Is Borders a Dead Fish Trying to Swallow a Barnes & Noble Whale?

Barnes & Noble (NYSE:BKS) has been up for sale for quite some time now (since August), and a potential buyer has finally come through the woodwork.

Last Monday, William Ackman, an activist investor and the manager of Pershing Square Capital Management, which owns 37.3 percent of Borders’ (NYSE:BGP) shares, announced that Pershing would be willing to finance a $960 million bid in cash, or $16 per share, to allow Borders to acquire Barnes & Noble.  This is a 20 percent premium to Friday’s closing price.

Will Border’s Acquisition of Barnes & Noble Work?

At first glance, this potential deal looks like the triumph of the little guy, David acquiring Goliath, if you will.  Borders has a market capitalization of approximately $100 million, while Barnes & Noble has one at around $865 million.

But really, this deal would just be a dead fish trying to swallow a whale.  Or, hooking two sinking ships together, or rearranging the deck chairs on the Titanic. You get the picture.  Both companies are facing an increasingly hostile retail environment, and they’re not doing that great individually anyway.  Seems like a desperate attempt to keep the both alive.  Together, maybe they’ll do less poorly, or so the reasoning goes.

Yet, the companies’ stock skyrocketed after the announcement.  What could possibly justify a 30 percent rise in share price?

Book Retailers on the Decline

The main problems with these two companies is that they’re becoming outdated, and they’re not making any money.  With the advent of e-books from Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), and as of this week, Google (NASDAQ:GOOG) (of course), Barnes & Noble and Borders are looking more and more like sinking ships.  Barnes & Noble suffered pretty big losses this year, and is saddled with debt.

The implications of this deal are pretty big.  On the one hand, the newly merged company may be able to take advantage of significant economies of scale and synergies since the companies are so similar.  Their similarity could also bite them, since they are similarly bad at making money.

Barnes & Noble has an interesting history.  When it appeared on the book scene in the early 1990s, it wiped out many small bookstore businesses, which simply could not compete.  Now it looks like Barney is getting a taste of his own medicine.  Now Barnes & Noble and Borders are closing stores on predictions that spending on physical books will drop in the coming years.

The Cast of Characters

Ronald Burkle, an activist investor, also has played an important role in Barnes & Noble.  Last year, Barnes & Noble adopted a poison pill to try to combat Burkle’s purchase of 20 percent of the company’s stock.  While putting itself up for sale, Barnes & Noble also had to deal with a proxy fight hatched by Burkle, which he lost in September of this year.

Ackman’s intentions are important in this deal.  According to the Wall Street Journal’s DealJournal, Ackman owns 42 percent of Borders’ shares, including warrants and swap options (the commonly cited statistic is 15 percent).  You can bet he’s trying to cash out.

Nooks and Books

Barnes & Noble has some things going for it, which could be another reason why Ackman wants in.  Take the Nook, for example.  What’s that, you ask?  It’s the Barnes & Noble version of the Amazon Kindle.

Barnes & Noble has been trying to compete (emphasis on trying) in the e-book market, but trends don’t bode too well for Barnes & Noble and BordersBorders especially.  They also sell e-books, but who’s ever heard of a Borders e-book?

I realize e-books are part of the future, but is it just me, or is it kind of weird to see people reading a book off of a tablet device?  It’s almost like buying those razors with disposables.  As soon as Gillette comes out with a sleeker version of its TurboMax or whatever they call it, they jack up the price on the disposables for the outdated razor and you feel inadequate if you don’t have the newer version.

As each new edition of the Nook and Kindle offers better features, buyers of the first version are essentially chumps.  No one can ever fault a person for carrying around a hard copy of a book, however.  It’s light, and you don’t have to worry about destroying its battery because you spilled coffee all over it.

According to the Amazon homepage, however, the Kindle is the “number one best-selling, number one most-wished-for, number one most-gifted product on Amazon.”  Maybe it’s a fad, maybe it’s not, but who wants to fork over almost $150 for a device that reads e-books, all of which you can get in your local library for free?  It doesn’t make sense, yet people are paying for it.

Are Barnes & Noble and Borders Destined to Be Together?

There still may be hope for Barnes & Noble in the form of a private equity buyout.  Second-round bids are due pretty soon, so we’ll see how that shakes out.  However, these companies have been trying to get together for quite some time now.

Well, Ackman has been trying to get them together.  In 2008, Barnes & Noble considered buying Borders, since it was up for sale, but they decided not to do so.  Ackman tried to twist some arms later that year, but to no avail.  Barnes & Noble apparently wanted nothing to do with Borders’ real estate portfolio and store leases.

The whole thing is a shame, really.  Both Barnes & Noble and Borders have such a nice selection of books.  Too bad no one’s buying them.  The companies are like the Whole Foods (NASDAQ:WFMI) of books.  Part of the experience is the stores’ ambiance, which we’re sure to lose if Barnes & Noble cannot compete any longer.

Disclosure: No positions in the stocks mentioned.