Barnes & Noble (NYSE:BKS) popped 30% on Friday thanks to a takeover offer from Liberty Media (NASDAQ:LCAPA). Does this offer signal that it’s time for investors to buy the stock?
Barnes & Noble operates bookstores and it sells the Nook e-book reader. At the end of January, the company ran 705 bookstores and operated 636 college bookstores.
Barnes & Noble is in surprisingly good financial shape considering that the industry is so difficult that rival Borders recently filed for bankruptcy. In Barnes & Noble’s most recent quarter, comparable-store sales increased 7.3% — beating its 5% to 7% forecast.
The bad news for investors was that the bookseller used the Borders bankruptcy as an excuse to stop issuing guidance for sales and earnings (of course, it’s possible that taking out a competitor could help sales). The company also suspended its dividend that had cost it $45 million in the January quarter. And when you consider that Barnes & Noble ran through $35 million of cash in the previous nine months and had a mere $26 million left, the decision to suspend the dividend signals a pretty serious cash flow problem.
So perhaps the offer from Liberty Media to acquire B&N — after the bookseller put itself up for sale last August — is well-timed. Liberty Media offered $500 million for a 70% stake in Barnes & Noble contingent on its current CEO, Leonard Riggio, staying on and holding onto his 30% stake. As Liberty Media CEO, John Malone, told the Financial Times, “I am also firmly of the view that there will be an enduring demand for physical bookshops, which are cultural centres within local communities.”
Most analysts consider Malone’s offer as an opportunity to gain control of the Nook device. As James McQuivey, an analyst at Forrester Research, told Variety, “It’s absolutely a play for the Nook. The real value of B&N right now is the ascent of its Nook platform, which is turning out to be a very solid foundation for building a digital media relationship with millions of consumers. And the fact that the Nook Color is being snatched up as quickly as B&N can make it is good evidence that the business has strong prospects in new directions like web apps and even video.”
It’s hard to know how much the Nook is contributing to Barnes & Noble’s sales and profits since its sales are buried in reporting for its online unit. But that part of the company enjoyed a 52% spike in sales in the most recent quarter — to $319.4 million. And that growth could continue given what the New York Times reports is the Nook Color’s popularity with women’s magazine readers. However, it represents a mere 13.7% of its revenue and lost $57 million during the period.
This leaves open the question of what will happen next. If the Liberty Media deal falls through, Barnes & Noble will drop back to where they were before the offer.
How does an investor decide what to do here? I suggest taking a look at the concept of expected value (EV). The theory says that you should consider the probability of a range of outcomes and multiply the probability of each by its payout and add up the EVs for each possible outcome. If the EV is positive, then you should invest, otherwise you stay away.
The hard part is that involves many assumptions — all of which could be wrong. But for the sake of illustration, let’s make the following assumptions (these figures are on a price per share basis):
- EV of Deal Falling Through: 84 cents. This assumes that there is a 20% chance the deal will fall through meaning the stock falls $4.22, to where it closed last Thursday.
- EV of Higher Offer: 73 cents. A 20% chance of a new offer coming in that values the company at $22, a 20% premium over its current price. An article at SeekingAlpha thinks it’s possible that Microsoft (NASDAQ:MSFT), Google (NASDAQ:GOOG), Sears (NASDAQ:SHLD), or Amazon (NASDAQ:AMZN) could put in a bid.
- EV of Deal Going Through: 0. A 60% chance of Malone’s deal going through — which would leave the stock price unchanged.
Based on these assumptions, you should not invest in B&N stock because its EV/share is -11 cents. But if Malone makes the deal and the company’s value increases 30%, the expected value of the investment would be positive. In that case, however, Liberty Media and Riggio would be the only shareholders to benefit from that increased value.
This seems like a risk to be avoided.
Peter Cohan has no financial interest in the securities mentioned.
