Borders: A Story in the Making

Booklovers are familiar with the hallmarks of a great read: an interesting protagonist, for one thing, plus forward-moving action and, perhaps, a dash of rivalry and intrigue. The combination of those elements can also make for an interesting investment story. And one analyst who has been watching the plots unfold at the major booksellers says developments at Borders Group have caught his attention.

Borders' story over the past few years hasn't exactly been a page-turner. The company, which owns Borders superstores as well as Waldenbooks, has regularly trailed industry-leader Barnes & Noble in key sales measurements, and "has been slow to reduce exposure to music, close underperforming mall stores and come up with a coherent international strategy," says analyst Gary Balter of Credit Suisse. Earnings have been punk the past couple of years, and the stock (BGP) has mainly gathered dust, falling nearly 9% from early 2004 through the September 7 close.

But the plot is thickening. Borders is trying to become a tougher competitor. To start, it has been revamping its namesake superstores, with a goal of renovating about half the stores by the end of this year. The difference in design hinges not so much on books -- Borders' bread-and-butter -- but on goods that have over the years come to be associated with the bookstore experience. Specifically, the remodeled stores scale back on music offerings (a good thing as demand for CDs has been on the decline) and give more prominence to stationery and gifts. The stores also feature Seattle's Best coffee shops. For the short term, extra spending on store renovations is cutting into the company's profitability. But early reports from the company show that the remodeled stores are performing better than their unremodeled counterparts. Balter expects better sales ahead as more renovations are completed. He notes that Borders expects the investment in refurbishing stores to pay for itself within four years.

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Balter points to two other important developments that should lead to a new chapter for Borders: The entrance of a strong protagonist -- in the form of new CEO George Jones, who was hired in July -- and a plot twist, in the form of a new customer rewards program. Balter likes that Jones, who previously served as CEO of the Saks Department Store Group, has a keen sense of the challenges Borders faces, and a vision for overcoming them. Balter says Jones is focused on improving merchandising at the stores, which essentially means giving customers a reason to visit the stores and encouraging them to spend their money. He also thinks Jones will come up with smart ways to turn around the struggling Waldenbooks segment and lackluster international sales.

Borders' rewards program, launched last February, should help the Ann Arbor, Mich.-based firm better compete against rival Barnes & Noble, Balter says. Notably, it could play a significant role in Christmas sales this year. Every time a member makes a qualifying purchase, 5% of the price is put away in a type of savings account, which the customer can then redeem during the holiday shopping season, potentially boosting fourth-quarter sales.

Balter now sees Borders as a more exciting stock than Barnes & Noble. It certainly was more exciting on September 8. Shares of Borders rose 7%, to $20.60, after Balter upgraded the stock to "outperform." He downgraded Barnes & Noble (BKS) to "underperform," but the stock barely budged, closing at $35.71.

Borders' story-drivers don't guarantee a happy ending, of course. "This is, as with all turnarounds, a high-risk story," Balter cautions. Still, the intrigue may well be enough to prompt investors to least pick up the book to see what happens next.