BARNES & NOBLE INC BKS
February 15, 2014 - 5:11pm EST by
MJS27
2014 2015
Price: 16.25 EPS $0.00 $0.00
Shares Out. (in M): 60 P/E 0.0x 0.0x
Market Cap (in $M): 973 P/FCF 0.0x 0.0x
Net Debt (in $M): 289 EBIT 0 0
TEV ($): 1,262 TEV/EBIT 0.0x 0.0x

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  • Retail
 

Description

LONG BKS

After trying and failing to restart the dialogue on the old BKS thread, I thought I would start a new one given recent developments and how the story has evolved in the last year or two.   It is worth reading the old write up and the comments.  Notice that the focus was clearly on the NOOK business at the time.

 

Pre Convert

 

Post Convert

Price

16.25

 

16.25

Shares

59,874,505

12,000,000

71,874,505

Mkt Cap

972,960,706

 

1167960706

Cash

297,254,000

 

297,254,000

Preferred

204,000,000

 

0

ST Note

127,250,000

 

127,250,000

LT Debt

105,000,000

 

105,000,000

Deferred Rent

149,934,000

 

149,934,000

EV

1,261,890,706

 

1,252,890,706

For The Elevator

Barnes and Noble is a classic case of a decent/good business paired with a money losing business.  The company operates 3 business lines: Retail, College, and NOOK (College and NOOK are held together as NOOK Media with MSFT owning 16.8% and Pearson owning 5%).  A quick glance at financials shows an operating loss of $220M in FY13 which leads popular perception to be “bricks and mortar is dead,” “AMZN is eating their lunch,” and a general revulsion toward the company. 

However, a look past the headline shows a core retail business with $376M of EBITDA in FY13 after having compounded at 18% since 2011, a college store with growing revenues that contributed $111M of EBITDA in FY13 on reduced margins, and a NOOK business that contributed negative $480M in EBITDA in FY1.  The enterprise value reveals that the entire company trades for 3.4x FY13 Retail EBITDA or 3.9x FY13 Retail EBITDA-Retail CAPEX or 5.7x FY13 Retail FCF assuming Retail paid all interest and was taxed at 35%: levels which are far too low for a business that is being managed for cash flow by excellent capital allocators.  It is true that the retail business may be caught in a slow decline, but it will not disappear any time soon. Importantly, management, key share holders, and the owner operator are all incentivized to let the core business shine through in the not too distant future.

From 40,000 Feet

An investment in BKS comes down to 2 questions:

1)      What is the core business worth?

2)      Will the core business be allowed to shine?

For the purposes of brevity I will largely look past the college business and NOOK business, but note that they have some value and add to a margin of a safety.

Why Does the Opportunity Exist?

Broadly speaking, the opportunity exists because “everybody knows” that book stores are dead in a digital age.  The bankruptcy of formerly highly levered competitor Borders Group proves this, right?  While it is true that retail revenue has declined in recent years, and will likely continue to decline in the future, a post holiday ’13 press release indicated that retail sales were basically flat YoY (core comparable sales down .2%).  I believe any future decline in revenues will be at a manageable pace on a store level, and tied to store closures on an income statement basis.  Similarly, “everybody knows” that the NOOK stands no chance in an iPad / Kindle world.  This may be true, but any negativity here depends on the company continuing to throw good money after bad in seeking to develop hardware to play the tablet game.  I believe this to be unlikely.

In the more immediate term, the December decline and subsequent volatility in the stock are attached to a disclosure that the SEC is investigating the company’s accounting practices, and the subsequent predatory law suits that come with that sort of thing.  Of course this is never a good thing.  However, the investigation is based on a former employee claiming that expenses tied to NOOK were improperly attached to the Retail business, essentially making NOOK look BETTER than it otherwise would and making Retail look WORSE than it otherwise would.  I am operating under the assumption that NOOK may be worth $0, so if the allegations prove true, I am fine with Retail being better than I assume now (not withstanding any fines etc).

Question 1: What is the Core Business Worth?

 “Reports of my death have been greatly exaggerated.”  ~ Samuel Clemens

In order to answer this question, it is first necessary to get over the popular perception that there is no room for brick and mortar book stores in today’s world.  A bit of history and a commentary on some of the major investors may be useful.

In late 2008 – early 2009 Ron Burkle of Yucaipa became an 8% holder of BKS stock before boosting his stake to almost 20% and kicking off a campaign to wrest control of the company from founder and Chairman Leonard Riggio.  That saga in and of itself is worth reading up on if you have the time, but in the interest of brevity, I will just give some background on Burkle.  If you’re not familiar with him, he is a college drop out that made billions in the ultimate low margin / “efficiency is key” business – super markets.  Early on in his career while seeking funding to buy a super market he became acquainted with Charlie Munger, who supposedly helped him further develop what came very naturally to him: only buying something if you think it is worth a lot more than you’re paying.  The point here is that Burkle is not the type of investor who would make an investment based on a speculative push into a new area such as E-Books.  The core of his investment was based on the belief that there were many levers to pull in the Retail business including cost cutting, stream lining distribution, closing stores, and ultimately managing for cash flow.  The NOOK business was just a lotto ticket.  Burkle eventually abandoned his stake for what I believe were personal/emotional reasons after losing a proxy battle to take control of the company.

In May of 2011, Liberty Media bid a hair over $1B for control of BKS, and ultimately settled for a ~17% stake via a convertible preferred in August of 2011 (7.75% convertible at $17).  Similar to Burkle, Malone is not the type of investor that is likely to make a speculative bet on a foray into a new product line.  Rather, he must have first gotten comfortable with the core business, and viewed the NOOK as a lotto ticket.

Dan Tisch, second son of the Tisch family of Loews Corp fame, also owns 8.4% of the company, having bought shares within the last month.  Once again, this is not someone who makes speculative investments on unproven technologies or fast moving industries.  This is the scion of a value investing legend who presumably has learned a thing or two.

 Moving on – on one hand we have 3 extremely sharp investors, who are all known to be patient and disciplined, who have made substantial investments in BKS not because they were so confident in the future of the NOOK, but rather because they were comfortable with the core business and viewed the NOOK as a lotto ticket.  On the other hand we have “everyone” who is more than happy to tell you that bricks and mortar are dead, Amazon is taking over the world, and there is no future for a company like Barnes and Noble.  I know which side I want to be on.

Here we are a few short years later, and the future of the NOOK is uncertain.  The company has dumped hundreds of millions of dollars into developing hardware – clearly not their area of expertise – and the iPad, Kindle, etc etc have basically beat them to the punch.  So how has the core business fared?

Retail

 

6 mos Oct '13

6 mos Oct '12

 

13-Apr

12-Apr

11-Apr

Stores

673

689

 

675

691

705

Sales

1,929,255

2,115,415

 

4,568,243

4,852,913

4,926,834

NOOK Elimination

90,989

123,423

 

272,919

400,847

401,610

Core Sales

1,838,266

1,991,992

 

4,295,324

4,452,066

4,525,224

Core Sales/Store

2,731

2,891

 

6,363

6,443

6,419

Core Sales Change

-5.5%

 

 

-1.2%

0.4%

 

COGS

-

-

 

3,168,520

3,398,773

3,491,365

NOOK Elimination

90,989

123,423

 

272,919

400,847

401,610

Gross Profit

-

-

 

1,399,723

1,454,140

1,435,469

Gross Margin

-

-

 

30.6%

30.0%

29.1%

SG&A

-

-

 

1,023,633

1,130,311

1,167,944

EBITDA

101,336

106,657

 

376,090

323,829

267,525

EBITDA YoY

-5.0%

 

 

16.1%

21.0%

 

D&A

64,218

79,922

 

148,855

162,693

164,934

EBIT

37,118

26,735

 

227,235

161,136

102,591

EBIT YoY

38.8%

 

 

41.0%

57.1%

 

CapEx

34,379

22,866

 

51,401

87,596

62,299

EBITDA-CapEx

66,957

83,791

 

324,689

236,233

205,226

 

  • Note corporate year ends in April        

Revenue has obviously come off a bit, but since 2011 Riggio has pulled many of the levers that Burkle referred to, and EBITDA has compounded at ~18%/year.  Importantly, ~35% of leases are up in the next 2 years, providing substantial opportunity to downsize where appropriate, increasing margins and reducing CapEx.  A few notes on YTD results: CapEx YTD is elevated due to a website overhaul – which also leads to higher SG&A on some level.  According to management this new site will yield cost savings.    This may or not be true, but what seems certain is that the increased spend will roll off.  Also increasing SG&A are several million in severance costs which will roll off.  On the sales line, YoY comparisons are also difficult to last year’s blockbuster sales of The Hunger Games and Fifty Shades of Gray – there don’t seem to be any major hits this year.

In sum, it is unclear how much more EBITDA margin can be squeezed out of the business, and surely it can’t go on forever.  Importantly however as of this past holiday season’s press release, sales were basically flat.  Given the difficulties the consumer has been facing and the extremely promotional environment across the retail landscape clamoring for consumer dollars, I’d say that this is reason for confidence – or at the very least tempered pessimism going forward. 

If the numbers alone aren’t enough and you are still in the camp that believes that AMZN is taking over the world, a few additional data points may interest you.  As reported by a recent Barron’s article, according to the American Booksellers Association, book stores are experiencing a resurgence.  Since 2009 membership and locations have grown by 16% and 19% respectively.   According to Nielsen, the volume of printed books is down since 2009, but it rebounded 5% in 2013.  There is some associated commentary that indicates communities like having book stores. 

This is not to say that AMZN is not a serious threat – it clearly is –  in terms of pricing, in terms of those people that like physical books and plan their reading list in advance and order books from AMZN, and in terms of people who are migrating to E-Books (AMZN may wind up “taking all” in the E-Book battle. It is worth noting however that a recent survey by the Pew Research Center indicated that only 4% of Americans exclusively read E-Books).   However, there is clearly still a section of the population that enjoys shopping in a physical book store where they can more easily browse, sample a chapter or two, and/or find something they didn’t know they were looking for.  This is a clear niche.  Bears chuckle at this comment, but the fact is that Barnes and Noble is the dominant force in bricks and mortar book retail. 

Valuation

 

Retail EBITDA Multiple (pfd converted)

 

Retail EBITDA-CapEx Multiple (pfd converted)

 

4

5

6

 

6

7

8

EV

1,504,360,000

1,880,450,000

2,256,540,000

 

1,948,134,000

2,272,823,000

2,597,512,000

LT Debt

105,000,000

105,000,000

105,000,000

 

105,000,000

105,000,000

105,000,000

ST Note

127,250,000

127,250,000

127,250,000

 

127,250,000

127,250,000

127,250,000

D'fd Rent

149,934,000

149,934,000

149,934,000

 

149,934,000

149,934,000

149,934,000

Preferred

0

0

0

 

0

0

0

Cash

297,254,000

297,254,000

297,254,000

 

297,254,000

297,254,000

297,254,000

Mkt Cap

1,419,430,000

1,795,520,000

2,171,610,000

 

1,863,204,000

2,187,893,000

2,512,582,000

Shares

71,874,505

71,874,505

71,874,505

 

71,874,505

71,874,505

71,874,505

Price

$19.75

$24.98

$30.21

 

$25.92

$30.44

$34.96

 

As a base case, I think it is fair to say that the core business is worth 5x FY13 EBITDA.  However, given that D&A greatly overstates CapEx which will continue to shrink due to a declining store base, and given that tax efficiency and capital allocation are virtually guaranteed to be top notch due to John Malone’s influence, I think 6x (or 7x EBITDA-CapEx) is nowhere near crazy.  Using FY13 numbers is obviously imprecise for a declining business, but as mentioned previously the increased CapEx tied to the website and the fact that holiday sales were ~flat are enough for me to be comfortable with this number given the huge margin of safety involved on these numbers, and given that we haven’t even added any value for College or Nook.  For reference, GME and BBY, 2 other retailers that are getting “killed by AMZN” recently traded at a 6x EV/EBITDA.  Of course both of these companies have aggressively bought back stock – BKS Retail will almost certainly do the same once it is on a stand alone basis.  (It is worth noting that GME was originally a BKS spin and Riggio was on the board until 2011. If Malone’s influence is not enough I am sure Riggio noticed the success that GME has had with buybacks.)  Also note that the above includes total lease liability.  Given that 1/3 of the leases are up for renewal in 2 years one could easily justify reducing this liability by 1/3, which would add ~$2/share.  In fact, given that bankruptcy is extremely unlikely, one could argue that the leases could be excluded from an EV entirely.  However, in the interest of conservatism, I have included them at full value.  Additionally cash and share count have not been adjusted for buybacks, which would be accretive and build in another layer of conservatism.

 

Question 2: Will the Core Business Be Allowed to Shine? 

Answering this question requires a peak at the motivations of the key players.

1)      Founder Len Riggio owns 26% of the company and is presumably self interested and thus will not continue funding NOOK throwing good money after bad forever.  It is worth noting that in December Riggio sold 2,000,000 shares.  These shares had purchases prices north of $35, allowing him to book a $40M tax loss.  Of course I’d prefer to see him buying stock rather than selling, but harvesting a tax loss in a year when everything else ripped higher seems reasonable.  Additionally a common complaint has been that Riggio runs the company as if it were private – this led to the aforementioned battle with Burkle and is a valid concern.

2)      John Malone’s Liberty Media owns ~17% of the company (and has 2 board seats) via a 7.75% preferred that is convertible at $17 and will presumably agitate for the company to not throw good money after bad forever.  Importantly, current CEO Mike Huseby is a Malone guy with spin off experience at Cablevision.  Upon being named CEO in January '14 (he was previously CFO and President of NOOK) he stated, ““My role, as I see it, is to enhance and unlock the value of these businesses for our shareholders.”

3)      MSFT invested $300M in NOOK in October of 2012.  As part of the agreement there is a 5 year put in place under which MSFT can receive “fair market value” for their share of NOOK if it has not been spun off from the core business.  The clock is ticking, and presumably Riggio, Malone etc do not want to write MSFT a check.  If you figure there is a ~3.5 year timeline until the spin “has” to be completed, I believe it is likely that the market will figure this out within ~2.5 years and start to price BKS stock on the value of the core business.

Other reasons to believe that a spin or other change in the NOOK strategy will come within the next three years include:

1)      The company has openly talked about a spin.  In fact, when MSFT made their investment in NOOK it was specifically structured to facilitate a spin of the NOOK and College business.  However, it has not happened yet, which has caused impatient investors to head for the door.  Once again though, the clock is ticking.

2)      On Feb 10, 2014 BKS announced that they had laid off engineers attached to the hardware side of NOOK.  As of the last K there were 750 employees attached to NOOK – there have been conflicting reports as to how many people were laid off with “less than 100” being the most common. It is impossible to know exactly what this means at this point, but it certainly means reduced CapEx and SG&A.  It seems likely the company will be continuing to develop a simple E-Reader while licensing the NOOK concept to outside developers for color/full service tablets.  Other theories out there range from giving up on NOOK all together, to allowing MSFT to take the lead.  A report that MSFT was looking to hire engineers to develop an Xbox branded reader adds some intrigue to the story and licensing deals.

In summary, I think it is a foregone conclusion that the NOOK business will be either spun off, sold off, or downsized appropriately allowing the strength of the core business to shine through within 3.5 years.  Importantly, at these prices investors are paying $0 for an asset that could potentially be worth a decent chunk of change.

 

A Brief Word On Other Businesses

College

The college business is more difficult to get a handle on than the retail business.  While the traditional book store segment seems to have stabilized and is generally a slow moving business, the way college students access books is rapidly changing.  College used to be a business with a captive clientele, but the last few years – or perhaps more appropriately semesters – have seen a rapid shift toward renting books.  While there will likely always be a subset of students that like to own books so that they can highlight, make notes in the margins etc, and another subset that at least wants a physical book to more easily flip pages, it is not hard to see most perpetually cash strapped students moving to a rental model on the cheapest basis possible, which is E-Books.  With E-Books of course there is no benefit to physical proximity, and price will likely be the sole determinant of who wins the business.  AMZN seems likely to be the clear winner, although Pearson’s investment in NOOK is interesting. 

Sales and gross margins have been improving in the college business, but EBITDA has been declining as the company is investing more money into “higher ed initiatives” which to me basically means “trying to figure out the future.”  Given this dynamic I think a 3x EBITDA is probably fair, equating to a touch shy of $4/share after backing out MSFT and Pearson’s interest in NOOK Media.  Importantly, at these prices investors are paying $0 for this business, and it may wind up being worth quite a bit more depending on how the future of text book rentals shakes out.

 

NOOK

I have no idea what NOOK is worth.  As recently as May of 2013 there were unconfirmed reports that MSFT would pay $1B for the whole NOOK business (note this may include all of College as College and NOOK are held at the NOOK Media level).  This is a rapidly changing market, and obviously AMZN is taking the lion's share of it.  I like to think that the folks at MSFT are smart enough to have some visibility on the future of the E-Book business and thus were not completely crazy when they made their initial investment and when they allegedly tried to buy complete control, but who knows.  If MSFT goes the “devices and services” route I suppose it makes sense to keep a foothold in the E-Book world, but predicting this sort of thing is not my game.  I’m fine with that though since at these prices investors are not paying for it.  What I do know is that if MSFT were to buy the whole business it wouldn’t be the first time they bought assets in an attempt to keep up with AAPL/AMZN/GOOG etc.   

What really matters is that the key players are incentivized to not let NOOK take down the whole ship.  The recent layoffs and reports that NOOK will continue to develop simple readers while abandoning full function tablets are evidence that NOOK will not take down the whole ship.

It is also worth noting that the publishers seem to hate AMZN due to AMZN constantly squeezing them on everything and anything, as well as the fact that AMZN has entered the publishing world as a competitor.  The publishers are likely incentivized to keep NOOK around as a foil to AMZN, and publishers also benefit from being able to negotiate w/ one BKS entity for both print and digital.   It may also be worth noting that  NOOK may benefit from the aforementioned upgrade of www.barnesandnoble.com (part of the Retail segment, although EBook sales flow through NOOK) which quite simply has been historically less user friendly than AMZN.  An improved website experience could/should help E-Book and possibly NOOK sales.  

And lastly, BKS has $29M of NOLS which are likely held at the NOOK Media level, although a company rep would not confirm that.  It is not clear if these NOLs will be able to be harvested as they have been recording valuation allowances, but I am confident that if anyone can maximize their value, it is John Malone et al.  I give them $0 value for now.

Suffice it to say that NOOK is likely worth more than zero, and possibly substantially more than zero depending on how the E-Book world / MSFT ecosystem develop.  Importantly, at these prices investors are paying $0 for NOOK.

Summary:

Barnes & Noble’s retail segment is far from a sexy business, but it does spit off a lot of cash into very capable hands, and its decline will likely be slower than “everyone” thinks. The key players in this story are motivated to let the core business shine through in the not too distant future, and NOOK and College are free lotto tickets.  The stock has spiked ~15% in the last few sessions on the back of the news of layoffs at NOOK – this was likely largely short covering, and prices are likely to drift back down to the ~$15 level in the coming weeks, making the potential for a doubling of the stock’s price in the next 2-3 years a reasonable possibility.  If sales at Retail decline faster than expected, the excellent capital allocators at the helm will likely aggressively repurchase shares, limiting any downside.

 

Disclosure: LONG

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Spin, sale or other with NOOK
Excellent capital allocation / buybacks
    sort by   Expand   New

    Description

    LONG BKS

    After trying and failing to restart the dialogue on the old BKS thread, I thought I would start a new one given recent developments and how the story has evolved in the last year or two.   It is worth reading the old write up and the comments.  Notice that the focus was clearly on the NOOK business at the time.

     

    Pre Convert

     

    Post Convert

    Price

    16.25

     

    16.25

    Shares

    59,874,505

    12,000,000

    71,874,505

    Mkt Cap

    972,960,706

     

    1167960706

    Cash

    297,254,000

     

    297,254,000

    Preferred

    204,000,000

     

    0

    ST Note

    127,250,000

     

    127,250,000

    LT Debt

    105,000,000

     

    105,000,000

    Deferred Rent

    149,934,000

     

    149,934,000

    EV

    1,261,890,706

     

    1,252,890,706

    For The Elevator

    Barnes and Noble is a classic case of a decent/good business paired with a money losing business.  The company operates 3 business lines: Retail, College, and NOOK (College and NOOK are held together as NOOK Media with MSFT owning 16.8% and Pearson owning 5%).  A quick glance at financials shows an operating loss of $220M in FY13 which leads popular perception to be “bricks and mortar is dead,” “AMZN is eating their lunch,” and a general revulsion toward the company. 

    However, a look past the headline shows a core retail business with $376M of EBITDA in FY13 after having compounded at 18% since 2011, a college store with growing revenues that contributed $111M of EBITDA in FY13 on reduced margins, and a NOOK business that contributed negative $480M in EBITDA in FY1.  The enterprise value reveals that the entire company trades for 3.4x FY13 Retail EBITDA or 3.9x FY13 Retail EBITDA-Retail CAPEX or 5.7x FY13 Retail FCF assuming Retail paid all interest and was taxed at 35%: levels which are far too low for a business that is being managed for cash flow by excellent capital allocators.  It is true that the retail business may be caught in a slow decline, but it will not disappear any time soon. Importantly, management, key share holders, and the owner operator are all incentivized to let the core business shine through in the not too distant future.

    From 40,000 Feet

    An investment in BKS comes down to 2 questions:

    1)      What is the core business worth?

    2)      Will the core business be allowed to shine?

    For the purposes of brevity I will largely look past the college business and NOOK business, but note that they have some value and add to a margin of a safety.

    Why Does the Opportunity Exist?

    Broadly speaking, the opportunity exists because “everybody knows” that book stores are dead in a digital age.  The bankruptcy of formerly highly levered competitor Borders Group proves this, right?  While it is true that retail revenue has declined in recent years, and will likely continue to decline in the future, a post holiday ’13 press release indicated that retail sales were basically flat YoY (core comparable sales down .2%).  I believe any future decline in revenues will be at a manageable pace on a store level, and tied to store closures on an income statement basis.  Similarly, “everybody knows” that the NOOK stands no chance in an iPad / Kindle world.  This may be true, but any negativity here depends on the company continuing to throw good money after bad in seeking to develop hardware to play the tablet game.  I believe this to be unlikely.

    In the more immediate term, the December decline and subsequent volatility in the stock are attached to a disclosure that the SEC is investigating the company’s accounting practices, and the subsequent predatory law suits that come with that sort of thing.  Of course this is never a good thing.  However, the investigation is based on a former employee claiming that expenses tied to NOOK were improperly attached to the Retail business, essentially making NOOK look BETTER than it otherwise would and making Retail look WORSE than it otherwise would.  I am operating under the assumption that NOOK may be worth $0, so if the allegations prove true, I am fine with Retail being better than I assume now (not withstanding any fines etc).

    Question 1: What is the Core Business Worth?

     “Reports of my death have been greatly exaggerated.”  ~ Samuel Clemens

    In order to answer this question, it is first necessary to get over the popular perception that there is no room for brick and mortar book stores in today’s world.  A bit of history and a commentary on some of the major investors may be useful.

    In late 2008 – early 2009 Ron Burkle of Yucaipa became an 8% holder of BKS stock before boosting his stake to almost 20% and kicking off a campaign to wrest control of the company from founder and Chairman Leonard Riggio.  That saga in and of itself is worth reading up on if you have the time, but in the interest of brevity, I will just give some background on Burkle.  If you’re not familiar with him, he is a college drop out that made billions in the ultimate low margin / “efficiency is key” business – super markets.  Early on in his career while seeking funding to buy a super market he became acquainted with Charlie Munger, who supposedly helped him further develop what came very naturally to him: only buying something if you think it is worth a lot more than you’re paying.  The point here is that Burkle is not the type of investor who would make an investment based on a speculative push into a new area such as E-Books.  The core of his investment was based on the belief that there were many levers to pull in the Retail business including cost cutting, stream lining distribution, closing stores, and ultimately managing for cash flow.  The NOOK business was just a lotto ticket.  Burkle eventually abandoned his stake for what I believe were personal/emotional reasons after losing a proxy battle to take control of the company.

    In May of 2011, Liberty Media bid a hair over $1B for control of BKS, and ultimately settled for a ~17% stake via a convertible preferred in August of 2011 (7.75% convertible at $17).  Similar to Burkle, Malone is not the type of investor that is likely to make a speculative bet on a foray into a new product line.  Rather, he must have first gotten comfortable with the core business, and viewed the NOOK as a lotto ticket.

    Dan Tisch, second son of the Tisch family of Loews Corp fame, also owns 8.4% of the company, having bought shares within the last month.  Once again, this is not someone who makes speculative investments on unproven technologies or fast moving industries.  This is the scion of a value investing legend who presumably has learned a thing or two.

     Moving on – on one hand we have 3 extremely sharp investors, who are all known to be patient and disciplined, who have made substantial investments in BKS not because they were so confident in the future of the NOOK, but rather because they were comfortable with the core business and viewed the NOOK as a lotto ticket.  On the other hand we have “everyone” who is more than happy to tell you that bricks and mortar are dead, Amazon is taking over the world, and there is no future for a company like Barnes and Noble.  I know which side I want to be on.

    Here we are a few short years later, and the future of the NOOK is uncertain.  The company has dumped hundreds of millions of dollars into developing hardware – clearly not their area of expertise – and the iPad, Kindle, etc etc have basically beat them to the punch.  So how has the core business fared?

    Retail

     

    6 mos Oct '13

    6 mos Oct '12

     

    13-Apr

    12-Apr

    11-Apr

    Stores

    673

    689

     

    675

    691

    705

    Sales

    1,929,255

    2,115,415

     

    4,568,243

    4,852,913

    4,926,834

    NOOK Elimination

    90,989

    123,423

     

    272,919

    400,847

    401,610

    Core Sales

    1,838,266

    1,991,992

     

    4,295,324

    4,452,066

    4,525,224

    Core Sales/Store

    2,731

    2,891

     

    6,363

    6,443

    6,419

    Core Sales Change

    -5.5%

     

     

    -1.2%

    0.4%

     

    COGS

    -

    -

     

    3,168,520

    3,398,773

    3,491,365

    NOOK Elimination

    90,989

    123,423

     

    272,919

    400,847

    401,610

    Gross Profit

    -

    -

     

    1,399,723

    1,454,140

    1,435,469

    Gross Margin

    -

    -

     

    30.6%

    30.0%

    29.1%

    SG&A

    -

    -

     

    1,023,633

    1,130,311

    1,167,944

    EBITDA

    101,336

    106,657

     

    376,090

    323,829

    267,525

    EBITDA YoY

    -5.0%

     

     

    16.1%

    21.0%

     

    D&A

    64,218

    79,922

     

    148,855

    162,693

    164,934

    EBIT

    37,118

    26,735

     

    227,235

    161,136

    102,591

    EBIT YoY

    38.8%

     

     

    41.0%

    57.1%

     

    CapEx

    34,379

    22,866

     

    51,401

    87,596

    62,299

    EBITDA-CapEx

    66,957

    83,791

     

    324,689

    236,233

    205,226

     

    • Note corporate year ends in April        

    Revenue has obviously come off a bit, but since 2011 Riggio has pulled many of the levers that Burkle referred to, and EBITDA has compounded at ~18%/year.  Importantly, ~35% of leases are up in the next 2 years, providing substantial opportunity to downsize where appropriate, increasing margins and reducing CapEx.  A few notes on YTD results: CapEx YTD is elevated due to a website overhaul – which also leads to higher SG&A on some level.  According to management this new site will yield cost savings.    This may or not be true, but what seems certain is that the increased spend will roll off.  Also increasing SG&A are several million in severance costs which will roll off.  On the sales line, YoY comparisons are also difficult to last year’s blockbuster sales of The Hunger Games and Fifty Shades of Gray – there don’t seem to be any major hits this year.

    In sum, it is unclear how much more EBITDA margin can be squeezed out of the business, and surely it can’t go on forever.  Importantly however as of this past holiday season’s press release, sales were basically flat.  Given the difficulties the consumer has been facing and the extremely promotional environment across the retail landscape clamoring for consumer dollars, I’d say that this is reason for confidence – or at the very least tempered pessimism going forward. 

    If the numbers alone aren’t enough and you are still in the camp that believes that AMZN is taking over the world, a few additional data points may interest you.  As reported by a recent Barron’s article, according to the American Booksellers Association, book stores are experiencing a resurgence.  Since 2009 membership and locations have grown by 16% and 19% respectively.   According to Nielsen, the volume of printed books is down since 2009, but it rebounded 5% in 2013.  There is some associated commentary that indicates communities like having book stores. 

    This is not to say that AMZN is not a serious threat – it clearly is –  in terms of pricing, in terms of those people that like physical books and plan their reading list in advance and order books from AMZN, and in terms of people who are migrating to E-Books (AMZN may wind up “taking all” in the E-Book battle. It is worth noting however that a recent survey by the Pew Research Center indicated that only 4% of Americans exclusively read E-Books).   However, there is clearly still a section of the population that enjoys shopping in a physical book store where they can more easily browse, sample a chapter or two, and/or find something they didn’t know they were looking for.  This is a clear niche.  Bears chuckle at this comment, but the fact is that Barnes and Noble is the dominant force in bricks and mortar book retail. 

    Valuation

     

    Retail EBITDA Multiple (pfd converted)

     

    Retail EBITDA-CapEx Multiple (pfd converted)

     

    4

    5

    6

     

    6

    7

    8

    EV

    1,504,360,000

    1,880,450,000

    2,256,540,000

     

    1,948,134,000

    2,272,823,000

    2,597,512,000

    LT Debt

    105,000,000

    105,000,000

    105,000,000

     

    105,000,000

    105,000,000

    105,000,000

    ST Note

    127,250,000

    127,250,000

    127,250,000

     

    127,250,000

    127,250,000

    127,250,000

    D'fd Rent

    149,934,000

    149,934,000

    149,934,000

     

    149,934,000

    149,934,000

    149,934,000

    Preferred

    0

    0

    0

     

    0

    0

    0

    Cash

    297,254,000

    297,254,000

    297,254,000

     

    297,254,000

    297,254,000

    297,254,000

    Mkt Cap

    1,419,430,000

    1,795,520,000

    2,171,610,000

     

    1,863,204,000

    2,187,893,000

    2,512,582,000

    Shares

    71,874,505

    71,874,505

    71,874,505

     

    71,874,505

    71,874,505

    71,874,505

    Price

    $19.75

    $24.98

    $30.21

     

    $25.92

    $30.44

    $34.96

     

    As a base case, I think it is fair to say that the core business is worth 5x FY13 EBITDA.  However, given that D&A greatly overstates CapEx which will continue to shrink due to a declining store base, and given that tax efficiency and capital allocation are virtually guaranteed to be top notch due to John Malone’s influence, I think 6x (or 7x EBITDA-CapEx) is nowhere near crazy.  Using FY13 numbers is obviously imprecise for a declining business, but as mentioned previously the increased CapEx tied to the website and the fact that holiday sales were ~flat are enough for me to be comfortable with this number given the huge margin of safety involved on these numbers, and given that we haven’t even added any value for College or Nook.  For reference, GME and BBY, 2 other retailers that are getting “killed by AMZN” recently traded at a 6x EV/EBITDA.  Of course both of these companies have aggressively bought back stock – BKS Retail will almost certainly do the same once it is on a stand alone basis.  (It is worth noting that GME was originally a BKS spin and Riggio was on the board until 2011. If Malone’s influence is not enough I am sure Riggio noticed the success that GME has had with buybacks.)  Also note that the above includes total lease liability.  Given that 1/3 of the leases are up for renewal in 2 years one could easily justify reducing this liability by 1/3, which would add ~$2/share.  In fact, given that bankruptcy is extremely unlikely, one could argue that the leases could be excluded from an EV entirely.  However, in the interest of conservatism, I have included them at full value.  Additionally cash and share count have not been adjusted for buybacks, which would be accretive and build in another layer of conservatism.

     

    Question 2: Will the Core Business Be Allowed to Shine? 

    Answering this question requires a peak at the motivations of the key players.

    1)      Founder Len Riggio owns 26% of the company and is presumably self interested and thus will not continue funding NOOK throwing good money after bad forever.  It is worth noting that in December Riggio sold 2,000,000 shares.  These shares had purchases prices north of $35, allowing him to book a $40M tax loss.  Of course I’d prefer to see him buying stock rather than selling, but harvesting a tax loss in a year when everything else ripped higher seems reasonable.  Additionally a common complaint has been that Riggio runs the company as if it were private – this led to the aforementioned battle with Burkle and is a valid concern.

    2)      John Malone’s Liberty Media owns ~17% of the company (and has 2 board seats) via a 7.75% preferred that is convertible at $17 and will presumably agitate for the company to not throw good money after bad forever.  Importantly, current CEO Mike Huseby is a Malone guy with spin off experience at Cablevision.  Upon being named CEO in January '14 (he was previously CFO and President of NOOK) he stated, ““My role, as I see it, is to enhance and unlock the value of these businesses for our shareholders.”

    3)      MSFT invested $300M in NOOK in October of 2012.  As part of the agreement there is a 5 year put in place under which MSFT can receive “fair market value” for their share of NOOK if it has not been spun off from the core business.  The clock is ticking, and presumably Riggio, Malone etc do not want to write MSFT a check.  If you figure there is a ~3.5 year timeline until the spin “has” to be completed, I believe it is likely that the market will figure this out within ~2.5 years and start to price BKS stock on the value of the core business.

    Other reasons to believe that a spin or other change in the NOOK strategy will come within the next three years include:

    1)      The company has openly talked about a spin.  In fact, when MSFT made their investment in NOOK it was specifically structured to facilitate a spin of the NOOK and College business.  However, it has not happened yet, which has caused impatient investors to head for the door.  Once again though, the clock is ticking.

    2)      On Feb 10, 2014 BKS announced that they had laid off engineers attached to the hardware side of NOOK.  As of the last K there were 750 employees attached to NOOK – there have been conflicting reports as to how many people were laid off with “less than 100” being the most common. It is impossible to know exactly what this means at this point, but it certainly means reduced CapEx and SG&A.  It seems likely the company will be continuing to develop a simple E-Reader while licensing the NOOK concept to outside developers for color/full service tablets.  Other theories out there range from giving up on NOOK all together, to allowing MSFT to take the lead.  A report that MSFT was looking to hire engineers to develop an Xbox branded reader adds some intrigue to the story and licensing deals.

    In summary, I think it is a foregone conclusion that the NOOK business will be either spun off, sold off, or downsized appropriately allowing the strength of the core business to shine through within 3.5 years.  Importantly, at these prices investors are paying $0 for an asset that could potentially be worth a decent chunk of change.

     

    A Brief Word On Other Businesses

    College

    The college business is more difficult to get a handle on than the retail business.  While the traditional book store segment seems to have stabilized and is generally a slow moving business, the way college students access books is rapidly changing.  College used to be a business with a captive clientele, but the last few years – or perhaps more appropriately semesters – have seen a rapid shift toward renting books.  While there will likely always be a subset of students that like to own books so that they can highlight, make notes in the margins etc, and another subset that at least wants a physical book to more easily flip pages, it is not hard to see most perpetually cash strapped students moving to a rental model on the cheapest basis possible, which is E-Books.  With E-Books of course there is no benefit to physical proximity, and price will likely be the sole determinant of who wins the business.  AMZN seems likely to be the clear winner, although Pearson’s investment in NOOK is interesting. 

    Sales and gross margins have been improving in the college business, but EBITDA has been declining as the company is investing more money into “higher ed initiatives” which to me basically means “trying to figure out the future.”  Given this dynamic I think a 3x EBITDA is probably fair, equating to a touch shy of $4/share after backing out MSFT and Pearson’s interest in NOOK Media.  Importantly, at these prices investors are paying $0 for this business, and it may wind up being worth quite a bit more depending on how the future of text book rentals shakes out.

     

    NOOK

    I have no idea what NOOK is worth.  As recently as May of 2013 there were unconfirmed reports that MSFT would pay $1B for the whole NOOK business (note this may include all of College as College and NOOK are held at the NOOK Media level).  This is a rapidly changing market, and obviously AMZN is taking the lion's share of it.  I like to think that the folks at MSFT are smart enough to have some visibility on the future of the E-Book business and thus were not completely crazy when they made their initial investment and when they allegedly tried to buy complete control, but who knows.  If MSFT goes the “devices and services” route I suppose it makes sense to keep a foothold in the E-Book world, but predicting this sort of thing is not my game.  I’m fine with that though since at these prices investors are not paying for it.  What I do know is that if MSFT were to buy the whole business it wouldn’t be the first time they bought assets in an attempt to keep up with AAPL/AMZN/GOOG etc.   

    What really matters is that the key players are incentivized to not let NOOK take down the whole ship.  The recent layoffs and reports that NOOK will continue to develop simple readers while abandoning full function tablets are evidence that NOOK will not take down the whole ship.

    It is also worth noting that the publishers seem to hate AMZN due to AMZN constantly squeezing them on everything and anything, as well as the fact that AMZN has entered the publishing world as a competitor.  The publishers are likely incentivized to keep NOOK around as a foil to AMZN, and publishers also benefit from being able to negotiate w/ one BKS entity for both print and digital.   It may also be worth noting that  NOOK may benefit from the aforementioned upgrade of www.barnesandnoble.com (part of the Retail segment, although EBook sales flow through NOOK) which quite simply has been historically less user friendly than AMZN.  An improved website experience could/should help E-Book and possibly NOOK sales.  

    And lastly, BKS has $29M of NOLS which are likely held at the NOOK Media level, although a company rep would not confirm that.  It is not clear if these NOLs will be able to be harvested as they have been recording valuation allowances, but I am confident that if anyone can maximize their value, it is John Malone et al.  I give them $0 value for now.

    Suffice it to say that NOOK is likely worth more than zero, and possibly substantially more than zero depending on how the E-Book world / MSFT ecosystem develop.  Importantly, at these prices investors are paying $0 for NOOK.

    Summary:

    Barnes & Noble’s retail segment is far from a sexy business, but it does spit off a lot of cash into very capable hands, and its decline will likely be slower than “everyone” thinks. The key players in this story are motivated to let the core business shine through in the not too distant future, and NOOK and College are free lotto tickets.  The stock has spiked ~15% in the last few sessions on the back of the news of layoffs at NOOK – this was likely largely short covering, and prices are likely to drift back down to the ~$15 level in the coming weeks, making the potential for a doubling of the stock’s price in the next 2-3 years a reasonable possibility.  If sales at Retail decline faster than expected, the excellent capital allocators at the helm will likely aggressively repurchase shares, limiting any downside.

     

    Disclosure: LONG

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Spin, sale or other with NOOK
    Excellent capital allocation / buybacks

    Messages


    SubjectRE: Thanks
    Entry02/16/2014 11:59 AM
    MemberMJS27
    The obvious answer is to reduce per store square footage (and thus inventory).  I don't have the statistics in front of me, but its something like 90% of all book sales in a given year are tied to a few hundred titles, so there is obviously some flex there given a typical BKS story carries tens of thousands of books.
     
    however, i'm not sure that it would be worth it to do that...  it is interesting to observe how customers interact with the store...  alot of people treat it like their living room - at least in the tri state area stores i have visited.  in my experience it is common to see people sitting on the floor tucked into a random corner flipping through a book.  Obviously people feel comfortable in the stores.  A smaller foot print would likely erode that feeling of comfort on some level and perhaps drive customers away.
     
    There is also talk of more community based programming whether it be educational or otherwise.  There is an online message board where BKS employees exchange scuttlebutt - again i don't have it in front of me - but some of the chatter there (which is largely negative -not surprising given min wage workers etc) indicates the company has tried this in the past and it hasn't worked.
     
    I do think the move toward educational toys, the cafes, and the last minute gift items is a good move - particularly the educational toys.  Thinking back to my youth I can remember asking my parents if we could go to Toys R' Us and them being less than enthused.  If i had asked to go to a book store i have to imagine they would have been more indulgent.
     
    As for what the new CEO may be capable of doing with the business, I don't have an answer beyond managing it efficiently for cash flow and wisely using that cashful for the good of shareholders.  I don't think he is likely to jump head first into some sort of new business line or make other drastic changes that will revolutionize the bricks and mortar book store business.
     
    The important thing is that at these prices you are paying for a drop off a cliff in sales and margins, and i don't think that is likely on the whole, and i think it is ESPECIALLY unlikely on a per share basis.
     

    SubjectRE: RE: Thanks
    Entry02/16/2014 02:36 PM
    Memberlatticework
    Solid write-up -- one follow-up question:

    On the free cash flow, you mentioned BKS is trading at 5.7x FY13 Retail FCF assuming Retail paid all interest and was taxed at 35%.  Do you have a view on the cash burn BKS will have to endure on the NOOK side (even assuming Malone & co. allocate capital more efficiently and only toward the simple e-reader platform, not the full-fledged color tablet efforts)?  What do you think normalized FCF is for Retail (incorporating your estimate for run-rate NOOK cash burn, if you have one), and what is BKS trading at on a yield basis using that normalized FCF?

    SubjectRE: RE: RE: Thanks
    Entry02/17/2014 09:47 AM
    MemberMJS27

    Unfortunately (or fortunately b/c it wouldn't be this cheap otherwise) I don't have a solid answer to those questions.  I am however in agreement with Seth Klarman who said:

    “Uncertainty is frequently accompanied by low prices. By the time the uncertainty is resolved, prices are likely to have risen. Investors frequently benefit from making investment decisions with less than perfect knowledge and are well rewarded for bearing the risk of uncertainty. The time other investors spend delving into the last unanswered detail may cost them the chance to buy in at prices so low that they offer a margin of safety despite the incomplete information.”

    I think of this as an investment that you have to model with a crayon because there are a lot of moving parts and pretending that I know how fast sales may fall off or how much more margin they can squeeze out would be farcical.  What you don't need a crayon for however is an opinion on if the company will appropriately use any cash that does come through the business, and I think the answer is a resounding yes.  So in terms of the cash burn on the NOOK side all I can say is that they appear to be doing the right thing in the immediate term by laying off engineers and reducing capex.  In terms of normalized FCF for retail, as of FY13 if they were paying all interest and were taxed at 35% it would be $222M and if they were taxed at zero (ie if NOOK continues to lose money in the short term which seems likely) it would be $289M.  Use a crayon to pick a number somewhere in the middle i guess.  Or just pick a number that reflects continued decline like $175M which gives you an almost 14% FCF/EV yield (on an EV that fully includes deferred rent.. as discussed this is likely overly conservative).

    Whatever number you use I think that you will find that the company is still very cheap. 

    Is there uncertainty?  YES.  Is there risk?  I think it is pretty darn low.


    SubjectTaxes? Nook Burn?
    Entry02/17/2014 10:13 AM
    Membernha855
    Now that BKS owns < 80% of Nook post the sale to Pearson. can BKS still consolidate NOOK? If not, doesn't that mean they return to being a cash taxpayer despite the losses at Nook?
     
    Any thoughts re: how much the Nook division burns in 2014 and how it gets funded? Does BKS need to fund its pro rata portion of a capital increase at Nook?

    SubjectRE: Taxes? Nook Burn?
    Entry02/17/2014 04:59 PM
    MemberMJS27
    NOOK is still consolidated and likely will be as long as BKS maintains >50% of the votes.
     
    No, no real thoughts on how much NOOK burns in 2014 other than less than 2013 and it will be rational.  I think there is very little chance of the company continuing to dump money into NOOK to gain market share etc.
     
    My assumption is that BKS would need to fund its pro rata portion of any capital increase at NOOK, but I admit I have not done the work to confirm that because I can't imagine a situation where they raise capital... unless for some reason it became clear that NOOK was going to take ground from Kindle/Ipad, which i think it extremely unlikely.
     
    i think it is much more likely that if NOOK needs capital it is b/c MSFT has some sort of grand scheme up their sleave, in which case MSFT would likely just try to buy NOOK altogether and license content from BKS.
     
    Good question though - I will update if/when I learn more.  thanks

    SubjectRE: RE: Taxes? Nook Burn?
    Entry02/17/2014 08:49 PM
    Membernha855
    My understanding is that to consolidate a subsidiary for tax purposes, the parent company needs to own 80%V of the subsidiary - see for instance http://en.wikipedia.org/wiki/Combined_reporting - if this is, in fact, correct is there a risk that the stores could be full taxpayers and then not benefit from the ability to deduct the nook losses?
     
    Also, I am not clear on your thoughts on the importance of Nook burn. Isn't there a risk that BKS needs to fund capital calls to Nook if there is not enough cash there? Is there a realistic scenario where nook is self-funding? If not, how are we being well-compensated for the risk that the stores are a melting ice cube? If they are melting ice cubes, isn't it really important for management to harvest (and not waste) the cash flows from the asset?
     
    I want to love this idea but the Nook burn concerns me, especially if they can't deduct the losses from their taxes.
     
    Thank you for your interesting idea.

    SubjectRE: RE: RE: Taxes? Nook Burn?
    Entry02/17/2014 10:37 PM
    MemberMJS27
    I admit my accounting knowledge is limited to what is required for the CFA which is not exhaustive.  To quote from the L2 accounting book, "consolidation is required when one company (the parent) has the ability to govern (control) the financial and operating policies of another company (the subsidiary).  Control is presumed to exist when the parent owns either directly or indirectly (i.e., through its subsidiaries), more than half of the voting shares of another entitiy (voting interest model).  Perhaps someone with more accounting expertise can add some insight?
     
    As for NOOK burn - apologies - when you originally asked about a capital increase I took it to mean a capital raise...
     
    Historically NOOK has been self funded.  Remember that the NOOK operating co is held at the NOOK Media level, and Nook Media is comprised of NOOK and College, so basically cash flow from College can be diverted to NOOK, but retail has been considered to be sequestered.  There is no 100% guarantee that cash from Retail will not be diverted to NOOK in the future, but management has indicated that they have no intention of doing so.  The fact that they are cutting NOOK CapEx / laying of engineers seems to provide evidence that they are trying to keep their word.... but again, there is no guarantee, so one must put their trust in the seemingly self interested owner operator and other major share holders who haven't built their careers on speculative cash consuming forays into fast moving technology.

    SubjectRE: RE: RE: RE: Taxes? Nook Burn?
    Entry02/17/2014 10:38 PM
    MemberMJS27
    just realizing that the CFA accounting quote actually pertains to IFRS, not GAAP, but GAAP is largely the same.

    SubjectRE: RE: RE: RE: RE: Taxes? Nook Burn?
    Entry02/17/2014 11:20 PM
    Membernha855
    The irs does not use gaap. It uses tax accounting. My question pertains to tax accounting, which is what ultimately causes cash tax inflows and outflows. Do you have an informed opinion as to whether or not the nook/college division can be consolidated for tax (again TAX and not GAAP) purposes?

    SubjectRE: RE: RE: RE: Taxes? Nook Burn?
    Entry02/17/2014 11:29 PM
    MemberMJS27
    Sorry, i'm realizing i should provide a touch more detail on my thinking.
     
    MSFT's original investment in the NOOK requires them to pay $60M a year for the first 3 years for licensing and pay $25M a year for the first 5 years for international content development (subject to some conditions, but so far so good)...  so figure for another year and a half NOOK gets $85M from MSFT per year.
     
    FY'13 EBITDA-CapEx at College was ~73M, so figure for this year there is ~$150 - 160M for NOOK to play with, plus any existing cash. 
     
    Management hasn't guided for what NOOK CapEx would be this year, but on one of the recent confernce calls one of the callers said something about previous management suggesting $200M in run rate CapEx for NOOK.  Present management disavowed that number and said they weren't going to talk NOOK CapEx guidance, but lets for a minute suppose it was accurate.
     
    I don't know what engineers in Silcon Valley get paid, but lets assume that salary and benefits etc cost $150k per man.  If NOOK just laid off 100 engineers that is $15M which I suspect is low b/c i'm sure some of those engineers were getting paid well more than $150k.  That gets us to $185M in potential NOOK CapEx.  Figure that other associated savings from reduced office space etc etc etc and shutting down whatever it is that they were working on saves another $10M.  That gets us to $175M in potential NOOK CapEx vs $150-160M in cash coming in from College and MSFT.  They don't split out cash btwn the segments, and NOOK Media definitely has SOME cash, but lets pretend for a minute that they don't have any and Retail has to fund $15-25M at NOOK.
     
    In this situation NOOK is still losing money so the company at the parent level is paying no taxes, which means Retail FCF is ~260M or a ~20% FCF yield on total EV.
     
    Would it be unfortunate if Retail had to shuttle some cash over to NOOK for a year or two before management was able to right size CapEx etc?  Yes, i suppose so.  But at these prices, I could live with it.
     
    To think of it another way, they haven't clearly delineated their plans for NOOK going forward, but the scuttlebutt is that they will continue on with the black and white readers, but scrap the plans for full function tablets.  Thinking back on NOOKs past CapEx what percent of it do you think went to black and white simple functions vs the full function tablets?  I have no idea, but if you told me that developing full function tablets was 10x more expensive than making black and white readers I wouldn't be shocked at all.  I think CapEx at NOOK drops sooner rather than later.

    SubjectRE: RE: RE: RE: RE: RE: Taxes? Nook Burn?
    Entry02/17/2014 11:54 PM
    MemberMJS27
    Apologies - yes for tax purposes you are of course correct regarding the 80% consoldiation threshold.  The Pearson transaction closed in December of 2012, so I would imagine that Retail will be taxed on some level in 2013.  I will try to clarification from the company.
     

    SubjectRE: RE: RE: RE: RE: Taxes? Nook Burn?
    Entry02/18/2014 12:01 AM
    MemberMJS27
    As pointed out by nha855 I may be wrong re: "In this situation NOOK is still losing money so the company at the parent level is paying no taxes, which means Retail FCF is ~260M or a ~20% FCF yield on total EV."
     
    Assuming they are taxed at 35% it would be a 15-16% FCF yield on Retail if they had to get over 25M to NOOK.
     
     

    SubjectRE: RE: RE: RE: RE: RE: RE: Taxes? Nook Burn?
    Entry02/18/2014 07:10 AM
    Membereverdeen
    I'm not super familiar with the BKS story, but the 80% rule for tax purposes only applies to domestic corporations or entities treated as such. Doesn't the Nook Media LLC agreement (exhibit to the investment agreement) specifically provide that they intend for it to be taxed as a partnership, with gains and losses flowing through directly to the members pro-rata to their interests?

    SubjectRE: RE: RE: RE: RE: Taxes? Nook Burn?
    Entry02/18/2014 09:50 AM
    Membernha855
    Is Nook capitalizing engineer salaries? Aren't there two sources of outflow - operating losses and capex? - how much total cash burn do you expect from Nook?

    SubjectRE: RE: RE: RE: RE: RE: Taxes? Nook Burn?
    Entry02/18/2014 11:18 AM
    MemberMJS27
    Sorry - i was fast and loose last night trying to quickly write answers w/o consulting notes.  
     
    On the Q1 conference call i referenced $200M was suggested as the "burn rate" for NOOK w/ no details given on CapEx vs OpEx.
     
    My (very) loose math in the previous post stands and I think that OpEx and CapEx and thus total burn will be rationalized in the not too distant future.
     
    As for putting an estimate on what it will be going forward, I don't have a number in mind, but as (very loosely) demonstrated previously, even if Retail has to move some cash to NOOK in the short term, I think the company still looks cheap.

    SubjectRE: RE: RE: RE: RE: RE: RE: Taxes? Nook Burn?
    Entry02/18/2014 12:34 PM
    Membernha855
    Very helfpul - thank you

    SubjectRE: RE: RE: RE: Congrats
    Entry02/21/2014 02:52 PM
    MemberMJS27
    I don't have any color on G Asset, but I think the proposal is good for very little other than maybe drawing a few more eye balls to the story.  With Malone, Liberty, and Tisch together owning ~51% of the company, I can't believe that an offer to take over 51% of the company for 22/share has any chance of going through.
     
    22/share drastically undervalues the company in my opinion.  I would expect the stock to drift from here, and if i were the type to trade around a position i'd be taking some off.

    Subjectquestion on segment accounting
    Entry03/05/2014 03:37 PM
    Membergb48
    I agree with the writeup and like you i see a lot of value here.
     
    a paranoid issue i am trying to do work on is the segment accounting and whether there are various inter-company allocations that make NOOK looke worse, and Retail look better. 
     
    For example, BKS Retail could be charging the NOOK segment "rent" for the in-store displays.  It could be cost-allocating in-store employee wages.  These would be totally fixed expenses that BKS Retail would incurr regardless of NOOK . If NOOK were to "go away", the costs then would get reallocated to Retail, crushing the segment profitability. 
     
    This may appropriate GAAP cost accounting for all i know, but it does cloud a sum-of-pieces analysis.
    I have no idea whether this is going on or not, just a through. Do you know?
     
    Thanks
     

    SubjectRE: question on segment accounting
    Entry03/06/2014 11:53 AM
    MemberMJS27
    Unfortunately I can't add any knowledge here.
     
    Given that over the last few years the focus of the company seems to have been to try to make NOOK look as sexy as possible, I think it would be unlikely that they would be doing something like you suggested, but there really isn't a way to know for sure that I know of.
     
    I would point out that the recent accounting headlines suggested the exact opposite of what you are worried about - ie that Nook was hiding expenses in Retail in order to make Nook look better.
     
    Additionally I would note that in the limited sample of stores I have visited the real estate allocated to NOOK is pretty limited in square feet - although in some cases I suppose it would be considered "prime."  Again, not really much help.
     
     

    Subject8k - NOOK / MSFT
    Entry03/14/2014 11:11 AM
    MemberMJS27
    On March 10, 2014, Barnes & Noble, Inc. (the “Company”) entered into an amendment (the “Amendment”) to its existing commercial agreement (the “Commercial Agreement”) between the Company and Microsoft Corporation (“Microsoft”).  Pursuant to the Amendment, NOOK Media LLC (“NOOK Media”) and Microsoft agreed to co-branding within the Microsoft Consumer Reader for reading content delivered by NOOK Media.  The Amendment also provided that subject to certain conditions NOOK Media would be permitted to discontinue distributing the NOOK Windows app and will cooperate in good faith with Microsoft to transition users to the Microsoft Consumer Reader.  Microsoft and NOOK Media also agreed to updated revenue sharing to address this possibility.  The Amendment also permits NOOK Media to cease efforts with respect to a Windows phone app.   Portions of the Amendment were redacted based upon a request for confidential treatment filed with the Securities and Exchange Commission.


    seems like a step toward BKS backing away from NOOK and letting the core business shine.  Unclear what an ultimate exit may look like, but I assume there is some dollar value to the NOOK name and the work they have done to develop content.

    SubjectLiberty reducing
    Entry04/07/2014 10:31 AM
    MemberMJS27
    A few days late here as I was travelling...
     
    BKS has traded off ~18% since Liberty announced last week they were reducing their stake by 90%.
     
    In my opinion this represents a buying opportunity.  
     
    When Liberty first got involved Malone had made comments along the lines of the Nook business being an interesting lotto ticket on top of a reasonable core business (for example http://dealbook.nytimes.com/2011/07/07/malone-explains-bet-on-barnes-noble/?_php=true&_type=blogs&_r=0).
     
    It seems clear at this point that the lotto ticket will not turn out to be a multi bagger so Malone is largely moving on, but NOOK likely still has some value, and the core business appears to have stabilized, is still producing plenty of cash flow, and has continued opportunity for margin expansion as leases roll off.
     
    I was really looking to Malone to GUARANTEE excellent capital allocation which in my view is essential in a declining business.  While the GUARANTEE may have faded a bit, Liberty will still have a board seat, and the owner operator is still strongly incentivized to concentrate on capital allocation (ie buy backs) in the near future.  Further more, his experience as a former board member of GME reinforces my belief that he will follow the playbook and buy back stock.  In summary, if Riggio acts rationally, Liberty's near exit changes nothing for BKS.

    SubjectRiggio reducing
    Entry04/17/2014 10:46 AM
    MemberMJS27
    Chairman / founder Len Riggio sold $64M of stock, reducing his stake to 20%.  He is 73 years old and issued a statement that the sale was for long term financial and estate planning purposes.  As a reminder he sold stock in December and said it was to harvest the tax loss vs other capital gains.  The tax loss harvesting seems to make sense.  This is somewhat more alarming.
     
    I still think the cash flow story on the core business side is intact, I still NOOK and college have some value, but it does not inspire confidence to see Malone and Riggio dumping stock.

    Subjectupdated thoughts / portfolio management
    Entry04/17/2014 01:58 PM
    MemberMJS27
    at the risk of being promotional, i want to point out that the core business here is now now trading at an ~18.5% FCF yield... vs BBY at 6.4%.

    A 13% FCF yield gets you to a $29 stock.  plus college is worth something, and NOOK is probably worth something.
     
    Since the original write up the following has changed:  Malone greatly reduced his stake, Riggio reduced his stake, and the company appears to have made moves to distance itself further from cash burn at NOOK.
     
    Thoughts on Malone: I definitely felt warmer and fuzzier with Malone having a major stake, but I don't think him reducing his position changes the real story at all.  It is well known that Malone is refocusing on cable and likely feels that he has better ways to deploy the capital.  Liberty is retaining a board seat, and will likely be a voice of reason when it comes time to allocate capital (ie buy backs).  Furthermore, SOMEONE bought the 16% that Malone sold.  It is not certain who at this point, but that SOMEONE could be a potential buyer etc in the future.  If the potential for buybacks is reduced, i note that i didn't account for any impact from buybacks in the original valuation anyway.
     
    Thoughts on Riggio:  Obviously you never like to see a key player (let alone 2) unloading shares.  Riggio has previously made tax loss sales vs stock that had a $30+ cost basis.  Its not clear yet what his cost basis on these shares is, but it is certainly possible this transaction just makes financial sense.  Riggio is in his 70s, has 3 daughters (i believe all younger - like in their 30s but i could be wrong) and none of them seem to have an interest in the business.  Additionally, Riggio is a well known philanthropist and would likley prefer to bequeath cash rather than stock in a company whose long term future is unknown
     
    Thoughts on NOOK:  Distancing themselves from NOOK is likely the right move and I consider this to be a positive.  The time frame on an eventual 

    The media reaction to all of this is along the lines of "death of books," "revenue continues to decline," "no future without NOOK."  I think the media fails to realize that a decline  in revenue has nothing to do with a decline in cash flow assuming the cost structure is appropriately adjusted.  EBITDA at retail has grown nicely in recent years, and is likely to continue growing in the future as sales have stabilized (for the time being), and 30% of store leases are up in the next 2 years providing ample opportunity to close under performers.  At the same time, CapEx will continue to decline, meaning FCF should stay relatively stable if not grow.

    Yes it is entirely possible that Malone and Riggio see something coming the pipe that I am blind to, but it seems like whatever it is priced in and then some at these levels.


    **************************************************************************
    On a side note (and this is probably better as a side topic), I now have seen 2 good size positions (i generally hold 12-15 positions, so everything is "good sized") which had nice gains (35%-50%) inside of 4-5 months since purchase  give up most of those gains in the last 2 weeks.  I did not lock in gains on a single share in either position.  I don't have a problem stomaching the volatility as I still believe in the bigger picture in both cases, but my short term performance would have certainly benefitted from locking in some gains and reloading at lower prices.  I realize that short term performance is meaningless (unless you have LPs or are thinking about taking on LPs).  

    If anyone has opinions on portfolio rules or guidelines they adhere to, I would love to hear them.  For background, i am not a professional investor and do not have LPs - i'm just a guy with a link to sec.gov - so the volatility really isn't a problem.  I am aware of the numerous studies demonstrating that lower turnover generally produces better returns over time, but I am also aware that as someone who can sell w/ ~0 market impact it might not be the worst idea to lock it in when i can.  One problem I do have is that looking for new ideas is not my full time job, so selling positions for me basically means just sitting in cash and i already maintain a sizeable cash balance.

    other thoughts:  I remember reading that Mike Burry had a hard rule that he sold 50% of a position no matter what if it went up 50% in 6 months.  Thoughts on this?  

    Mohnish Pabrai - only selling when a stock hits 90% of intrinsic value (ie doesnt' really scale out)  thoughts on this?

    Greenblatt - take advantage of small size (i read this in his class notes from CBS, but there isn't really any context - ie curious if he meant take advantage of being able to jump in and out?  that seems to be in contrast to his theme of stomaching the volatility) thoughts on this?

    thanks for any and all insight and opinions.

     


    SubjectRE: updated thoughts / portfolio management
    Entry04/17/2014 02:16 PM
    Memberaagold
    I think I discussed this in a side topic thread, but I believe there's no logic *at all* to rules like "sell 50% when you're up 50% in 6 months".  Your portfolio should always consist of the securities you believe have the best profile of expected *future* return and risk of permanent capital loss relative to *current* price.  Neither *future* return nor risk of loss relative to *current* price has anything whatsoever to do with what price you initially paid for the security.
     
    - aagold
     

    SubjectRE: RE: updated thoughts / portfolio management
    Entry04/17/2014 02:58 PM
    MemberMJS27
    you did say something like that in the "what to do with new money" thread that i started.

    i'm not sure its as simple as that though.  

    for starters there is plenty of research tied to the negative effects of selling winners too fast...  

    and on the other hand the third dimension here in addition to current price and target price is of course time.  I am by no means a technical trader, but if a stock rips very quickly based only on multiple expansion, i think it is more likely that those short term gains will be given up at some point.... meaning that maybe it does make sense to take some stock off the table even if you think it is still significantly undervalued.  in other words, with BKS, it ripped more than 50% in just a few months, but when it was at $22 i still thought it was significantly under valued vs where it will be in 2 years so i didn't sell any.  this is the right thing to do by your logic (and i tend to agree with you) but in hindsight i would have been better selling a stock that was still ~50% unvalued in my mind and rolling into something that was say maybe only 30% undervalued.

    obviously there is no right answer here and hindsight is a wicked companion.

     the way i'm thinking about it now is that i basically classify ideas as compounders or special situations.  there is obviously a grey area as well, and I think BKS falls into the gray area but closer to the speical sits side.

    With compounders - ie the intrinsic value is going to just continue to grow and grow - i am more inclined to stick with the mohnish pabrai school and only sell when you hit 90% of IV.  If you don't trim your position along the way that is fine, b/c IV is continuing to grow.

    With special situations, the intrinsic value of the business is not necessarily going to grow and grow - for example with BKS, i think the IV per share will likely grow through buy backs, but the IV of the business will likely continue to shrink.  The question becomes which will happen faster.  In this case my belief is that it will be the IV per share, however the margin of safety on this is certainly lower than what you would get on a stock that will see IV per share grow as well as a business that sees IV grow.  As such I am more inclined to take profits more quickly in special situations (or at least i will be in the future... unfortunately i was not thinking that a month ago when the 2 stocks in question were much higher than they are now.)

    other opinions appreciated

    SubjectRE: RE: updated thoughts / portfolio management
    Entry04/18/2014 12:00 AM
    Memberaagold
    Interestingly, the idea that your personal purchase price should be irrelevant to your trading decision holds even if you believe in momentum, technical analysis, sunspots, or any other theory about future stock price movements.  Even if any or all of those things determine which direction the stock is going to move tomorrow, one thing that cannot possibly affect it is your *personal* purchase price.  That's different for every investor, whereas the future stock price movements are the same for all investors.
     
    Let's take your example of a stock that's moved up too far too soon (i.e., it becomes overbought) without a significant improvement in fundamentals.  You're saying it might make sense to sell part of your position and move money into a second stock, even if the first stock is still more undervalued than the second.  Well, even if you *that* trading strategy is a good one, notice something important: it has nothing to do with what price you personally paid for the stock.  That is, a determination that the stock "ripped by more than 50% in just a few months" has nothing to do with your purchase price.
     
    - aagold
     

    SubjectRE: RE: updated thoughts / portfolio management
    Entry04/18/2014 10:37 AM
    Memberstraw1023
    if you are tax-sensitive, then your purchase price and purchase timing are important. In the absence of taxes (and some perverse social pressure), then purchase price is irrelevant.
     
    In general, in the absence of (a) taxes, (b) transaction costs, and (c) costs to remain perfectly updated on the information flow and valuations, then the optimal answer is you should be rebalancing portfolio constantly as prices change and the information set changes. This should be pretty obvious from basic calculus since all the math functions in the optimization problem are "smooth." Anytime you have a smooth objective function, any change in circumstance requires a change in optimal response.
     
    However, back to the real world . . . given that there may be taxes and there certainly are transaction costs and most importantly, remaining perfectly updated is costly and not the best use of time, the problem becomes much more complex. This is why there are all these (frequently conflicting) rules of thumb. What rule of thumb is correct for you is going to depend on your specific circumstances with respect to taxes, transaction costs, and opportunity costs to remain updated. The more of each of these, the less likely you should be rebalancing.
     
    --------------
     
    On your point about a couple of your stocks retreating, I am guessing that this has been a horrible month for event-driven/value-based/hedge-fund-held/small-cap stocks. There has been some bad news (BKS) but most of it appears to be domino effect from the momo tech beatdown (see Tiger Cubs). AGYS is a good example. On no company-specific news and no relevant industry/macro news that I could discern, the stock's TEV dropped 30%. 
     
    It will be interesting to see if this pain causes further selling or whether these stocks will bounce back. I see lots of long VIC ideas that are compelling after getting hit hard over past few weeks.
     
     

    SubjectRE: RE: updated thoughts / portfolio management
    Entry04/18/2014 11:00 AM
    Memberaagold
    Yes, I should have mentioned that in a taxable account it is rational to consider purchase price, but actually the way it ought to affect trading decisions is the *opposite* of how people normally think about it.  In this example of BKS that MJS27 discussed, he thinks maybe he should have sold some quickly because of his *short-term* unrealized capital gain, which is a trading strategy that's not only based on purchase price, but is also particularly tax *inefficient*.
     
    - aagold
     
     

    SubjectBKS to spin off Nook
    Entry06/25/2014 09:19 AM
    MemberMJS27
    http://online.wsj.com/articles/barnes-noble-to-split-into-two-companies-1403699838
     
    seperation expected to be complete by Q1'15

    Subjectany updated thoughts after the most recent earnings?
    Entry12/10/2014 01:15 AM
    Membermrsox977

    this has been a solid idea


    SubjectRe: any updated thoughts after the most recent earnings?
    Entry12/10/2014 05:25 PM
    MemberMJS27

    Hi mrsox

    I honestly don't really have much to add.  the thesis was that the core business is a cash cow, and it would be revealed at some point through a spin off or shut down of the money losing Nook segment.  That thesis seems to be on track.

    I have to admit i was surprised by the recent announcement that BKS bought out MSFT - I really didn't even consider that as a possibility, and I don't have a great grasp on what that does in terms of opening up strategic options, although the chattering classes seem to think it is a positive (makes the business more saleable, etc).

    On one hand I really don't care because I continue to think that the core business is worth north of $30 in a slow bleed situation (depending on how you play with leverage and buybacks you can get it north of $35 easily).

    On the other hand, given the capable capital allocator at the healm and the owner/operator set up I am hopeful that the MSFT transaction will prove to be value accretive to the Nook/College segment. At this point I more look at this piece of the business as part of the margin of safety rather than as something of value however.  Hopefully we will get more clarity here soon. 

    Sorry I don't have more to add... from the beginning it was a "big picture" investment, and it still is in my view.


    SubjectRe: Re: college spin
    Entry02/27/2015 11:45 AM
    MemberMJS27

    S-1 http://www.sec.gov/Archives/edgar/data/1634117/000119312515064273/0001193125-15-064273-index.htm

    under Barnes and Noble Education.

    The Chegg comment was a joke - Barnes and Noble College is largely a physical business... however, they are developing Yuzu, which is in the Chegg model.  I have no idea how to value stuff like this, but I do know that at times people go crazy and put huge valuations on stuff like this so who knows.  certainly not base case however.

    I too was surprised to see that they were spinning college and keeping NOOK.  To be honest, i'm still not sure what to make of it. My assumption - which I have not looked into yet - is that the NOLs are attached to NOOK and can thus be used to shield FCF from the retail stores.

    Sticking with your assertion that college is worth at most 6x EBITDA, that means college is worth somewhere between $425 - $640ish million (4-6x avg EBITDA from the last few years) with a lotto ticket that crazy people might get fired up about Yuzu.

    At the high end, that gives you the retail + NOOK business at less than 5x EBITDA.  NOOK remains a question mark obviously, but with sales trends at BKS looking ok and BBY at 7x EBITDA, i'm ok with saying that BKS should trade at 6x EBITDA (numbers are fuzzy here b/c its not clear what cash will look like post the holiday season, and its not clear if spin-co will dividend some cash up to retail etc).

    Anyway - that might not seem like much of a margin of safety, but retail is essentially unlevered, the CEO is a malone guy, Liberty maintains a board seat, and Riggio knows the buyback playbook as evidenced by GME, which was spun off from BKS a few years ago. Putting a turn or 2 of leverage on this highly cash generative business allows you to buy back 30 or 40% of the stock in short order.... so consider that a lottery ticket as well.

     


    SubjectRe: Re: Re: college spin
    Entry02/27/2015 11:58 AM
    MemberMJS27

    *Retail and NOOK at less that 4x Retail EBITDA

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