Apparently, the performance at book retailer Borders Group (NYSE:BGP) will have to go down to go up, because 2007 is turning out to be a more challenging transition year than investors had anticipated.

Tuesday after the market close, Borders reported a loss of $0.61 per share, or about 60% greater than Wall Street had predicted. This was also nearly double the loss reported during last year's first quarter. Granted, the first quarter is a slow period for book retailers, and archrival Barnes & Noble (NYSE:BKS) also posted a loss in its first-quarter results released last week, but it still managed to beat analyst expectations.

First-quarter trends served as another reminder that Borders is floundering (while Barnes & Noble is at least treading water) in a challenging environment for bricks-and-mortar booksellers. Books aren't struggling as much as newspapers, but the Internet age is definitely hurting demand for hard-copy reading materials and making it easy to snag the latest bestseller on Amazon (NASDAQ:AMZN), pick up a used copy for half-price on eBay (NASDAQ:EBAY), or find a close-out special at Books-A-Million (NASDAQ:BAMM), which also happens to run a number of bricks-and-mortar stores in the Southeast.

The fight to keep existing customers is further exacerbating near-term earnings weakness. Borders appears to be taking it on the chin and will be adding more debt to its capital structure by the second quarter. Again, Barnes & Noble is struggling less; fellow Fool Alyce Lomax recently pointed out that it has a "nice balance sheet with $120.7 million in cash and no debt, and it generates free cash flow."

I recently anted up for exposure to Barnes & Noble's free cash flow, though its growth prospects are a bit murky. However, with folly comes opportunity: Borders reckons 2007 is "a year of transition as we execute our long-term strategic plan for the turnaround of the company." In other words, there is substantial upside if it can successfully close the Waldenbooks stores and other underperforming superstores, and unwind the international operations.

Philip Durell at Motley Fool Inside Value sees a turnaround in Borders' future, and the downside risk looks to be muted, because weak operating performance is keeping the share price low. There's definitely no hurry because conditions could get even worse before they get better, but Fools may want to at least consider bookmarking the two largest chains for future reading.

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Fool contributor Ryan Fuhrmann is long shares of Barnes & Noble but has no financial interest in any other company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.