21 February 2011

The Definitive Work on Pain (2)

I'm trying to get at least the first two parts of this ode to The Machine up before filings start happening again on Tuesday morning. This entry will move from the essentially unavoidable 7% loss to creditors caused by the fact of the bankruptcy filing to the particulars of the Borders matter, and why creditor v. creditor fighting (all too similar to "Spy vs. [sic] Spy" at times) is going to be much more significant than the priorities struggle in this particular proceeding. In part 3, I'll discuss the reasons that all of these calculations are horrendously overoptimistic.

In any event, the key problem with any retailer's bankruptcy is the conflict between cash flow and inventory — a conflict magnified when, as in this instance, a substantial proportion of the inventory is not properly treated as the retailer's property, but is instead properly treated as consignment goods. For example, the most-recent quarterly filing discloses that Borders owed approximately $445 million in trade accounts payable on 30 October 2010. Now, undoubtedly some of this has been paid; on the other hand, this was pre-holiday season. I've seen estimates of $219 million to $290 million as the "currently owed" figure, with a median of around $270 million, to print publishers of all sizes. Keep in mind that all of this is based upon unaudited financial statements; historically, in retail-sector bankruptcies there's a 1-3% understatement of the amounts actually owed, usually due simply to timing artifacts (e.g., a shipment was made the day before the bankruptcy filing that will be ultimately reflected as an amount owed, but did not make it into the books in time for the filing... if only because it was still in transit) and not to any creative accounting.

The problem here is the unsecured portion of receivables claimed by various financiers of the Borders cash accounts. When Joe Customer buys a copy of Bestseller X as Borders, he hands over (round numbers for the sake of argument) $25, plus sales tax, at the register (or online; it's immaterial for this purpose whether it's a brick-and-mortar sale or a 'net sale). As pointed out last time, that sales tax is no longer in the picture; it has a higher priority than almost any unsecured claim, specifically including claims on failed security interests (such as financiers' claims on inventory). And there's the problem: The amount that Borders then owes the publisher for the book — for the sake of argument, a trade-long discount of 40% net 90, or $15 — is also claimed by the bank/lender that financed the cash-flow accounts for Borders' current operations.

This is the difference between "debts owed" — the $1.15 billion that Borders owed after we accounted for the priority claims — and "claims for debts owed," which will total a helluva lot more than that... because both the publishers who own the inventory and the lenders who took an imperfect security interest in that inventory will claim on that inventory. The fight between the publishers and the lenders doesn't increase the amount that Borders owes; it just decreases the amount that individual publishers and individual lenders receive from that claim. Once again, the subtle dynamics of grade-school recess help illustrate this. Assume that Calvin, our student, has $3.00 in lunch money. Calvin is not entirely stupid; he knows that either Mo or Suzy is going to take his money. Both Mo and Suzy think that they have the proper claim on Calvin's lunch money. Miss Wormwood (the Bankruptcy Judge) will instead divide the $3.00 equally between Mo and Suzy, meaning that each receives 50% of his/her claim. Calvin is probably in for another pounding tomorrow at recess, but he doesn't owe any more from today's lunch money: He's already paid all of it.1

And this is why authors are screwed. The authors are the rest of Mo's and Suzy's respective gangs — the ones Mo and Suzy each ordinarily give fifty cents a day out of Calvin's lunch money. Since Mo and Suzy only got half of their daily expected proceeds, they're only going to pay the gang members half of what they ordinarily get. At present prices, that's not even enough for a bag of stale corn chips.

Fortunately, the situation at present doesn't appear to be quite that bad. My back-of-the-envelope calculations indicate that — absent other legal shenanigans, which will be forthcoming — the various creditors will file approximately $1.45 billion in allowable claims against the assets of $1.07 billion. The LRR (reread Saturday's piece) then becomes 0.93 * (1.07/1.45) or about 68%... in a hypothetical liquidation.

But this isn't a liquidation, hypothetically or otherwise. So, next time, we'll have a bit more fun with numbers, wild-ass guesses, and The Machine.

  1. "But," I hear you mumble, "What about the money that Borders is earning from store-closing sales, and all this talk about continuing operations as a debtor-in-possession?" Well, that money doesn't count for today any more than does tomorrow's lunch money for Calvin. Thanks to the magic of a superpriority claim by lenders who are providing funding for debtors in possession (see Doc. 28, 16 Feb 2011, requesting superpriority; Doc. 17, 17 Feb 2011, granting request), that money goes first to repay the lenders of the money being used to keep Borders afloat during the bankruptcy proceedings; that is, only the profits from sales, after expenses of lending and interest are deducted, will be poured back in to the bankruptcy estate.