Ironically enough, as I write this there sits 5 packages from Amazon next to me. Amazon might’ve killed the bookstore, but Borders didn’t do much to help themselves. In the end, the Borders bankruptcy shows what happens when a company is slow to change.
I mention slow to change because Borders epitomized this characteristic. To say that they were slow to adapt to the internet would be an understatement.
When internet sales first started to get off the ground, Borders shot themselves in the foot by outsourcing all of their internet purchases to Amazon. This was a grave mistake that eventually crippled their bottom line, seen especially evident in 2006 and later.
In business, getting the customer is the name of the game. A business’s most likely customer is a previous customer. Borders failed to understand this miserably, giving away all of its online sales to Amazon from 2001-2008. What a way for Amazon to jump start their business!
That’s not the only way that Borders yielded to Amazon. Jeff Bezos, the founder of Amazon, figured out very quickly that the ebook was soon to take over the publishing space.
As a result, he made sure that his Kindle was the first e-reader to be released, in late 2007. Barnes and Noble wisely followed suit with their Nook release in 2009. Borders finally released the Kobo in 2010, but it was too little, too late.
The Borders bankruptcy could also thank the company’s inefficiency for contributing. In a time period where big box retailing was losing its allure, Borders continued to expand and insert their big box strategy into ill-suited locations. This predictably resulted in crushing liabilities in the form of binding lease agreements coupled with decreasing store traffic.
The miscues and lack of sound direction from management could very well be attributed to the fluctuating status of top level executives. What I mean is, management was constantly either leaving or being replaced.
Leading to the Borders Bankruptcy…
Borders started losing money in 2007. In 2009, the company cleaned ship. The CEO was replaced and given a severance package, the CFO was replaced, and 5 of the 8 board of directors were replaced as well.
The new CEO Ron Marshall only lasted a year before jumping ship, resigning and moving to be CEO of a different company. He had effectively convinced most if not all of the top executives to resign, including those who had faithfully worked in the company for over 20 years.
Of course, this all leads to speculation of the chicken versus the egg. Did the company collapse because the old management was all cleared out, or did old management destroy the business?
It’s hard to definitively say, and frankly, it doesn’t matter. What matters is that this ship was headed for the icebergs once it started losing money, and shareholders who were smart enough to jump onto lifeboats didn’t lose substantial investment like the rest of them did.
The final chapter of Borders’ book came on February 16, 2011, when they filed for Chapter 11 bankruptcy. The Ch. 11 was eventually converted to a Chapter 7, which just shows how miserable things really were. When it’s better to liquidate than re-organize, the business is failing catastrophically.
I’m guessing that the cold hard facts of this case will reveal that the bankruptcy could’ve been easily avoided by the average investor. Forget the internet and retail talk, and let’s dive in.
Here’s the last annual report filed before the Borders bankruptcy, on April 1, 2010. As always, the numbers inside the parentheses are negative.
Like I mentioned before, the company was not profitable after 2006. Although it may have been able to prolong its survival, the bankruptcy filing was inevitable unless radical change and a recovery occurred. Neither of those things happened, and the company paid the price.
[Note: The earnings growth numbers you see above are taken from the most previous positive annual earnings. This is done because growth numbers involving 2 negative numbers become inaccurate and are impossible to calculate.
Also, this avoids the possibility of a high growth number just because of very poor performance the year prior. We want to see real earnings growth, not accidental mathematical anomalies.]
A very interesting takeaway from these financials involves the Value Trap Indicator numbers below. Keep in mind that a Strong Sell ( > 800) was marked in all 4 years prior to bankruptcy.
First and foremost, the debt to equity in 2010 is ridiculously high for a retailer. It’s too much debt for any company, let alone one that is fully dependent on the economic spending cycles of the consumer.
The debt to equity was also increasing every year. This is the only way that the company was able to stay afloat, and obviously that’s not sustainable. When you see debt levels growing at that fast of a pace, it should be triggering alarms all around your head.
Dividend Growth Investing Warning
Now, the big point I wanted to make was concerning the dividend payments. Look at how the dividend increased from 2007 to 2008.
Most dividend growth investors would keep holding the company stock because these payments are still growing. A dividend growth investor’s chief concern is dividends, and if that dividend is growing every year. Thus the name.
The problem with that strategy, while generally a very profitable one, is that you get into situations such as this one where the company is desperately trying to save face and act like everything is ok while in reality the crap is about to hit the fan. A dividend payment, especially an increase, is a bold statement by management to shareholders that business is doing well.
However, the business was very obviously not doing well. They lost money in 2007 and in 2008. A dividend investor should’ve gotten out at the first sign of negative earnings. If management isn’t going to be responsible, you have to be. Even if that means missing a few dividends.
Look at how bad investors got hit if they waited until AFTER dividend payments stopped to sell. An average of $8 a share in the first quarter, down from an average of $20 the previous year.
This is yet just another reason why I am so strong about selling stock on negative annual earnings. A loss of 50% or greater is not worth it to me to wait and find out if the business can recover. There’s too many other great businesses out there to put money in.
As always, the bankruptcy presented teaches us another valuable lesson on when to sell. It’s almost magical how each of these major bankruptcies teaches us something different.
As if the universe is trying to fully equip us against every bad situation.
I wouldn’t ignore it.
This blog post is part of the Stock Market History series. This series tries to uncover what went wrong in the biggest stock market bankruptcies, and how investors can use these lessons to prevent major losses in their own portfolio. This Stock Market History series shows the Value Trap Indicator values in the years right before a company went bankrupt. As you’ll soon see, many of these bankruptcies could’ve been easily avoided by following the Value Trap Indicator.
Today, there’s one portfolio that utilizes the Value Trap Indicator to find the best deals in today’s market for continuous compounding and superior returns. Those stock buy ideas are published monthly in the Sather Research eLetter, complete with research and Value Trap Indicator values. To subscribe to the Sather Research eLetter, click the link.
**2011 Stock Market History: Borders Bankruptcy**
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