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Stock Highlight: Barnes & Noble
Before we get started we should preface this article with a brief explanation, because to say this is truly a highlight may get current Barnes & Noble (BKS) shareholders excited. Perhaps a more accurate term would be recap or synopsis. You see, there have not been any highlights in the ongoing tale of Barnes & Noble to speak about of late.
Just a few years back there was a distinct air of enthusiasm surrounding Barnes & Noble. Its primary nemesis throughout a good portion of its history, Borders Group, had announced it was going out of business, and in the liquidation that followed, BKS’ results perked up, as bookworms that had gone to Borders locations simply found the nearest Barnes & Noble store and got their reading materials there. Also at the time, the company announced plans and poured serious funding into launching a digital platform. Barnesandnoble.com was already up and running but now the company would roll out an e-reader, dubbed the NOOK, to go against the likes of Amazon’s (AMZN) Kindle, a product that had an enormous head start on BKS’ device in terms of market penetration.
Around this time, from a stock-price performance view, BKS was holding up, as the investment community saw Borders clients coming over to Barnes & Noble and this gave the shares some support. Coincidentally, at the same time, we (along with a handsome portion of Wall Street) were clamoring for management to abandon their old-school brick-and-mortar methodology in an effort to trim costs dramatically and funnel the proceeds toward getting the NOOK on an even playing field with rival e-readers. Cannibalization by Amazon.com and other online retailers were damaging book sales and the exorbitant costs of leases and real estate pushed the bottom line into the red ink where it presently remains on an annualized basis.
We would be remiss if we did not mention that all this while, the company was on the auction block looking for a purchaser to come in with a hefty cash infusion with which to propel the NOOK franchise to new heights. Buyout news again buoyed the stock and rumors swirled repeatedly on potential buyers and price points. Then, it was announced that Liberty Global Media would be purchasing the company. Knight in shining armor, conclusion, happy ending, story finished. But, the investment world does not always work that way. What ended up happening is that Liberty Media balked at the price that BKS was expecting, and given minimal visibility into the nascent NOOK franchises capabilities, that company decided they would be better off taking just a stake in the operation. That piece ended up equating to roughly 17% of the total and the cash brought in by the agreement was indeed used to prop up the NOOK business, albeit at a later date than was originally forecasted. The market did not necessarily disapprove of this move, but it had been anticipating a full buyout and sentiment quickly turned negative. While escalating into the 20s at some point during 2011 and 2012, the shares have also fallen to around $9 during both campaigns.
Currently, this equity sits above the $15-a-share mark, having climbed from the $13 range on the news that company founder and chairman Leonard Riggio wants to purchase the retail business. Mr Riggio has no interest in the NOOK platform, he simply plans to make an offer for the store locations and the company’s website. This matter is very much up in the air, however, as initial calculations by industry experts have placed the value of these assets around the $1 billion mark. This is a sizable expenditure given the fact that the company as a whole recently had a market cap of just over $900 million. Still, BKS’ top brass stated that an independent counsel would take a look at this offer and put no timetable on when a decision would be rendered. In the meantime, the investment community’s patience seems to be nearing an end.
A few months back, another glimmer of hope arose when Microsoft (MSFT - Free Microsoft Stock Report) came to the bargaining table and wanted to get involved with the NOOK. That firm invested $300 million for a 17.6% position in the tablet business of BKS. In addition to the initial outlay, MSFT agreed to pour $180 million into revenue-sharing payments on the strength of its Windows 8 launch, and pay $125 million to bring the NOOK to international markets over the next five years. Normally, getting in bed with a technology titan like this might have been enough to get the company back on its feet, but this does not appear to be the case. All the while that the NOOK was being shopped, it was losing more and more market share to the aforementioned Kindle, not to mention Apple’s (AAPL) iPad, which took a leadership position in the tablet field basically upon its launch. Coincidentally, Apple’s rise to prominence in the tech field takes away a lot of the shine of the Microsoft pact. To be blunt, every announcement the Seattle-based software maker makes no longer carries the same kind of buzz it once did. Readers should note that education-focused Pearson PLC has also invested $89.5 million for preferred interests in the NOOK, or roughly a 5% stake. We at least see an angle here as far as going for schools and the educational aspect of the device, but again, this seems to be a field well covered by Apple. Any one that takes public transportation with a school on that route can attest that well-heeled houses of education have already begun passing out iPads to their students.
Clearly, the company will now be hitching its wagon to the digital side of operations going forward, but we fear that management is well late to the party, and that is putting it kindly. The iPad and Kindle are higher functioning and omnipotent in the tablet marketplace, with techies choosing Apple’s offering for its endless applications and bookworms picking Amazon’s for its quicker-to-market updates and upgrades and its tremendous catalogue of selections. There is nothing, we repeat nothing, wrong with the NOOK per se; it is simply not a large portion of the tablet market’s device of choice. Can this franchise be saved? Perhaps, but time is ticking and things are not looking good at this moment in time.
Take holiday sales for instance. In a period where big things were expected, the NOOK swung and missed. Unit sales were down as much as 5% and selling prices fell more than 8%. In order to meet its end goal of driving digital content sales Barnes needs people to first adopt the NOOK. In the fourth quarter of 2012 the company sold one million NOOKs, which equates to a market share of 1.9%. If we had these figures to use as a baseline maybe we could draw up a plan for future growth, but that is just the problem; these metrics are down significantly on a year-over-year basis from sales of 1.4 million devices and a market share of 4.6%. So even with the aforementioned funding infusions, higher-profile partners, and all the attention of top brass, the NOOK made no added penetration into this field. Depressing news any way you look at it.
So the question on most investors’ minds is….Now what? We can report that as of mid-February, management has hatched a plan to shutter up to a third of its stores. The contraction calls for an average of 20 stores to close each year. Of the nearly 700 physical book stores currently weighing on BKS’ expense ledger only 450 to 500 are expected to remain in a decade’s time. A separate college division which has another 675 locations is not expected to participate in the downsizing. Full disclosure, we had hoped for the unwinding of these properties on a larger and rapider scale, but it remains, nonetheless, a step in the right direction. We note that the aforementioned offer by Mr. Riggio is still under consideration and no details have been given as to what the plan would be if the retail segment was bought out.
As far as the NOOK business goes, we still believe this arm has a place in the tablet arena, albeit a smaller, niche-sized one. Exactly how BKS and its partners will chisel out this space is highly debatable right now. We can say that comparisons need to improve, and in a hurry. At the end of the most recent reporting period, the company had just shy of $475 million in cash and a manageable debt-to-equity ratio hovering near 30%, so the time should be there to lay out a new plan. Continuing to string together quarterly losses (with the exception of the January holiday period) will not aid in this process though.
A quick glance at the Value Line page (page 2167 in our most recent cycle) provides a depiction of how low we are on this equity at its present valuation. It is one of a handful of stocks that is currently trading above the High in our 3- to 5-year Target Price Range. Too, many retail pundits believe the company will not be around as a viable entity for the pull to 2016-2018. Our view is not that dour, but we would like to see progress in the near term. More color on Mr. Riggio’s plans, a purchase price for example, will certainly help as well.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.