Gloomy Future For Barnes & Noble

Anjum is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

With the resignation of William Lynch as the CEO of Barnes & Noble (NYSE: BKS), investors have lost faith in the company. Moreover, increasing competition has led to significant losses. Let us look at some of the weaknesses of the company and how it can affect its future prospects.

Weak and unprofitable segments

For the fiscal year 2013, the company witnessed a decline of 4% in total revenue. Its EBITDA decreased by 94% from $177 million in 2012 to $10 million in 2013. The company has also suffered operating losses in both 2011 and 2012. Comparable store sales have decreased by 3% during the fiscal year 2012.

A closer look of the segments shows that the retail and Nook segment of the company are performing poorly. With Nook being acquired last year, the segment is not generating profits and the acquisition seems to be counterproductive. EBITDA margin for Nook has declined by 82% to ($475) million in fiscal 2013 from ($262) million in fiscal 2012. Nook has also witnessed operating losses of $286 and $229 million respectively for fiscal 2012 and 2011. Selling and administrative expenses in 2012 totaled 65.2% of sales for the segment; yet, it has not materialized into profit for reasons discussed later in the article.

The retail segment has also suffered a decline in revenue. This is primarily because of the shift of customers from retail outlets to e-books and discount stores. With technological advancement, ease in purchase of books is what the customers want. Even big institutions and governments have shifted to an electronic mode of reading. According to a recent survey, e-book sales have increased by around 42% over the past year. This figure also shows a shift in demand from retail outlets to the electronic mode. Barnes & Noble have 675 bookstores in 50 states, and with declining demand of printed books, the company has planned to close 15 stores a year. The fear is whether Barnes will be able to pull itself through declining demand, or will it face the same fate as Borders Books.

Weaker strategy

Nook had initially started off well attracting potential investors such as Microsoft and Person. However, the prospective investments have not actualized as the segment is reporting losses. Unable to keep pace with its competitors and undergoing losses, the company has planned to stop making its Nook color touch screen tablets. Barnes has significantly spent in Nook devices to be in line with the changing reading habits and to make the product competitive. However, the company has failed to differentiate its product aggressively enough to attract customers from big names like Amazon and Apple.

Merchandise inventories increased by 13.6% as of April 28, 2012 compared with April 30, 2011. This increase was primarily due to larger inventories of devices and accessories. Increasing inventories over the years reflects inefficiency on the management part and the highly competitive market. It might also result in loss in value of the inventory due to decline in demand of the hardware devices of the Nook. This inefficiency is also evident in the company’s decision to sell its inventory at reduced prices.

Management uncertainty

The sudden announcement of the resignation of William Lynch as the CEO of Barnes & Noble was received as a surprise by investors. This announcement was only two weeks after the company’s quarterly earnings release. William Lynch has played a pivotal role in the development of Nook as a segment, but with his resignation, it is likely that the company is in plans to get out of the loss making digital business.

Peer comparison

Amazon (NASDAQ: AMZN), the world’s largest internet retailer was a winner by selling physical books at a lower cost online. There has been 27% growth in sales in the past twelve months; even the first quarter of 2013 has shown a 22% rise in sales over the last year.

Kindle Freetime Unlimited, which was launched few months ago, has content to attract kids and parents - books, games, educational apps, movies and TV shows. With increasing demand, a thousand new titles have been added to Kindle Freetime Unlimited in just six months.

Amazon will also start publishing more original comics and graphic novels through Jet City Comics. These comics will be published on the Kindle, which is supposed to have done the most damage to Barnes & Noble's e-book business.

Apple (NASDAQ: AAPL) with a PE of 10.9 and earnings growth rate of 11.43% for fiscal year 2013 has a PEG of just 0.82.

Apple has recently announced a $30 million iPad deal with Los Angeles School Board of Education, the country’s second largest school district. This will lead to a large distribution of iPads to students across the school district.

The iPad is hard to compete against, and this can be understood by the fact that nearly 10 million iPads are already used by students in the world today. This can be considered a first step towards acquiring a larger unconquered school market of Los Angeles. Therefore, Apple’s growth strategy also serves as a negative for Barnes & Noble.

Conclusion

The retail books business is declining, and this is reflected in Barnes & Noble’s financials. Further, competing with giants like Amazon would be tough for Barnes in the digital book business, which might have provided a growth avenue for the company. The digital business is not generating profits with tough competition from products like the Kindle and iPad. As a result, I would not consider Barnes & Noble as a good investment opportunity. On the contrary, investors having exposure to the stock can consider switching to a better investment opportunity.

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Anjum Khan has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Apple. The Motley Fool owns shares of Amazon.com and Apple. 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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