Borders - Bounding Towards Bankruptcy?

A little over a week ago, Borders Group, Inc., (tkr: BGP) announced that it would delay payments to several vendors that are critical to its business, including landlords, product wholesalers and publishers, for the second month in a row. Prior to that announcement, on January 15, 2011, the Wall Street Journal reported that Borders had hired the law firm of Kasowitz, Benson, Torres & Friedman to assist it in obtaining a new line of credit from GE Capital of about $500 million. The new line of credit would replace Borders's outstanding lines of credit, and be used to pay down some of its senior debt and give it additional operating capital to be used while it restructures its business out of court.

Unfortunately for Borders, but perhaps creating a special opportunity for investors, on February 4th, Borders filed an 8-K with the SEC, notifying investors that on January 28th, Borders had received a notification letter from NYSE Regulation, Inc., that its stock's 30 day average closing price was $0.97 per share, $0.03 below the minimum trading price of stocks listed on the NYSE. If Borders's stock's 30 day average closing price does not increase above $1.00 per share over the next six months, the stock will likely be delisted. In addition, the 8-K also noted that, if Borders's stock is delisted from the NYSE, Borders will be required to payout an undisclosed sum pursuant to a warrant agreement through which it had issued warrants to acquire 25,944,236 shares of Borders stock to Pershing Share Capital Management, L.P. and its affiliates. Borders's most recent 10-Q estimates the value of the payout to be $25.7 million.

Will Borders stock be delisted, triggering the warrant payout? Probably. The six-month high for Borders stock is $1.58, achieved in early October, 2010, while the stock has only eclipsed the $1.00 mark once since Borders first announced that it would defer payments to vendors in early January. Further, Borders stock has fallen over 30% during the last 52 weeks. Put simply, Borders is trending down. However, if Borders acquires a new line of credit, thus delaying the prospects of bankruptcy, it is likely that its stock would see some rebound (though likely small considering the company's terrible financial state as reported on its most recent 10-Q).  I think it is unlikely that Borders will acquire a new line of credit, especially considering that, according to the Wall Street Journal, several publishers (whose blessing is almost certainly a prerequisite to a new line of credit) question the long-term viability of Borders's strategy.

Borders has apparently offered to sweeten the deal to publishers by offering them interest-bearing, collateral-back notes in exchange for forgoing payments in the short-term. I question the value of any such notes to publishers.

Borders's most recent 10-Q, for the period ending October 30, 2010, notes that its current credit facility with Bank of America (that will supposedly be replaced by the GE Capital credit facility) is secured by a first priority security interest in substantially all of Borders's inventory, accounts receivable, cash, etc. At the time of the filing, the outstanding amount owed under the BOA credit facility was approximately $295 million; it is likely that this amount has been accelerated and is due in full. While the GE Capital line of credit would replace that of BOA, it is likely that the GE Capital line would be secured in a similar manner as the BOA credit facility. Additionally, Borders has a term loan with GA Capital, LLC, that is secured by a second priority security interest in the same general assets as the BOA line of credit. At the time of filing, there was $57.8 million outstanding under the term loan agreement, due in 2014; however, it is very likely that this loan is in default and has been accelerated. The 10-Q lists "trade accounts payable," which would be comprised of amounts owed to publishers and other vendors, as $444 million. Borders also lists "other long-term liabilities" as $346.9 million, part of which is comprised as the payout value of the Pershing and other warrants. It is not clear what composes the rest of the amount reflected under "other long-term liabilities." The total outstanding liabilities listed on Borders's 10-Q is $1397.4 million. 

Borders lists total assets of $1356.6 million, of which $895.8 million is inventory. Borders's total outstanding liabilities that will almost certainly have priority over any notes issued to vendors (the BOA credit facility, GA Capital term loan and taxes) are valued at $386 million, leaving $509.8 million to satisfy the approximate $444 million outstanding to vendors, or about $65 million in excess of what is owed. However, I think it very likely that the liquidation value of the outstanding inventory is much lower than as listed in the 10-Q, so vendors would probably have to look to other of Borders's assets for satisfaction of their notes. Borders's 10-Q lists over $320 million in property and equipment, but makes no explanation of what composes this number, it also lists amounts for cash and accounts payable (neither of which Borders likely controls at this point considering their probable default on the BOA credit facility). In short, it's hard to say what, or how much benefit Borders's vendors would get by accepting notes for deferred payment.

It is clear from Borders’s 10-Q that its finances are in shambles and that it is facing a liquidity crisis. Where there is crisis, there are special opportunities.

The Plays:

So, knowing everything above, what sorts of special opportunities are there?

1. Short Borders's stock. If Borders does not successfully open a new line of credit from GE Capital, the company is probably totally illiquid, and will be forced into bankruptcy. Now is a good time to short Borders’s stock, though be careful to close any short position before the stock is delisted to avoid the headache of closing a delisted stock.

2. Consider buying claims from entities that would have 503(b)(9) claims. Section 503(b)(9) of the Bankruptcy Code gives priority status to amounts owed on goods delivered in the 20 day period before bankruptcy. It is hard to estimate when Borders would file, but it will probably have to soon if it does not get a new line of credit. The real risk here is buying a claim that arose before the 20 day period and being stuck with a general unsecured claim. 

3. Attempt to purchase secured debt at a discount, though it is probably difficult to do so. Borders probably has enough in assets to cover its first and second lien debt in full, even in a liquidation situation. Though, as always, there is risk.