Todd Sullivan's - ValuePlays

The poster child of poor capital management might just be Borders Group.

Borders, which runs one of our favorite book stores in the country (Union Square in San Francisco) and goes by the ticker BGP, is the now-beleaguered bookseller spun out of K-mart long ago in happier times.

Borders is also one of those companies that so desperately wanted to make Wall Street’s Finest happy—not to mention its own shareholders—that it spent all its cash, and more, to buy back stock.

“Returning value to shareholders,” it was called back in February 2005, when Borders management proudly announced a $250 million share repurchase plan, and the stock price was $25.

Wall Street’s Finest were, of course, delighted, and the company received the kind of “attaboys” that caused a long list of management teams to pursue the greatest value-destroying fad in American business history. In this case, it crippled a once wonderful chain of bookstores:

“The stock’s cheap, in our opinion, and the company seems to agree,” [hedge fund manager Bill] Ackman said last week at the Value Investing Congress in New York. Borders…has “one of the most aggressive share-repurchase programs I’ve ever seen.”

—Bloomberg LP, November 2006

In the end, of course, that repurchase program was far too aggressive.

Five years ago Borders had a $1.9 billion market value and more cash than debt on its books. Today, Borders has a $50 million market value (yes, that’s right, $50 million) and more debt than cash. Like, $525 million in debt against $38 million in cash.

Oh, and the stock’s current price? $1.00 a share.

“Returning value to shareholders?” No. “Mortgaging the future,” at best. “Destroying the company,” at worst.

The improvement we have seen in just the last few months is very encouraging, and perhaps in a better macro environment, could make an interesting story. However, in an environment where the comparable-store-sales declines are worsening, its gap with its No. 1 competitor is widening, in a retail segment on the decline and shifting to other channels, and with technology threatening to change the business even further, we see limited upside from current operating levels and remain cautious on the stock.

Overall, we believe Borders management deserves credit for the progress it has made. In the midst of a challenging macro environment, the company has managed to cut costs without destroying the bottom line, has sold off business lines to focus on the U.S., and has positioned the company to survive.

Results for the third quarter, while worse than expected, showed lower expenses as promised, improved gross margins absent the fixed-cost deleverage from lower sales, better management of promotions, a significant reduction in debt, and much improved cash flow. The company also upped its cost savings target by $20 million to $140 million.