pumped the price from $13.3 to $15.5 overnight on the news.
To us this harassment of B&N has gone on long enough. All shareholders will be stressed and there will be persuasion to allow this deal to go ahead at the right price, so that the company can have some say in its destiny and what that means is that if most shareholders opt to remain within the new merged entity, then the great bulk of the $1 billion that Borders is in the process of raising from Ackman’s funds, will stay within the company, and its net worth problems will be a thing of the past and B&N and Borders will have to time effect a digitally led recovery.
And this is where Faultliners should be interested. The creates a merged book seller with a strong online and retail brand, which has a brand new ebook strategy to rival Amazon. Borders has a $2 billion annual run rate, and 679 mostly US stores, while B&N has a $6 billion run rate and 717 retails stores and 633 college based book stores, again mostly in the US. The combined group adds 50% to its buying power and can surely find a few $100 million in savings, plus continue to develop its brand and Nook strategy. It can partner oversees and also in Amazon it has a $30 billion run rate gorilla in its territory who’s digital strategy it can ape.
That digital strategy includes letting consumers buy things other than books, and includes hot areas like games and portable devices and online streaming video, so despite the extremely low net worth on the combined balance sheets of these two organization, with the right type of well managed merger, and the extremely high acceptance of the Nook ereaders and the new NookColor tablet, there could be an instantaneous turn around and a potential international future for the combination. However only one brand can emerge, and this is something we have said continually on the Faultline, that household names have to disappear as new digital business models take root, and our money is on the Barnes and Noble brand emerging victorious and quite a bit stronger.