Barnes & Noble Is Not Doomed

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Barnes & Noble (NYSE: BKS) is well on its way to becoming profitable again, despite all the negative attention associated with Barnes & Noble and the sensationalizing of digital media formatted books along with the cheaper content collection provided through the Amazon book store. The fact is that there are people who prefer buying books in a retail store. In fact, I prefer buying books in person. The current short interest as a percentage of the float is 38.15%. If any of you are caught shorting the stock of Barnes & Noble, you should be cautious of the potential upside catalysts that could cause the stock to appreciate in a parabolic pattern.

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Source: Barnes and Noble

Barnes and Noble book stores (retail) have generated revenue growth of 1.4% in fiscal year 2012, and 0.7% revenue growth in fiscal year 2011. While I am willing to agree that the amount of growth that is presented by the stock is not anything substantial, I would also like to state that the growth is fairly reasonable in light of the fact that investors are short the stock hoping that the company may at one point file for bankruptcy.

Amazon was able to grow revenue in its media division (which includes books, music, movies, video games, software, and digital downloads) by 13% year-over-year in 2012. Amazon's revenue growth is declining in its media division which may imply that Barnes & Nobles position as a brick and mortar store isn't being subdued by its online rival. In fact, it may imply that the market for physical books will remain intact, for quite a while longer. Even if physical books were to become obsolete, the obsolescence will take many more years to fully play out, based on the revenue statistics Amazon and Barnes & Noble have been able to present for the most recent fiscal years.

One of the most dangerous things about shorting retail companies, especially diversified retail companies, is the large store foot print. Retail companies can turn a quick profit just by closing stores. Examples of this include Safeway, which was able to close 50 of its unprofitable stores between 2009 to 2011 and was able to generate net income of around $500 million. Barnes & Noble closed over a hundred stores over the past year in order to generate profits. I have observed that time and time again, brand loyalty, and the intangibles add further value to the business than what accountants are willing to acknowledge.

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Source: Barnes and Noble

Barnes & Noble stores will most likely generate a profit in the immediate future due to two overriding factors.

1. Barnes & Noble stores are generating revenue growth. This means that consumers are willing to walk into a book store and buy paper copies of a book. This implies that Barnes & Noble is not operating a legacy business model.

2. Barnes & Noble can close all of its un-profitable stores in order to generate profitability. You will often find that stores in certain locations will be able to generate profits while others won’t. Economics often refers to this phenomenon as locational monopoly. But, don’t look too deep into the terminology. The thesis is a lot simpler, the fact is Barnes & Noble can cut out all of its under-performing book stores in order to generate a profit from its low-growth book store concept.


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Source: Barnes and Noble

Barnes & Noble generated substantial growth in its Nook division. In fact, both Barnes & Noble College and Nook are generating substantial sales growth. The Barnes & Noble College division has been able to generate reasonable revenue growth due to book sales on college campuses. University campuses aren’t going out of business any time soon, and it is likely that a certain population of college students will continue to buy books from the campus book store regardless of how much more expensive it is to buy books on campus. According to Sallie Mae, enrollment is projected to increase by a total of 11% between 2011 and 2020. This increase in enrollment is a positive factor that should add to Barnes and Noble's book sales through its College campus division. Sallie Mae is a major student loan provider, and its analysis on future student enrollment is likely to be highly accurate. After all, who would know better than the biggest student loan bank?

Barnes & Noble’s business portfolio will become even more impressive due to its advances into the self-publishing space. While extremely similar to Amazon’s self-publishing platform, Barnes & Noble will give authors book space on its virtual platform for the Nook. According to Investor’s Business Daily:

Nook Media on Tuesday launched Nook Press, a self-publishing platform that gives authors a free way to write, edit, collaborate and publish e-books and directly distribute them to readers through the new Nook service.

Nook Press will generate additional revenue to Barnes & Noble and could contribute significantly to future growth, especially during a period when Barnes & Noble is cutting costs aggressively in order to generate profits for shareholders. The company will eventually carve a niche where it can generate substantial profits without sacrificing revenue.

I anticipate the company to report an EPS figure that will beat analyst expectation by 37%. Analysts on a consensus basis have quarter one earnings estimates at -.94 per share, I estimate earnings at -.62 per share. The stock could justify a higher valuation in future years due to cost-cutting in its retail business unit along with earnings growth in its Nook business unit.

Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends The Motley Fool owns shares of Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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