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Tickers in this Article: BGP, BKS, AMZN
In November, William Ackman, who heads well-known activist hedge fund Pershing Square, revealed that the fund had taken a position in book retailer Borders Group (NYSE:BGP). The stock has taken a pummeling since that time, yet Ackman hasn't wavered.

Ackman's interest seems strong and Pershing has accumulated a roughly 24.4% stake through the purchase of swap agreements according to an article from the Associated Press. So, what exactly does Ackman, who has a reputation for taking positions in undervalued companies and ultimately unlocking shareholder value, see in Borders? Let's have a look. (For more on the relentless push for shareholder value, see Activist Hedge Funds.)

Cover to Cover
Ackman may be intrigued by borders' ability and potential to generate cash flow, which should help it weather the current downturn in consumer spending. He has also said competition concerns involving online retailer Amazon (Nasdaq:AMZN) are overblown according to a New York Post story.

There are other items that boost Borders' valuation. First, the company proved its ability to compete over the holiday season. Its same store sales during the spending season were up a healthy 2.4%. This is significant, because during that same time, brick and mortar competitor Barnes & Noble (NYSE:BKS) saw its comps decline 0.4%.

The company's book value as of November 2007 stood at about $7 a share, or just south of where the stock is trading. In other words, the market is placing very little value on the company's potential to generate earnings going forward. For comparison purposes, Barnes & Noble trades at about 1.7-times its book of approximately $16 per share.

Next we should examine borders' international exposure. In the latest quarter, it garnered almost 10% of its sales from international sources. This diversification seems attractive given the waning U.S. economy, and also when compared to Barnes & Noble, whose sole focus appears to be on the domestic market.

Finally, it's important to note that the company is in the process of building out its own website. It's doubtful the site will instantly compete with either Amazon's or Barnes & Noble's in terms of page views or actual sales. However, this potentially high-margin business could gain some traction in a hurry because of Borders' vast physical presence, and the approximately 23.5 million customers reportedly enrolled in its Borders Rewards program.

Possibility of a Combo?
Above I've tried to show that Ackman is probably interested in buying under-appreciated assets on the cheap. However, he may want to ultimately push for a sale of the company to Barnes & Noble.

The most obvious benefit of combining forces would be to help counter Amazon's threat. However, combining the two companies could have other advantages as well, including a broad footprint in 50 states and a presence overseas. The combined companies could almost certainly make deep cuts to SG&A. Advertising and other selling expenses could be done under one umbrella instead of two. Then there are the hard assets from Borders that Barnes & Noble could theoretically pick up on the cheap.

The Bottom Line
Pershing Square has accumulated a large stake in Borders. Borders' potential to generate cash flow, its book value, its international presence and new website are all attractive features. As a wild card, Ackman may consider working behind the scenes to combine forces or sell the company to Barnes & Noble.

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