Boring Portfolio

Boring Selling BGP
January 27, 1999

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Borders Group, Inc. (NYSE:BGP)
500 E. Washington St., Ann Arbor, MI 48104
Phone: 313-913-1100

Today the Boring Portfolio announces two sells, which are probably the last of the sell decisions we will make on the holdings that were in the portfolio when we took it over.

The first sell is Andrew Corporation (Nasdaq: ANDW), a manufacturer of wireless communications and broadcast equipment. Year-over-year, sales declined 5% for Andrew and net income was down 18%. This was mitigated by the company's repurchase of shares, bringing in an EPS decline of 12% year-over-year. Our prior assessment that the shares of Andrew were undervalued may have been incorrect.

Here's why. You can model something to death and not capture the essence of what is going on. In our valuation of the company, the growth numbers in the model are very small. They would be seemingly easy to achieve. As I learn more about Andrew, however, the thing that I miss is the company's positions in the PCS buildout across the globe. The part about Andrew I fear is the changing outlook for infrastructure investment per population unit in Andrew's markets. Namely, sale-leaseback transactions of towers conducted by Andrew's customers could mean a permanently lower potential growth path in certain market segments for Andrew.

With these sale-leaseback transactions, a wireless communications provider no longer has control over its own towers. It just leases the space on the tower from whatever company buys the properties and that buyer then leases the tower out to other wireless companies. In one set of transactions, the wireless company that formerly owned the infrastructure now gets to redeploy capital and the company that buys the infrastructure gets to increase capacity utilization of those assets. My fear is that Andrew loses all the way around -- as far as towers, cable, microwave relays, and other products go.

A seemingly helpful trend for Andrew -- that of increased capital investment by wireless providers resulting from an institution of flat-rate pricing -- would be diminished if this hypothesis is correct. And why wouldn't it be? Sure, coverage is going to increase, which necessitates more towers and cable. But in markets where towers are underutilized, it makes sense for wireless providers to outsource the ownership of the towers and for the wireless provider to add more software intelligence to the network. What the Boring Portfolio needs is more investments in high vale-added intellectual property companies and not so many investments where it's more difficult all around to add value.

Mr. Market Is Not That Dumb

We are going to add this as a Boring Tenet. In a sense, we fear that Andrew's total potential growth path has shifted downward. Mr. Market is not that dumb. On occasion, he suffers from bi-polar episodes. He'll offer you a price that is way higher than the intrinsic value of the business at times. At other times, he'll offer to sell you his part of the business for far below what a rational buyer would pay for the company. On the whole, however, Mr. Market is a rational individual. His assessment of a company's value is usually pretty good because he knows a lot about the company and is usually pretty good at estimating how a company will do in the future.

With Andrew, we are afraid that Mr. Market has guessed that its potential growth path has indeed shifted down and that Andrew's position, as far as PCS infrastructure growth goes, won't be the same as for cellular infrastructure growth. Indeed, only about 10% of the first quarter's orders were for PCS products, as PCS orders fell 33%, or $10 million, in the latest quarter. But that was about 23% of the approximately $44 million year-over-year decline in orders at Andrew. When your marginal growth driver falls as badly as this and when anecdotal evidence of PCS orders in the U.S. show very robust growth, you start to worry. Andrew said that some of the lead-times on products are very short. But if the market is efficient, and we believe it is most of the time, the market would have correctly discounted this by now. It tried earlier this year, but the conference call left investors cold on guidance.

As we've said in the past, we love what Andrew is doing with the buybacks and we wouldn't mind being owners of this company in a private situation. But there are a number of better opportunities in the public equity markets today, even at higher valuations, than this one. We know Andrew's management is doing a good job, but we can't see where this company is going in the future. We'd rather own the companies that are adding the most value to telecom, such as Cisco Systems (Nasdaq: CSCO), than a company whose best days may be behind it, as we and the market see it now.

In a world where we inherited Andrew and could not sell by the dictates of some trust or other document, we wouldn't feel that bad about owning it. We think Andrew's management is pretty darned good. It comes down to relative opportunities in the end. On an absolute basis, the growth here is unattractive and on a relative basis, there are more than a few companies with much higher valuations on today's numbers that present better value.

Our Second Sell

We're also selling Borders Group (NYSE: BGP). Our list of dislikes with this company is very long.

We worry that the company doesn't realize that the online booksellers are taking Borders' prime demographic customers. As Alex Schay noted earlier this year, the 80-20 rule applies to this business as well as so many others. That is, 80% of your sales come from 20% of your customers. We think and have made incursions into Borders' precious 20% customer base and that Borders is not responding appropriately.

Overall, we've never liked the economics of this business (Dale more so than Alex, especially as it pertains to the potential economics of the business), given the slow cash conversion cycle and the capital investment needs to expand Borders. Management at Borders has focused way too much in the past on's valuation, but the fact is that yielded free cash flow of $29 million in their most recent quarter, compared to free cash flow at Borders of $33.4 million last year. That's on sales of $252 million for versus sales of $2.27 billion for Borders. Sure, there's seasonality in the book business, but it's highly likely will expand sales sequentially next quarter.

If we have zero confidence in management (Alex thinks they're smarter than I do), we're not going to feel comfortable with this investment. And we're well aware that this can go higher at some point, making us look wrong about this decision. Speaking personally, I derive no pleasure in being an owner of this company. And that's not our idea of a productive relationship between a company and its shareholders. Finally, the company should worry about its own share price instead of disparaging at trade shows, as the company's former CEO did. We understand that the new CEO has the right priorities in mind, though.

As we said the other day, the market's not that dumb. It's discounting a number of problems that may or may not be real. We do happen to be selling at a price of near maximum pessimism. But I feel, more strongly than Alex, that the new competitive landscape may be doing substantial damage to Border's market position. Same-store comps that are so flat in a year of buoyant consumer spending is a bad sign and we believe, again, that the best demographics might be slipping away. Maybe if the company could provide comps for markets where snowfall was not a factor we could make a better assessment.

If there were no better opportunities around, we could wait for this company to turn around a badly listing shareholder value creation vessel. But this thing's burning above the waterline. There are better opportunities available and I personally don't want to find out the harrying end to this story where the ship sinks and all the passengers drown. With one lifeboat left, we're out of here and we're not coming back for any other screaming survivors in the water.

-- Dale Wettlaufer (TMF Ralegh)