Barnes & Noble: Make a Profitable Divorce

by Will Ashworth | February 26, 2013 1:41 pm

Leonard Riggio is buying Barnes & Noble’s (NYSE:BKS[1]) retail stores … or at least, that’s what the founder told the company he plans to do[2]. The Feb. 25 news sent the stock up almost 12%, so investors obviously like the idea. But should you?

Let’s take a look at the possibilities.

Two Components

Some believe Riggio is cherry-picking the company’s best asset. Ultimately, the board will request that any bid be for the entire company, including Nook Media, which encompasses its Nook business as well as college bookstore operations.

We have two segments — one profitable and one not.

Barnes & Noble reports third-quarter earnings Feb. 28. The company already has said its fiscal 2013 Nook segment’s EBITDA loss will be greater than in fiscal 2012. Further, Nook Media’s 2013 revenue will be less than $3 billion. Its retail division — which I blithely called a poor performer[3] in an article about Nook in late January — is actually doing quite well. In the first six months of the year through the end of October, it generated $103 million in EBITDA on $2.12 billion in revenue.

Meanwhile, Nook Media had an EBITDA loss of $34.4 million on $1.4 billion in revenue. More importantly, the retail division’s EBITDA increased 91% year-over-year.

Retail Turnaround

BKS’ turnaround has come on a combination of things.

  1. It has less competition thanks to the 2012 closing of Borders, its largest competitor.
  2. Gross margins for the first half of fiscal 2013 improved by 150 basis points year-over-year due to a better mix of higher-margin products combined with more generous vendor allowances.
  3. By closing underperforming stores, it’s improved the profitability of the 689 that remain open.

Add to this same-store sales growth of 2.4%, and you have the ingredients of a more successful retail business.

But let’s not get ahead of ourselves. BKS’ retail business for the nine-week holiday period ending Dec. 29, 2012, saw revenues decline by 10.9% to $1.2 billion.

Fortunately, when you exclude Nook product sales, its same-store sales decline was just 3.1%. The company expects its retail segment will deliver a 2013 same-store sales decline around the same amount. Management considers this a victory given its increased profitability, and it’s hard to argue with that logic.

John Malone

A little over two years ago, Liberty Media (NASDAQ:LMCA[4]) offered to buy 70% of Barnes & Noble for $1 billion, or $17 a share. As part of the deal, John Malone required Leonard Riggio to stay and operate the company while also maintaining a stake in the business. Malone is the second-largest shareholder owning 17% of the company, so despite the fact Riggio owns a 30% stake, any deal he hopes to make will have to go through Malone.

Berkshire Hathaway‘s (NYSE:BRK.A[5], BRK.B[6]) recent $12.4 billion investment in partnership with 3G Capital to buy Heinz (NYSE:HNZ[7]) could be the exact template that Riggio and Malone use to buy the retail stores. According to Bloomberg, analysts put a value of $1 billion on the retail business, which is presently more than the company’s market cap ($915 million). Liberty’s 17% stake is in the form of preferred shares paying 7.75%, so I suspect Malone will back Riggio with some sort of common/preferred investment (a la Buffett) that provides Liberty with some sort of purchase option down the road.

Nook Media

Credit Suisse estimates Nook Media could lose $300 million in fiscal 2013, so Barnes & Noble’s board is faced with a difficult decision. If it doesn’t split the company, it stands a chance of bringing down the profitable retail business with it.

In my January article about Nook, I likened its situation to that of Kobo, where Canada’s Indigo Books & Music (PINK:IDGBF[8]) was forced to sell its 51% interest in the e-reader to Rakuten (PINK:RKUNF[9]) because of ongoing losses and the hemorrhaging of cash.

Nook Media, which is facing the same symptoms, also appears to have more value in the hands of others. In the past five months, Microsoft (NASDAQ:MSFT[10]) and Pearson (NYSE:PSO[11]) have invested $390 million for 22% of Nook Media. Both companies were acutely aware of the cash flow problems facing the division. As a standalone business, it’s unlikely Nook Media will last too long without an influx of cash. As part of a much larger and financially stable organization, it can thrive or at least attempt to do so.

Is It a Buy?


Clearly the argument is whether Nook Media has any value, and if so, how much. Further, while the retail business is profitable, there are some who believe physical books won’t be around much longer. That will limit how much anyone — including Riggio — is willing to pay for the retail stores.

Microsoft and Pearson’s 22% investment values Nook Media at $1.8 billion. Let’s assume the analysts are right and the retail business is worth $1 billion. With cash and debt both around $470 million, they cancel themselves out, leaving a market cap and/or enterprise value of $2.8 billion, or $47 per share. Cut that by 50% and you’re still talking about $23.50 — a 57% premium to its current price around $15.

The sooner the board separates the two businesses — whether by closing on a deal with Riggio or some other group interested in the retail stores, or by splitting into two publicly traded companies — the sooner it can unlock shareholder value.

The enemy at this point is time. The longer BKS management debates the issue, the more likely the company’s stock will drop back near $10.

This is Barnes & Noble’s best chance to reward shareholders. I’m confident John Malone will make sure it happens.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

  1. BKS:
  2. that’s what the founder told the company he plans to do:
  3. poor performer:
  4. LMCA:
  5. BRK.A:
  6. BRK.B:
  7. HNZ:
  8. IDGBF:
  9. RKUNF:
  10. MSFT:
  11. PSO:

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