Thursday, December 09, 2010

Barnes & Noble + Borders: William Ackman Plays Modern-Day JP Morgan

Tuesday's Wall Street Journal featured an article describing hedge fund manager William Ackman's bid to reprise J.P. Morgan's historic industrial reorganization role with his bid, as an owner of Borders, to merge that firm with Barnes & Noble. The story noted,

"The threats posed to the big store chains were underscored Monday, when Google Inc. unveiled its new online bookstore, a retailing venture that adds a major player to a crowd of digital sellers that includes Inc. and Apple Inc.

A hedge fund managed by Borders investor William Ackman is now offering to finance a bid of $960 million in cash, or $16 per share, for Borders to buy the much bigger Barnes & Noble, which put itself up for sale in August. Mr. Ackman, whose Pershing Square Capital Management LP holds 37.3% of Borders shares, made his offer in a regulatory filing that became public Monday.

The past year has been rocky for Barnes & Noble. In November 2009, the company adopted a "poison pill" antitakeover defense after activist investor Ronald Burkle and his Yucaipa Cos. purchased nearly 20% of its stock. In August, the retailer put itself up for sale. Mr. Burkle launched a nasty proxy fight for board representation, a bid that was defeated in late September.

A marriage of the two book behemoths could lead to some significant cost savings through economies of scale. Barnes & Noble also has proven to be a more adept operator, with skills that it could be applied throughout a single, combined chain. But a combination of the No. 1 and No. 2 bookstore chains in the U.S. would face headwinds, including antitrust scrutiny and Borders' own shaky finances."

I guess since Ackman already has such a large stake in Borders, conventional concerns regarding whether the merger's cost savings can really offset changing consumer behaviors with respect to bricks and mortar book retailing may be moot. He has to minimize damage to his existing investment, short of simply bailing out.

The Journal article went on to identify the most likely reason that Ackman wants Borders unified with its large competitor,

"Mr. Ackman's proposal may be a bet on Barnes & Noble's rapid investment in digital bookselling, built on its Nook e-reader device and e-book offerings. Recently, the retailer introduced a Nook Color reader, and claims to have captured about 20% of the digital book market, which Forrester Research says could more than triple to $966 million in revenue this year. Borders sells e-books through a bookstore powered by Kobo Inc., a Toronto-based e-retailer in which it is an investor.

Observers say Mr. Ackman's bid for Barnes & Noble may be an attempt to help Borders survive. But because Borders is facing even bigger challenges than Barnes & Noble, it may not be seen favorably as an acquirer."

This makes sense, of course, for Ackman and Borders. But why would Barnes & Noble allow itself to be low-balled for its more valuable asset, its burgeoning online reader business? Won't other bidders keep a realistic, market-based value on that which will prevent Ackman from stealing it on the cheap?

The story provided some detail on past merger ideas for the two firms, explaining,

"The idea of joining the two companies has been floated before. In May 2008, Barnes & Noble assembled a team of executives and advisers to study the possibility of acquiring Borders, which had put itself up for sale. But in August of that year, Barnes & Noble decided against making an offer.

Mr. Ackman had also pursued the idea. In November 2008, Mr. Ackman, then the second largest investor in Barnes & Noble, with a bit more than 10% of the stock, tried to get the book giant to buy Borders, arguing that the combined business would be stronger than either operating independently. He also owned more than 11% of Borders at the time.

His efforts were rebuffed by Barnes & Noble, however, which was concerned about inheriting Borders' real estate portfolio and lengthy store leases. Mr. Ackman later sold his Barnes & Noble stock. It is unclear whether he owns any shares today."

It's unclear to me why Ackman has so diligently and doggedly pursued either physical book retailer over the past few years. With Amazon and Google targeting the space, and Apple's recent iPad adding to the mix, it wouldn't seem to be an easy product/market in which to earn substantial gains by maneuvering with the remaining two, damaged retailers, would it?

Ackman has a track record as a smart investor. But, then, so did Ed Lampert before his plunge into owning retailers K-Mart and Sears.

Nearby is a price chart for Borders (BGP), Barnes & Noble (BKS), and the S&P500 Index for the past five years.

Why on earth would anyone have bought into these turkeys even as long as three years ago? Their underperformance has only increased since then.

I suppose Ackman has a very short-term, 'turnaround' sort of mentality that seeks a quick, abrupt rise in share price from an unexpected reorganization, followed by a hasty exit from his positions.

Somehow, though, JP Morgan's steel-sector integrations of a century ago seem to have involved an industry with much more growth and opportunity ahead of it than Ackman's book retailers have.

I'm just not seeing the logic to this situation for Ackman, other than desperation to rescue some value from his 1/3+ ownership of the worse-performing, lesser-sized turkey in the sector. Is Ackman hoping, if successful, to sell the Nook business and eventually realize real estate gains from the resulting moribund combined bookselling business? He tried that when he approached Target, but was rebuffed. Here, he is already heavily invested, and the prospects are dimmer, so his motivations might be heightened.

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