22 February 2011

The Definitive Work on Pain (3)

We've seen that, in a hypothetical liquidation of Borders, and assuming (since there is no better data as yet) that what was in the most-recent quarterly statement bears some resemblance to reality, publishers — thanks to the priority system — can expect to get around two-thirds of their invoiced receivables that were due prior to the bankruptcy filing on 16 February. This leads to two intertwined issues:

1. Isn't "inventory" just "inventory"? How can several parties have simultaneous claims on the inventory? This comes from two entirely different difficulties with books. The one that is common in all bankruptcies is the simultaneity problem. In a liquidation, debts that would otherwise be payable over time are all accelerated to be payable on the date that the bankruptcy is filed. In a world that runs on credit, this obviously causes some problems, because the total debt load is managed because it does not all come due at once. (In Borders' own case, the maturing of several debts, and refusals by lenders to renew and/or reschedule others, just exacerbated an already precarious situation. One could, and probably should, consider that the worst villain in all this was GE Capital...) That can cause assets that otherwise would have been divided among several parties over time to be claimed by all of those parties at once. For example, assume that an apartment landlord suddenly demanded the entire year's rent at once; that wouldn't leave much for paying the electric and water bills, the phone bill, the cable bill, etc.

The part that is unique to the world of book retailing, though, is the nature of the "inventory." The key thing to remember is this: What is called "inventory" for accounting purposes is not the same thing as "liquidatable property" in bankruptcy, although accounting standards tend to ignore that difference. It is a particular problem when the bookstore does not have clear, irrevocable title to the books in its inventory... and, if you recall the Publishers' Group West (distributorship) bankruptcy from a couple of years ago — which was also in the Southern District of New York — the court was very careful to treat books that were fully returnable as consigned, and not sold, property. As long as the books were fully returnable at the whim of PGW (then, and Borders now), for full credit, title had not passed irrevocably to PGW (or to Borders now)... meaning that the legal title to the books was the publishers', even if the books were in the possession of PGW (Borders).

2. All of the calculations were for a "hypothetical liquidation." What does that mean in a reorganization? Well, it's a beginning point. The hypothetical-liquidation calculations do have to be done, because they're part of the baseline that the Bankruptcy Judge must consider when deciding whether to confirm the proposed reorganization plan. However, a continuing business has two different cashflows that make the hypothetical liquidation calculations no more than a guideline and outer limit:

  • Incoming cash flow from continuing sales, and
  • Outgoing cashflow from continuing overhead, new merchandise purchases, and so on.

For example, the amounts that Borders receives from the store-closing liquidation sales will be part of an incoming cash flow... and the amounts it has to pay employees, the power companies, etc. while holding those store-closing liquidations sales will be part of an outgoing cash flow. The same goes for regular sales at stores not planned for closing.

Although the commodity-goods retail sector has developed some rules of thumb over time about the balances between these flows, those rules are entirely ridiculous for books. Unlike, say, a grocery store — in which, contrary to manufacturer representations, one box of dried spagetti noodles is fungible with (replaceable by) another — books are inherently nonfungible. If the store has no copy of The Two Towers, but does have a copy of The Return of the King, a buyer looking for The Two Towers cannot just buy The Return of the King instead. Further, as one goes to greater and greater levels of abstraction — author for author, category for category — they become even less likely to be replaceable.

What authors (and others dependent upon payments from publishers) need to remember is this: That 68% figure is the upper bound of what publishers can expect to receive on their outstanding receivables invoices. The actual figure is likely to be at least 8–10% lower than that, but it's much too early to tell. Keep in mind, too, that current sales should result in payment of very close to 100% of invoice value to the publishers; that 68% (or whatever) proportion is for receivables due and payable, but not yet paid, on 16 February 2011 — under normal publishing industry practices, essentially the entire holiday period and a bit more.