Keywords Companies

Raincoast's successful manoeuvre quickly inspired copycatting by other publishers, including the prestigious Toronto-based HarperCollins Canada Ltd. Two weeks ago, HarperCollins, which publishes such bestsellers as The Perfect Storm and The Poisonwood Bible, put Chapters on a "credit hold." They refused to ship any new books to Chapters until the bookseller coughed up part of the more than $10 million they say they were owed from as far back as Christmas, 1999. But when word of the standoff leaked out, HarperCollins and Chapters quickly papered over their differences. "Chapters is in good financial standing with HarperCollins," said HarperCollins president Claude Primeau, "and we have every confidence about our future relationship with this valued partner."

Despite the efforts at public reconciliation, the 44-year-old Stevenson is furious that his company is under attack. He insists that Chapters' suppliers are being paid after 60 days. He vehemently denies Chapters is in a cash crunch. But late last week, Chapters' chief financial officer, Tamara Lawson, left the firm. She was preceded by Rick Segal, the president and chief operating officer of Chapters' troubled online operation, who departed in late June. And Chapters Inc. stock is in the doldrums. After peaking at just above $35 one year ago, it hit an all-time low of $7.95 last week. By week's end, it had edged back to close at $9.30. Stevenson, who still holds more than 600,000 shares himself, charged that newspaper reports chronicling his disputes with publishers were erroneous and had harmed the company. "Standard operating issues are being blown into a financial crisis," Stevenson said last week as he announced Chapters' first-quarter results.

Those results were decidedly mixed. For the 13-week period ending July 1, company sales rose from $122.4 million to $136.9 million. But Chapters' losses grew too: to $12.7 million, well up from $9.4 million for the same quarter a year ago. Most of the red ink came from Chapters' online operations and its money-losing wholesale business, Pegasus, which buys books from publishers at a steep discount. Still, Stevenson says he was pleased with the company's overall performance: "We've actually never been in better financial shape." Maybe so, but Chapters is still bending over backwards to hook buyers: in an interview with Maclean's, Stevenson confirmed that visitors to its Web site can order Margaret Atwood's keenly awaited new novel, The Blind Assassin, at a stunning 50-per-cent discount. "It's a loss leader," explained Stevenson. "It's a cost-effective way of acquiring a customer."

Some analysts weren't so sure. "There are red flags everywhere around this company," said Toronto's Benj Gallander, editor of Contra the Heard, an investment newsletter which tracks publicly traded companies. Gallander, who has written two financial books, first heard about Chapters' tardy payment practices from his own publisher, Mike O'Connor of Insomniac Press. But for Gallander, what counts are the company's moves over the past five years. Gallander believes that in establishing its dominant market share, Chapters may have expanded too quickly. He also questions the company's costly start-up of Pegasus in June, 1999, and Stevenson's recent decision to sell it if the price is right. "That's highly questionable," said Gallander. "They go to all the effort to establish it and then they backtrack a year later."

That road leads back to Stevenson, a Toronto venture capitalist with a masters in business administration from Harvard who is the brains behind Chapters. In 1991, he targeted Canada's $1.3-billion book-selling industry as being ripe for an American-style takeover. Using more than $70 million in private investors' money, he merged Canada's two largest book chains, Coles and SmithBooks, creating Chapters, and its bold new superstore format, in 1995. The big, flashy stores - also adopted by Chapters' main rival, Indigo Books, founded by Toronto's Heather Reisman in 1996 - promised consumers a different book-buying experience. And Canadian publishers salivated at the thought of stocking the acres of shelves in these lushly appointed emporiums. "We were happy to keep filling this pipeline," said one publisher.

But there were victims of this massive expansion as well: about a dozen independent booksellers, including Lichtman's in Toronto and Sandpiper in Calgary, collapsed their tents as the Chapters juggernaut rolled through the industry. Gerry Ruby, a 30-year publishing veteran and owner of the now-bankrupt Lichtman's, believes Chapters was a stock play for Stevenson. "Larry is a bright boy," Ruby told Maclean's. "He knew that even with a monopoly there's not nearly enough business in Canada to support these superstores. Not enough people read. But he knew that he and his executives could make some money. No matter what happened to the company." In fact, two stock offerings - Chapters Inc. in 1997 and Chapters Online in 1999 - raised close to $76 million. Stevenson himself held 591,541 shares worth more then $20 million when they touched above $35 last year.

Stevenson says that's dead wrong. "It's categorically untrue," he told Maclean's. "It's been a great financial story having very little to do with stock. We've built Canada's leading e-tailer. How can you have the number 1 brand in the country and say that's a stock play?"

No one can deny that Stevenson's concept has been popular with many consumers. There are now 71 superstores across the country, offering deep discounts and comfortable armchairs where shoppers can spend an afternoon sipping cappuccino and sampling books and magazines. "Larry has done some good things for publishing," said Ken Thomson, vice-president of sales and marketing for Canadian publishing icon McClelland & Stewart. "He's increased the profile of books and brought more people into the bookstores." Thomson adds that since Chapters came on the scene, McClelland & Stewart's sales have grown year over year. "It's been significant," said Thomson, who came to the book business 5½ years ago. But when asked whether selling more books has also fattened M&S 's profits, his answer is succinct: "No, it hasn't."

One big reason publishers aren't making more money, even though they are selling more books, is simple: Pegasus, which is controlled by Chapters, demands deep discounts of 50 per cent. That is about five per cent above the normal discount rate, just enough to whittle publishers' profit margins - already razor-thin - down to almost nothing. When Chapters and Pegasus were ordering huge numbers of books, as they were in previous years, the discounts were easier to stomach. But that changed abruptly earlier this year. Suddenly, spring book orders dropped precipitously. Moreover, Chapters and Pegasus started unloading unprecedented amounts of inventory: although it is standard practice for retailers to return unsold books, and Stevenson says it is part of a rigorous new inventory management system, publishers say that Chapters is taking advantage of the industry tradition. One publisher got six times as many books returned this year as in 1999. "Returning books keeps their accounts in order. But it's a chicken-and-egg thing. They're short of cash. They can't pay us. They send us returns. We're short of cash."

The publishers' complaints about Chapters' business practices amuse Jim Munro, owner of Munro's Books in Victoria. With 38 years in the business, Munro says the publishers have no one to blame but themselves for the fix they are in. He maintains that they repeatedly caved in to Chapters' demands on everything from discounts to terms of payment. They even agreed to pay Chapters to have certain titles displayed in the stores. "The publishers created this monster," said Munro, whose 6,000-square-foot store in a stately heritage building in downtown Victoria sits within a couple of blocks of a Chapters superstore. "After embracing Larry, they gave him everything he wanted. Now, they're finding that the more they give, the more he wants and the more desperate everything gets." In these tumultuous times for book publishing, one thing is clear: the final chapters of this story have yet to be written.

Handsome Returns
Larry Stevenson may be slow to pay Canadian publishers for their books at times, but he has done better when it comes to making money from Chapters. A sampling of the personal returns his venture has generated:

- Total salaries and bonuses (1996 to 1999): $1,438,833

- Total sales of stock (Aug., 1998, to Feb., 1999): 240,600 shares worth $5,666,152

- Total purchases of stock since the last time he sold stock on Feb. 26 (Nov., 1999, to June, 2000): 18,900 shares for $289,760

- According to insider-trading reports filed with the Ontario Securities Commission, Stevenson still owns 610,441 shares of Chapters Inc. At $9.30, the closing price on Fri. Aug. 4, his holdings are worth $5.7 million.

Maclean's August 14, 2000

Author JANE O'HARA