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Finding Value in Nooks and Crannies

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

I’m not sure about the market for crannies, but investors are seeing substantial value in NOOK Media, the majority-owned subsidiary of Barnes & Noble (NYSE: BKS) and developer of the NOOK family of electronic reading products. 

On December 28th, Barnes & Noble announced that Pearson (NYSE: PSO), the British publishing giant, had bought a 5% stake in the NOOK business for $89.5 million, which valued the subsidiary at $1.8 billion.  This deal comes on the heels of Microsoft’s (NASDAQ: MSFT) $300 million investment in NOOK Media at the end of April 2012 that placed a similar overall value on the unit.  The two investments from global leaders in the publishing and software sectors will add much needed capital, technology, and access to new markets.

What’s the value?

Founded in 1965, Barnes & Noble is the sole remaining national bookseller through its 1,363 retail and college bookstores.  It also participates in the digital e-book business through its NOOK Media subsidiary and owns Sterling Publishing, which is a niche publisher of 500 titles annually.  Despite a retail store base that contracts each year, the segment is still the largest part of the company’s business and generated 68.1% of its sales in 2012.

While Barnes & Noble has tried to drive sales growth by remaking its stores into community gathering spots, the stores have continued to lose business due to the cheaper prices and limitless inventories available in the online world.  In addition, the rise of digital downloads and e-readers have eliminated the need for incurring large real estate costs with big box superstores. 

While Barnes & Noble has an award-winning product with its NOOK device, it is competing against a field of fierce, better capitalized competitors.  At the top of the list are Apple (NASDAQ: AAPL) and Amazon (NASDAQ: AMZN) with annual sales of $156.5 billion and $48.1 billion, respectively, and dominating market shares in the tablet and e-reader segments.

In its latest fiscal year, Barnes & Noble reported sales growth of 1.9%, as declines in the retail and college segments were offset by a 34.3% increase in the NOOK unit.  However, the company generated an overall operating loss as its digital business continued to incur substantial costs in a bid to grow market share, which is currently estimated to be between 13% and 25% of the domestic e-reader market. 

Amazon has become the industry leader by selling its devices at cost, with the belief that lost profits will ultimately be recovered by the future sale of content and accessories.  Consequently, Barnes & Noble has had to match pricing on its own devices or risk declines in its user base and the related sales of content.

Looking ahead

In FY2013, the company’s overall sales growth has been flat and it continues to generate operating losses due to rising costs in its digital segment.  Sales growth in Barnes and Noble’s NOOK business has declined, with only a 2.6% gain, as device sales have slowed and average prices have declined. 

Meanwhile, the company has improved the operating efficiency of its bookstores, which reported operating income of $73.2 million, a 128.4% gain compared to the prior year period.  While Barnes and Noble’s retail segment has reported lower sales due to a smaller store base, comparable sales are up 2.4% this year, as lower physical book sales have been offset by higher sales of device accessories and non-book products.

The recent investment values the NOOK unit at roughly 1.9 times FY2012 sales, a reasonable multiple if the company is able to find a way to generate profits from its large user base.  The business probably needs to be part of a larger tech organization that can spread the large technology and marketing costs across a diverse product base.  With its 16.8% stake in the NOOK unit and a perennially large cash position, Microsoft seems well positioned to be a future buyer of the business as the device would be another outlet for its Windows operating system.  Either way, Barnes & Noble looks like the ultimate winner with its 78% stake and investors should take a position in this unfinished story.


rghanley owns shares of Apple and Amazon.com. The Motley Fool owns shares of Apple, Amazon.com, and Microsoft. Motley Fool newsletter services recommend Apple, Amazon.com, 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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