This Could Be The Beginning of the End for Barnes & Noble

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Shares of Barnes & Noble (NYSE: BKS) tumbled on Tuesday after the company reported disastrous earnings. Management largely blamed its NOOK division for the loss, and vowed to alter its strategy going forward.

Unfortunately for Barnes & Noble, there appear to be some terrible trends affecting its business.

Barnes & Noble’s recent quarter

In its most recent quarter, the bookseller saw its revenue fall over 7% on a year-over-year basis, while the company’s EBITDA loss of $122 million was more than 10 times the prior year.

In the earnings release, management drew attention to the NOOK division. That portion of the company’s business struggled to a greater degree than the others, with revenue dropping by a whopping 34% from the prior year and EBITDA loss increasing by nearly 130%.

To correct that weakness, Barnes & Noble plans to partner with a hardware manufacturer for production of NOOK tablets. The company will continue to make basic eReaders in house, but production of NOOK HD devices will be picked up by a (as of yet unidentified) third party.

Not just the NOOK

But here’s the thing: Barnes & Noble’s poor performance wasn't due to the NOOK alone. Its retail operation also saw its revenue and profitability decline. Retail revenue dropped 10% from the prior year, while EBITDA declined roughly 24%.

Barnes & Noble attempted to explain this decline by arguing that the prior year was extraordinary; that The Hunger Games and 50 Shades of Grey generated what amounted to a windfall.

But I’m skeptical of this explanation. Digital book sales are becoming increasingly popular -- last year, they grew by 43% -- and this must be affecting Barnes & Noble’s retail operation, at least partially (there’s a reason they got into the NOOK business to begin with).

Moreover, the fact that the company is so heavily dependent on the sale of blockbuster books is cause for concern. Admittedly, a best seller can outsell several hundred other books combined, but Barnes & Noble’s unique value proposition is the depth of its offerings.

To put it another way, titles like The Hunger Games and 50 Shades of Grey are freely available at non-book stores. Places like Wal-Mart, Target and even Kroger stock books of this caliber.

If so much of Barnes & Noble’s retail operation is dependent on just a handful of titles, it doesn't speak well to the continued existence of dedicated book stores.

Will the NOOK be sold?

There have been reports that Microsoft (NASDAQ: MSFT) is interested in buying the NOOK business for $1 billion. The Windows-maker already owns a minority stake, and there are reasons that it might want to own the entire thing.

Microsoft’s operating system competitors Google and Apple both sell books on their respective media stores. By selling content, the companies are able to lock consumers into their respective ecosystems.

If Microsoft purchased the NOOK business, it would presumably phase out the hardware production while adding the NOOK bookstore directly into Windows 8. Microsoft would gain a pre-existing digital book business, and might be able to sell some Surface tablets to NOOK devotees.

Given that Barnes & Noble’s market cap is less than a billion, such a purchase would amount to a significant catalyst for the stock if it were to take place. But at this point, it remains mere speculation.

Amazon claims another victim

Barnes & Noble’s release on Tuesday suggests that Amazon (NASDAQ: AMZN) is about to claim another victim.

One can argue that the NOOK HD is superior to Amazon’s competing Kindle Fire. In a recent article comparing the two, CNet’s Brian Tong concluded that the NOOK HD was a better buy. And yet, to date, the Kindle Fire has far outsold the NOOK HD.

It could be Amazon’s larger advertising budget, or its digital presence -- after all, the types of consumers more inclined to go with digital books (younger, more Internet savvy) might also be Amazon’s core customer.

But the death of the NOOK HD should be taken as a good sign for Amazon’s shareholders -- it illustrates Amazon’s continued retail prowess.

Investing in Barnes & Noble

Tuesday’s Barnes & Noble selloff seems justified. Unless one believes that Microsoft is about to cut a big check, the stock should likely be avoided.

Granted, physical books won't disappear anytime soon -- too many people still prefer them over digital copies. But if Barnes & Noble’s retail business is also shrinking, perhaps there just isn't a market for dedicated, warehouse-style bookstores anymore.

Joe Kurtz has no position in any stocks mentioned. The Motley Fool recommends The Motley Fool owns shares of 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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