Barnes & Noble: Of Bricks and Nooks

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Barnes & Noble (NYSE: BKS), in a move designed to push sales of its eBook reader Nook tablet higher, is instituting price reductions on some of the older versions of its tablet. The Nook tablet (8GB) will be available for $159, while Nook color can be bought for $139. Nook’s business have been challenged with the release of the latest iterations of the Kindle and iPad by Amazon (NASDAQ: AMZN) and Apple (NASDAQ: AAPL).  To say that tablets and e-readers have completely changed the market dynamics of the traditional book retailing industry would be to engage in the height of understatement. Consolidation in the publishing industry has not just hit magazines and newspapers; Pearson Plc (NYSE: PSO) is launching a joint venture with Random House as well as acquiring Author Solutions, the world’s leading self-publishing firm.

The Nook price reductions have come ahead of the holiday shopping season as the company prepares to launch its camera-less 7-inch Nook HD and 9-inch Nook HD+ tablets in the second week of November. The new Kindle paper white tablet was released in September, and is priced at $109; meanwhile, Amazon’s basic Kindle tablet is now available for just $69, $30 less than B&N’s lowest priced tablet Nook, Simpletouch.

B&N’s business is divided into three segments: Retail, College, and Nook. The company has 689 retail bookstores and 667 college bookstores located across 50 states in shopping malls and university campuses.  Amid the rise in usage of tablets and eBooks, it has been generally considered that B&N’s retail operations are in ruins. However, the opposite of that is true.

The company continues to lose money on the Nook, but its retail operations are growing. For the first quarter of its fiscal year 2013, ending July 28, 2012, B&N reported a rise in revenues by 2.5% to $1.45 billion, which was driven primarily by the 2% increase in revenues of its retail division to $1.12 billion. Its EBITDA for retail increased by 88% over the same quarter a year ago to $75 million, but it ended up increasing its losses by 15% for College and 11% for Nook to a loss of $14 million and $57 million, respectively, which dragged the entire EBITDA down to just $4 million.

B&N has been able to earn gross profit consistently across all of its units, but the downward pressure on prices caused by increase in competition in the eBook arena has translated into losses. In the previous five quarters, B&N has been able to post profits only once, which translates into a loss per share (trailing twelve months) of $1.21.

Despite the company’s poor financial performance, its stock is up 12.4% since January. Between the 11.6% stake taken by Jana Partners LLC, the growing use of Nook as a full service internet device, and better than expected revenues from its bricks and mortar operations, investors have been willing to buy the idea of a B&N turn around. In the past, Jana Partners has made significant successful changes in those companies it invested in, such as Marathon Petroleum and Mc-Graw-Hill, that significantly increases the business’s value.

After that, on April 30 B&N announced a strategic partnership with Microsoft (NASDAQ: MSFT), and the two companies are jointly working to form a new subsidiary, Newco, which will be a combination of B&N’s Nook and College business units. Microsoft is making an investment of $300 million in Nook media for a 17.6% stake in the business, and plans another $305 million in the next five years, which pushes the market cap of B&N to $1.7 billion (from the current $965 million). In Microsoft’s opinion, B&N is clearly undervalued. In fact, its current share price of $16 is about half the value of its retailing and Nook division combined. Its projected revenues for the current fiscal year are more than eight times its market cap.

With Microsoft on its side, the money-losing Nook, which accounts for 27% of total eBook sales and is ahead of Amazon in terms of magazine subscriptions, looks to be justifying the investment through increased ebook sales.  Moreover, there is a growing hostility at the retail level to Amazon and its Kindle. Target and Wal-Mart have both signed deals with B&N to use Nook to partner with for their eBook sales.  Neither one is selling the Kindle anymore and are now actively promoting the Nook.

Turning to B&N’s retail operations, which are already profitable, they are looking to completely dominate the American market after the demise of Borders. The company’s CEO William Lynch reminded shareholders that the company now owns "64% of the total shelf space at bricks-and-mortar" book sellers, which while not a huge growth market will provide a strong cash flow position while its mobile and eBook strategies play out. 

<table> <tbody> <tr> <td> </td> <td> <p><strong>Barnes & Noble</strong></p> </td> <td> <p><strong>Amazon</strong></p> </td> <td> <p><strong>Pearson</strong></p> </td> <td> <p><strong>Apple</strong></p> </td> </tr> <tr> <td> <p><strong>YTD Stock</strong></p> </td> <td> <p>12.40%</p> </td> <td> <p>34.22%</p> </td> <td> <p>5.30%</p> </td> <td> <p>44.38%</p> </td> </tr> <tr> <td> <p><strong>Market Cap</strong></p> </td> <td> <p>$965 million</p> </td> <td> <p>$105.24 Billion</p> </td> <td> <p>$16.21 Billion</p> </td> <td> <p>$550 billion</p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p>N/A</p> </td> <td> <p>2,749.76</p> </td> <td> <p>10.55</p> </td> <td> <p>13.19</p> </td> </tr> <tr> <td> <p><strong>EPS</strong></p> </td> <td> <p>-1.21</p> </td> <td> <p>0.08</p> </td> <td> <p>1.88</p> </td> <td> <p>44.15</p> </td> </tr> <tr> <td> <p><strong>Yield</strong></p> </td> <td> <p>N/A</p> </td> <td> <p>N/A</p> </td> <td> <p>2.40%</p> </td> <td> <p>1.80%</p> </td> </tr> <tr> <td> <p><strong>ROA</strong></p> </td> <td> <p>-0.38%</p> </td> <td> <p>1.58%</p> </td> <td> <p>4.40%</p> </td> <td> <p>23.61%</p> </td> </tr> <tr> <td> <p><strong>ROE</strong></p> </td> <td> <p>-6.38%</p> </td> <td> <p>0.52%</p> </td> <td> <p>17.04%</p> </td> <td> <p>42.84%</p> </td> </tr> </tbody> </table>

B&N is an interesting play at this point.  The market is completely discounting practically all of its assets, while the Nook quietly presents the market with an e-reader that is a compelling choice. Strategy Analytics' latest report noted the strength of the tablet market, which saw Apple’s share drop to just over 50%, and they noted in their press release a number of vendors, including Nook. 

This holiday season will tell the tale on B&N’s Nook strategy.  The design choices may hold the Nook back from stronger sales with competition from the Nexus 7.  Being unable to access the Google Play store is a mistake for B&N.  While the Nook HD/HD+ look like brilliant purpose-built devices, they will likely not make a dent in the Google/Amazon juggernaut. 

PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple,, and Microsoft. Motley Fool newsletter services recommend Apple,, and Microsoft. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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