Barnes & Noble: Wait For a Turnaround on this Overvalued Stock

By Maxwell Fisher - May 1, 2012 | Tickers: AMZN, BKS, MSFT | 0 Comments

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Barnes & Noble (NYSE: BKS) is soaring to new 52-week highs at the time of this writing, and the big news is that the company is creating a subsidiary for its e-book and college textbook businesses.  While that alone probably would’ve been enough to get this stock sizzling, what’s even more interesting is that Microsoft (NASDAQ: MSFT) is throwing down $300 million for a stake in this business.  The subsidiary is temporarily being called “Newco,” and it appears that Barnes & Noble’s strategy will either be to make a stock offering or sell it to private investors.  Essentially, Barnes & Noble’s problem is that Amazon’s (NASDAQ: AMZN) Kindle and Kindle Fire have been dominating the Nook, and it seems reasonable that Barnes & Noble simply isn’t equipped to maximize the value of this device.  In my opinion, this is a wise move for Barnes & Noble, but I don’t think the stock should be reacting this much.

Before anything else, let’s quickly review the history of some of Barnes & Noble’s businesses.  Back in 2009, Barnes & Noble bought its current college bookstore business from Leonard Riggio for $596 million, although the deal actually closed for $460 million due to cash that the unit already had.  Since then, the college bookstores have fared decently, taking advantage of the fact that college students invariably have to buy textbooks.  More recently, though, Barnes & Noble acknowledged that it might be best for the company to either spin off its Nook business or make an aggressive push overseas.  (I know, those options represent very different directions).  Two months later, G Asset Management, a shareholder of Barnes & Noble offered $460 million for a 51% stake in the college bookstore business, although the deal included some interesting provisions.  Specifically, Barnes & Noble would have to keep its current management and separate the Nook business from the rest of the company.  Additionally, the college bookstore unit would start out private but eventually be offered publicly.  Barnes & Noble didn’t comment on the potential deal, although this new plan can perhaps be thought of as a response.    

Clearly, Barnes & Noble has been under pressure to make a move, although I think the infusion of capital from Microsoft makes this a pretty easy decision even without that.  Teaming up with Microsoft provides a number of benefits.  There will now be a Nook application for the company’s Windows 8 tablets, and it seems reasonable that Microsoft would help to promote the e-reader.  Microsoft benefits, too, because its own e-book library has turned out to be a bust.  Seeing as that software will be discontinued on August 30^th, this was rather good timing for Microsoft.  It’s also worth noting that Microsoft’s stake in the new company will be 17.6%.

Although I’ve outlined some of the reasons why this deal makes sense for both Barnes & Noble and Microsoft, I’m surprised that the market has reacted so favorably to this development.  As always, I encourage investors to consider some of the more basic statistics to understand why Barnes & Noble is still in a weak position.  With trailing twelve months earnings per share of -1.45, this company has simply been losing money hand over fist.  That means the stock’s price to earning ratio can’t be calculated, and other ratios like price to book (0.95) and price to sales (0.12) are significantly higher than similar companies like Books-A-Million and Hastings Entertainment.  While Books-A-Million and Hastings are obviously much, much smaller than Barnes & Noble, these ratios are still worth taking a look at.  Margins for Barnes & Noble have been unimpressive as well – those numbers are -1.06% net profit, 25.62% gross, 2.33% EBITD, and -0.93% operating. 

One thing I am impressed with, however, is Barnes & Noble’s newest Nook product, the Nook Simple Touch with GlowLight.  Here’s what CEO William Lynch had to say: “It’s like having two Readers in one, with our breakthrough GlowLight technology making the device as exceptional for reading in the darkest bedroom as on the brightest beach, and all at the amazing value of just $139.”  Because this product uses both the GlowLight technology and the E Ink technology, it is possible that it could become immensely popular.  That would obviously help to make the new Nook subsidiary more valuable, but in my opinion, Amazons’ e-reader products are still very tough competition.  It’s hard to justify the current stock price with Amazon looming in the background.  (That’s not to say Amazon is appropriately priced either). 

What’s even more interesting is that Barnes & Noble saw a big surge even before the most recent one.  That occurred on April 23^rd when hedge fund Jana Partners disclosed its 12% stake in the company.  So really, Barnes & Noble is being overvalued not only due to one uncanny surge, but actually two.  A look at Barnes & Noble’s statement of cash flows is another way investors can tell between fact and fiction. Over the last three quarters, Barnes & Noble has brought in $117.32 million of operating cash inflow, ultimately leading to a net loss in cash of $32.03 million.  While Barnes & Noble has done an honorable job of retiring its debt, much of that was also due to unwise capital expenditures.  The company also brought in cash by issuing more stock.  I’m not here to suggest that Barnes & Noble is pursuing a terrible strategy, but the current stock price implies a market capitalization of over $1.3 billion.  Surely, separating the Nook and college businesses is a value-adding move, but I still don’t see this company being worth that much.  I’m going to need to see more signs that Barnes & Noble is making a turnaround before adding this stock to my portfolio.   

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