Boring Portfolio

The Book on
Wednesday, April 8, 1998
by Greg Markus (TMF Boring)

ANN ARBOR, Mich. (April 8, 1998) -- Major market averages closed mixed Wednesday, with the Nasdaq recovering 8 of the 30 points it shed the day before but the S&P 500 and Dow both off 0.7%.

The Boring Portfolio fell 0.38%, with five of six stocks on the downside. The sole exception was Atlas Air (NYSE: CGO), which rose $1 13/16 to $33 1/8.

BT Alex. Brown was the wind beneath Atlas' wings today. The brokerage firm initiated coverage of Atlas with a "strong buy." I was unable to locate further details. If you spot them, I'd be grateful if you'd pass them along.

Andrew Corp. (Nasdaq: ANDW) stock eased $1/4. The auction of Brazil's B-Band cellular licenses continues to go well, with a consortium including Motorola (NYSE: MOT) and Japan's DDI Corp. laying claim to the eighth area license. According to a Reuters story, the group is likely to use CDMA cellular technology supplied by mighty Moto as part of its infrastructure buildout in Brazil's Area 5, which includes the states of Parana and Santa Catarina.

I mention this because Andrew has been a major player in cellular infrastructure development in Brazil -- and the rest of South America, as well. Also, Motorola is a long-standing Andrew customer. Heck, Andrew headquarters is a leisurely bike ride from Motorola HQ in suburban Chicagoland.

I learned today that Robert DiRomualdo, chairman and CEO of Borders Group (NYSE: BGP), participated recently in a Merrill Lynch Retailing Conference in New York. At the conference, DiRomualdo offered insights into his company's international and e-commerce initiatives and his overall outlook for Borders in 1998, according to a reliable source.

On the international front, DiRomualdo said Borders is focusing on sizable markets with highly literate and preferably English-speaking populations and limited political and regulatory barriers -- places that offer good prospects for making a "meaningful" contribution to earnings.

One example is Singapore, where Borders opened its first international store last year -- one that is reportedly a big hit. Borders currently has two stores under construction in the U.K. and one in Melbourne, Australia.

As for, the company's much anticipated -- and much delayed -- e-commerce site, DiRomualdo said that although he believes the Internet will provide a "substantial business" for Borders, there are aspects of the current environment that "give us all pause."

In particular, DiRomualdo questions the way the stock market is valuing Internet-based bookselling operations. In researching Internet opportunities, DiRomualdo said he looked at data on four public entities selling books and music on the Web last year. Combined sales of those four entities totaled $190 million in 1997. Combined pre-tax losses were $82 million. However, the combined market capitalization of this group is about $3.3 billion.

"Clearly, e-commerce is getting high-tech valuations," said DiRomualdo, "but this is not Microsoft (Nasdaq: MSFT), where I sell an extra 100,000 copies of Windows 95 and my cost of goods is zero and all these additional sales drop to my bottom line. This is not Yahoo! (Nasdaq: YHOO) where the feeding frenzy allows me to triple my rates for search engine space which all drops to the bottom line. This is a low-margin retail business."

"The gross margins on the Internet-based booksellers are in the teens," DiRomualdo said. "At this stage, we have 1000 basis point gross margin advantage over them and our gross margin includes occupancy. This is also not a free labor cost business. You're not downloading a piece of software. We have to singularly pick and ship goods."

DiRomualdo also pointed out the high cost of Web "real estate."

"As I understand it," he said, "the Barnes & Noble (NYSE: BKS) deal which they signed a couple of months ago with America Online (NYSE: AOL) was for $41 million. Whether that is a good deal or not, I don't know. However, I have a feeling that if they had paid $61 million for the same deal it would have made no difference in any of the valuations of any of the stocks today. It literally is a feeding frenzy."

So how does DiRomualdo account for the "feeding frenzy"? In a nutshell, he attributes it to a stock market that is rewarding companies based only on revenue growth (or prospects for it) and not on profits, or even potential profits.

"When a market rewards revenue gains, a firm will do anything to drive revenue, including severe discounting and inefficient advertising," he said.

Of course, Borders is not completely averse to partaking in the feeding frenzy. "Obviously, we would like to get some of this valuation," said DiRomualdo. At the same time, however, Borders has scrupulously avoided disappointing the Street since the company went public in 1995, and it wants to continue that record. "We do not want this type of valuation unless we think it can produce profit over time," DiRomualdo said.

As noted in the March conference call following Borders' report of 1997 fourth-quarter results, the company's objective on the Internet is to extend the brand, including internationally, and to provide an online alternative for Borders customers. To the greatest extent possible, will reflect the values and environment of a brick-and-mortar Borders superstore. It will offer books, music, and video, and the emphasis will be on selection and service.

As for the in-store cafe, "We cannot deliver a hot cup of coffee online, but we will sell you the bean," DiRomualdo said.

Having bricks-and-mortar stores as well as an e-commerce site offers a number of opportunities for cross-leveraging. As one example, DiRomualdo pointed out that Borders' new fulfillment center in Nashville, Tenn., will serve both and the superstores. "This fulfillment center has 53 miles of shelving and is capable of stocking 750,000 'skus' (shop-keeping units) of books, music and video," he said.

"Our goal is to achieve zero wasted trips when people come to shop our stores. When you come to a Borders, you will see 200,000 to 250,000 skus of books, music and video that we carry. There you can sample it, open the book, etc. If we do not have what you want, we will have 700,000 skus available for immediate shipment to your home from the fulfillment center," DiRomualdo said.

"If we don't have it there, he continued, "we will search through 'all else in print' through Ingram, Baker and Taylor or anybody else who has it. And if they don't have what you want, we -- unlike other Internet providers -- will not have to go to the publisher where you may have to wait two months. We can go to our 'chase team' who can go to Borders stores where very obscure titles may be sitting on a store shelf and get it much, much faster. If all else fails, we will go to the publisher. We also have an investment in Harvest, which is the premiere out of print search service, who is our partner in our Internet venture."

Originally slated to be open in time for the 1997 holiday shopping season, has had its debut pushed back a number of times. Regarding's long gestation, DiRomualdo said, "We are going to be on the Internet for the next 50 years, so we want to do it the right way. We're not concerned about launching our site in one specific month versus another, although we do intend to launch this quarter [which ends in a few weeks]. The site will be evolutionary, because we are trying to make it profitable. There is a limit to how much money we can throw at it."

Borders is forecasting sales of about $25 million for its website in 1998 and does not expect to see a profit this year, an expectation that is built into management's earnings guidance. Based on last month's conference call, that guidance is for sales to rise to $2.6 billion, an increase of approximately 16.5%, while earnings are projected to increase to $1.21 per share, as compared with last year's $0.98 per share.

FoolWatch -- It's what's going on at the Fool today.

Stock  Change    Bid 
 ANDW  -  1/4   19.19 
 CGO   +1 13/16 33.13 
 BGP   -  5/16  31.81 
 CSL   -  7/16  47.50 
 CSCO  -  13/16 68.19 
 FCH   -  5/8   36.25 
                   Day   Month    Year  History 
         BORING   -0.38%  -2.29%  -1.24%  24.27% 
         S&P:     -0.71%  -0.01%  13.52%  77.22% 
         NASDAQ:  +0.46%  -1.56%  15.07%  73.59% 
     Rec'd   #  Security     In At       Now    Change 
   2/28/96  400 Borders Gr    11.26     31.81   182.62% 
   6/26/96  150 Cisco Syst    35.93     68.19    89.76% 
   8/13/96  200 Carlisle C    26.32     47.50    80.44% 
    3/5/97  150 Atlas Air     23.06     33.13    43.66% 
   11/6/97  200 FelCor Sui    37.59     36.25    -3.56% 
   1/21/98  200 Andrew Cor    26.09     19.19   -26.46% 
     Rec'd   #  Security     In At     Value    Change 
   2/28/96  400 Borders Gr  4502.49  12725.00  $8222.51 
   6/26/96  150 Cisco Syst  5389.99  10228.13  $4838.14 
   8/13/96  200 Carlisle C  5264.99   9500.00  $4235.01 
    3/5/97  150 Atlas Air   3458.74   4968.75  $1510.01 
   11/6/97  200 FelCor Sui  7518.00   7250.00  -$268.00 
   1/21/98  200 Andrew Cor  5218.00   3837.50 -$1380.50 
                              CASH  $13625.51 
                             TOTAL  $62134.89