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Barnes & Noble's shares have crashed against the rocks of the bull market, falling 35% over the past five years, compared with a 115% gain for the S&P 500, as investors worried that Amazon.com (ticker: AMZN) would bury the country's largest bricks-and-mortar bookseller. And the company's attempt to compete with Amazon's Kindle and Apple's iPad with its own e-reader, the Nook, has generated big losses and only modest traction.
At a recent $16, Barnes and Noble looks like a very cheap stock, and any number of catalysts, including a corporate breakup, could get it moving. On a sum-of-the-parts basis, the stock could be worth $36.
Barnes & Noble (ticker: BKS) operates 663 bookstores in 50 states, giving it two-thirds of the country's retail bookshelves, and it's one of the two largest operators of college bookstores with 696, including several in the Ivy League. Its Nook division offers e-readers and digital content, including three million books and hundreds of magazines and newspapers. There are 4.5 million active Nook users. Total revenue probably topped $6 billion in its fiscal year ended in April. The company is due to report results for the April quarter in late June.
Yet Barnes & Noble has a bite-size market value of $1.2 billion. At the end of the January quarter, it had $362 million of net cash, or $5 per share. That means its enterprise value (in this case, market value minus net cash) is less than four times its $250 million in estimated earnings before interest, taxes, depreciation, and amortization in its fiscal year ended in April. That's one of the lowest valuations in retail.
The Nook division has lost more than $1 billion in the past four years. But the red ink is diminishing—running at $61 million in the company's third fiscal quarter, ended in January. Barnes & Noble plans to outsource production of color e-readers. The goal is to reduce or eliminate hardware losses to showcase profitable sales of digital content. Exclude Nook losses, and the enterprise value/Ebitda ratio is just two. Meanwhile, the retail bookstores, regularly described as "troubled" in the media, remain profitable, with an estimated $350 million of annual Ebitda and $175 million of free cash flow after taxes and capital expenditures.
THERE ARE SEVERAL scenarios under which Barnes & Noble could deliver for shareholders. It could split into three companies: retail stores, college bookstores, and Nook. This scenario may not occur soon because it probably hinges on a continued reduction in Nook losses and a resolution of a complex arrangement in whichMicrosoft (MSFT) and Pearson (PSO) combined own about 22% of Nook Media, which includes the college business. Other possibilities are a large stock buyback or a sizable dividend. (The company currently pays no dividend and isn't buying back shares.) The retail bookstores' profits probably could support a dividend of $1.50 a share or more.
"We've been studying and continue to look at strategic alternatives. Should all three businesses stay together or be split to enhance value," says CEO Mike Huseby. "We're working hard and will do whatever it takes to drive value for customers, employees, and shareholders."
Huseby, who was named CEO in January, understands corporate breakups, having worked as chief financial officer atCablevision Systems (CVC) from 2004 to 2011, when the Long Island cable TV operator successfully spun off AMC Networks (AMCX) and Madison Square Garden (MSG), owner of the New York Knicks and Rangers.
"IF HUSEBY IS ALLOWED to follow through with a strategy of breaking up the company, shareholders finally could be rewarded after the Nook debacle," says Rick Schottenfeld of Schottenfeld Group in New York, a Barnes & Noble shareholder. He says a breakup would "allow the earnings from the bookstores to be highlighted." He values the shares at $45. Maxim Group analyst John Tinker has a target of $32. Based on Tinker's work and investor discussions, Barron's estimates the sum of the parts at $36. Schottenfeld says it's "absurd" that the company isn't buying back stock, given its strong balance sheet and low valuation.
Barron's wrote favorably on Barnes & Noble ("The Underestimated Anti-Amazon," Oct. 29, 2012) when the stock traded below $15. The shares have since trailed the market, and we have done several follow-up articles.
Why is Barnes & Noble so cheap? For one thing, its chairman and founder, Len Riggio, has been a seller of stock; and John Malone's Liberty Media (LMCA) sold 90% of its $204 million of convertible preferred stock in April. Riggio sold 3.7 million shares at $17 that month, leaving him with 12 million, or 17% of the stock. Both Riggio and Liberty have sought to downplay the importance of their sales, but investors wonder whether they're worried about the company's outlook. With Riggio's stake diminished, the company could become a takeover target.
At around $16, Barnes & Noble looks like a very cheap stock. A breakup, a big buyback, or a dividend could unlock value for shareholders.
While the retail stores are mature, the college business is a growth story. The company has talked about expanding its store count to as many as 1,000. It offers college textbook rentals, which are increasingly popular and more profitable than textbook sales. It's also rolling out a digital-education platform called yuzu that lets students read textbooks on their favorite device, take notes, and communicate with others in the same course.
Chegg (CHGG), a textbook-rental outfit trying to position itself as an Internet portal for college students, went public last year and has a market value of $450 million. Its annual revenue of about $300 million is less than 20% of the Barnes & Noble's college revenue. We assume a value of $600 million for the college division, a big discount to Chegg's valuation, based on revenue and profits.
Barnes & Noble looks misunderstood and undervalued. Now that Nook losses are diminishing, the company may finally reward its long-suffering shareholders.