BARNES & NOBLE INC BKS
April 22, 2012 - 3:45pm EST by
Rotin
2012 2013
Price: 11.34 EPS -$1.31 -$1.44
Shares Out. (in M): 60 P/E NA NA
Market Cap (in $M): 682 P/FCF NA NA
Net Debt (in $M): 428 EBIT -44 -98
TEV ($): 1,414 TEV/EBIT NA NA

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  • Sum Of The Parts (SOTP)
  • Potential Spin-Off
 

Description

LONG Barnes & Noble (BKS)

Price: $11

Market Cap (fd): $800 mm

Enterprise Value: $1.3 b

Average Daily Volume: $17 mm

 

Thesis

 

BKS is a long because it has an under-appreciated asset in the Nook eReader platform, whose value will be illuminated through a partial sale of that business segment in 2012. We believe a conservative sum of the parts valuation for BKS is $11/share for the existing Retail and College bookstores and $26/share for the Nook resulting in a $37 sum of the parts valuation or 230% upside.

 

 

Business Description

 

BKS is 3 distinct businesses: 1) the 700 Retail bookstores that carry the Barnes & Noble brand name  2) the college bookstore business which operates campus bookstores at 640 different colleges and  3) the Nook eReader platform which sells the devices and digital content and will generate $1.5 b in platform sales in FY12 (FY ending in April).

 

The Retail bookstore is a dying business as we shift from physical to digital online purchasing of physical. We estimate underlying SSS are declining ~7% annually. However, due to the liquidation of Borders and downsizing of selling square feet for physical books at WalMart and Target, actual SSS will be positive 1$ in FY12 and flat in FY13. EBITDA in FY12 will be $325 mm (or ~$294 mm excluding the Nook EBITDA that is accounted for in the Retail segment) and flat in FY13. Importantly, we believe there is significant value in the retail bookstores because their leases are increasingly becoming more short term (average duration of the portfolio is ~2-3 years) allowing for significant flexibility (and minimal friction costs) in downsizing the store base as 4-wall profit contribution turns negative. BKS is closing 20-30 stores annually or 3-4% of their store base.

 

The College bookstore is a much better business than Retail. The majority of what is sold in a campus bookstore is not trade books, but rather textbooks and college paraphernalia. SSS and EBITDA are stable ($124 mm of EBITDA in FY12). BKS operates the store on behalf of the school; BKS pays a % of revenues as rent so if sales decline the rent payments decline as well. In addition, there is flexibility to adjust the rent payment % or terminate a management contract on 60 days’ notice should a store become unprofitable.

 

The Nook eReader is the hidden asset of BKS. Nook is the #2 player in the eBook market with 25% market share behind Amazon at 65% markets share (iPad, Kobo, and others share the remaining 10%). Nook went from a standing start in 2009 to 25% market share by leveraging their 700 physical retail stores to sell the Nook to a predominantly women audience who value the in-store customer support. Nook has grown from nothing in FY10 to $900 mm of platform sales in FY 11 to an expected $1.5 b in FY 12 (ending 4/12). While Nook currently loses money (~$250 mm in FY12) given the large R&D and marketing budget, we believe this platform has real value due to a rapidly growing market (50% expected CAGR for the next 3 years) and customer stickiness that should result in Nook maintaining its market share. We expect a positive inflection point in profitability by CY14.  

 

 

Short Thesis & Our Variant View

 

There are 17 mm shares sold short which is 29% of the shares outstanding. Many smart investors do not agree with our bullish view on BKS. Below we lay out the short thesis and our variant view.

 

Short Thesis: Bookstores are a dying business

Variant View: We agree! However, that does not mean that the bookstore business is worthless. First, 1/3rd of the EBITDA of the bookstores comes from the College Bookstore business which is NOT dying but rather is a stable business that does not face the same secular headwinds the Retail bookstores have. We value College at 4.5x EBITDA for a $500 mm valuation. For the Retail bookstores, because of the short lease length, there is minimal friction costs as they wind down the business. We run a DCF of the Retail bookstores that assumes a hard run-down of the business and come to a valuation of $780 mm which is 3.0x EBITDA. As a reference point, BBY, another secularly challenged retailer, trades at 3.0x EBITDA.

 

Short Thesis: BKS is losing money… there is no margin of safety to make a valuation case on.

Variant View: You cannot look at BKS on a consolidated basis. The bookstores are quite profitable, but the cash flow is being reinvested into growing Nook market share while the eBook industry is still in its infancy and sticky customer relationships are being formed. If for whatever reason the Nook failed and was shut down you would still have the profitable bookstores. If you shut down the Nook, BKS would be trading at 3.5x EBITDA.

 

Short Thesis: Nook is not worth much because it is losing money and has deep-pocketed competitors.

Variant View: The argument that there is fierce competition in the eBook space is as true today as it was in 2010 when AMZN had ~100% market share. This did not prevent Nook from going from 0% market share to 25% in 2 years. The physical retail store presence is a large competitive advantage for the Nook that BKS has been able to leverage to grab share in this fast growing market. You do not need to assume further share gains in this fast growing market for the Nook to be worth a lot of money as a separate company or as a partner to a strategic investor.

 

Short Thesis: the recent anti-trust lawsuit and partial settlement over eBook price-fixing means that AMZN will be able to sell eBooks at a loss and drive out the competition (mainly the Nook).

Variant View: the anti-trust settlement is clearly not a positive and introduces uncertainty over the next 6 months in terms of how the eBook pricing regime will evolve. 3 of the big 5 publishers which represent ~30% of trade books have agreed to it, while Apple and the other publishers are going to fight it out However, the conclusion that AMZN will pursue a scorched earth pricing strategy and successfully destroy the competition is misguided. A key industry dynamic that is critical to understand is that the publishers despise AMZN because of their attempt to cause eBook price deflation while also trying to dis-intermediate the publishers with their own in-house publishing effort. Read Jeff Bezos’ annual letter where he spent half of the entire letter talking about their publishing business, then think about what your reaction would be if you are a publisher. Because of this antagonistic relationship, the publishers are hell-bent on ensuring that there are several healthy customers, primarily BKS as the last physical bookstore of scale as well as the biggest competitor to AMZN in eBooks. This was the entire reason for forcing agency pricing scheme in the first place; to level the playing field for new entrants. The publishers will be doing everything possible to ensure that BKS is a healthy competitor that can serve as a governor on AMZN’s potential to destroy the traditional publishing business. In what form this support for BKS and other competitors is still uncertain, but as an example, there is a specific clause in the anti-trust settlement agreement that expressly allows a publisher to support bricks and mortar stores (ie BKS) with promotional and marketing dollars.

 

 

Financials & Valuation

 

We arrive at a $37 sum of the parts valuation for BKS by using our CY12 estimates and putting 3.0x EBITDA on Retail, 4.5x EBITDA on College, and 1.0x platform sales on Nook. From this $3.3 b EV we subtract net debt and pension of $240 mm, deferred rent of $160 mm, and our estimate of Nook losses until breakeven after-tax of $200 mm. This arrives at an equity value of $2.7 b or $37/share after fully-diluting the shares outstanding to 72 mm due to the Liberty Media convertible preferred.

 

Obviously the most contentious part of this valuation is what the Nook is worth. It’s not worth zero just because they are currently spending through the opex line to grab market share in a rapidly growing space. We think 1.0x sales is conservative if it were to trade to a strategic or be IPO’d. There are no great comps but we found several data points that we think are relevant: 1) Kobo is a smaller ($100 mm of sales) eReader platform that was sold to Rakuten in Japan for 3.0x sales  2)  NFLX traded as low as 1.0x sales when it was at $70 and the world thought the company was unprofitable and in a death spiral  3) LXK is priced to go out of business at 7x EPS and 0.5x sales. Additionally our conversations with bankers and cap markets suggest 1.0x would be conservative; rather, 2-3x sales could be on the table if properly marketed. Every ½ turn of sales is worth $13/share. 

 

Another way to frame the valuation is to think about what you are currently paying for the Nook at the current BKS price of $11/share. We think the core business ex-Nook is worth $11/share which means you are paying nothing for the Nook today. That strikes us as a particularly asymmetric risk/reward.

 

 

Management & Board

 

Management and the board are an important element of the story to BKS.

 

Len Riggio is the founder of BKS and owns 30% of the shares out. He has created a lot of shareholder value over time through the success of the Barnes & Noble concept, the acquisition and growth followed by a spin-off of Game Stop, the IPO of B&N.com during the tech bubble followed by its buy-in post the bubble, and now the successful ramp of the #2 eReader platform which will be partially monetized this year. He made what must have been an excruciatingly hard decision to take all the cash flow the bookstores generated for the last 2 years and invest it in the Nook start-up which will speed up the disintermediation of his core bookstore business. Not many management teams can destroy a sacred cow like this (ie Borders).

 

John Malone via Liberty Media has a $200 mm convertible preferred that they completed in the Fall of 2011 that converts to 16% of the fully diluted shares at $17/share. Note that this preferred investment followed a terminated sale process where Liberty bid $17 for the entire company in May 2011. We believe the sale process was not terminated because Liberty found something they didn’t like but rather that the financing package that was offered to Liberty was pulled in the market melt-down in the summer. Liberty has 2 board seats (Greg Maffei & Mark Carleton). Malone has one of the best track records in the media business and we take his involvement in BKS seriously. We do not think it was a coincidence that only 4 months after the Liberty investment the company announced their intention to monetize a portion of the Nook business. Trackers, spins, and financial engineering that create shareholder value is vintage Liberty Media.

 

Mike Huseby was recently hired as the CFO of BKS which we think is another confirmatory data point to the Nook monetization thesis. Huseby was previously the CFO of Cablevision where he had extensive experience with trackers, spin-offs, leverage, share shrink, and MBO’s.

 

 

Risks

 

The biggest risk to our investment thesis is the future of the Nook and the execution of the Nook monetization. We could be wrong on the industry dynamics and Nook’s competitive positioning vs. AMZN. The market doesn’t give BKS credit for the Nook value today and without an event to illuminate the perceived value it is unlikely that the market will change its mind for the foreseeable future.

 

The Retail bookstores could decline faster than we expect and our DCF value could be optimistic.

 

The College bookstores could be less stable than we believe, most likely due to incremental pressure from digital textbook substitution. We think digital textbook disintermediation for college-level students is still several years out and even then will have a slow adoption curve.

 

Len Riggio has a mixed track record on corporate governance. Many investors believe the sale of College bookstores to BKS was not done on an arms-length basis. BKS also adopted a poison pill to fend off Ron Burkle in 2010. We are not concerned about this risk given Liberty’s involvement on the board.  

 

 

Catalyst

The key catalyst is the monetization of the Nook. BKS announced strategic alternatives for the Nook in January and we believe there is a parallel process being run now to investigate potential strategic interest as well as prepare for a partial IPO of the Nook.

 

A secondary catalyst is separate segment financial reporting for the Nook which we expect in June on the Q4 earnings release. This will allow the market to more clearly understand the cash flows from the Bookstores vs. the Nook, which currently is jumbled into both the Retail segment as well as the B&N.com segment. We expect to see more SoP analysis from the sell side following this disclosure.

 

While we aren’t expecting it, we could see a potential bid for BKS from Liberty Media & Len Riggio again. They made an offer to buy BKS at $17 in May 2011 that we believe was pulled due to the credit markets falling apart that summer. Given the credit markets have now recovered to frothy levels we believe the original financing plan is now viable again (4x debt/EBITDA).

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    Description

    LONG Barnes & Noble (BKS)

    Price: $11

    Market Cap (fd): $800 mm

    Enterprise Value: $1.3 b

    Average Daily Volume: $17 mm

     

    Thesis

     

    BKS is a long because it has an under-appreciated asset in the Nook eReader platform, whose value will be illuminated through a partial sale of that business segment in 2012. We believe a conservative sum of the parts valuation for BKS is $11/share for the existing Retail and College bookstores and $26/share for the Nook resulting in a $37 sum of the parts valuation or 230% upside.

     

     

    Business Description

     

    BKS is 3 distinct businesses: 1) the 700 Retail bookstores that carry the Barnes & Noble brand name  2) the college bookstore business which operates campus bookstores at 640 different colleges and  3) the Nook eReader platform which sells the devices and digital content and will generate $1.5 b in platform sales in FY12 (FY ending in April).

     

    The Retail bookstore is a dying business as we shift from physical to digital online purchasing of physical. We estimate underlying SSS are declining ~7% annually. However, due to the liquidation of Borders and downsizing of selling square feet for physical books at WalMart and Target, actual SSS will be positive 1$ in FY12 and flat in FY13. EBITDA in FY12 will be $325 mm (or ~$294 mm excluding the Nook EBITDA that is accounted for in the Retail segment) and flat in FY13. Importantly, we believe there is significant value in the retail bookstores because their leases are increasingly becoming more short term (average duration of the portfolio is ~2-3 years) allowing for significant flexibility (and minimal friction costs) in downsizing the store base as 4-wall profit contribution turns negative. BKS is closing 20-30 stores annually or 3-4% of their store base.

     

    The College bookstore is a much better business than Retail. The majority of what is sold in a campus bookstore is not trade books, but rather textbooks and college paraphernalia. SSS and EBITDA are stable ($124 mm of EBITDA in FY12). BKS operates the store on behalf of the school; BKS pays a % of revenues as rent so if sales decline the rent payments decline as well. In addition, there is flexibility to adjust the rent payment % or terminate a management contract on 60 days’ notice should a store become unprofitable.

     

    The Nook eReader is the hidden asset of BKS. Nook is the #2 player in the eBook market with 25% market share behind Amazon at 65% markets share (iPad, Kobo, and others share the remaining 10%). Nook went from a standing start in 2009 to 25% market share by leveraging their 700 physical retail stores to sell the Nook to a predominantly women audience who value the in-store customer support. Nook has grown from nothing in FY10 to $900 mm of platform sales in FY 11 to an expected $1.5 b in FY 12 (ending 4/12). While Nook currently loses money (~$250 mm in FY12) given the large R&D and marketing budget, we believe this platform has real value due to a rapidly growing market (50% expected CAGR for the next 3 years) and customer stickiness that should result in Nook maintaining its market share. We expect a positive inflection point in profitability by CY14.  

     

     

    Short Thesis & Our Variant View

     

    There are 17 mm shares sold short which is 29% of the shares outstanding. Many smart investors do not agree with our bullish view on BKS. Below we lay out the short thesis and our variant view.

     

    Short Thesis: Bookstores are a dying business

    Variant View: We agree! However, that does not mean that the bookstore business is worthless. First, 1/3rd of the EBITDA of the bookstores comes from the College Bookstore business which is NOT dying but rather is a stable business that does not face the same secular headwinds the Retail bookstores have. We value College at 4.5x EBITDA for a $500 mm valuation. For the Retail bookstores, because of the short lease length, there is minimal friction costs as they wind down the business. We run a DCF of the Retail bookstores that assumes a hard run-down of the business and come to a valuation of $780 mm which is 3.0x EBITDA. As a reference point, BBY, another secularly challenged retailer, trades at 3.0x EBITDA.

     

    Short Thesis: BKS is losing money… there is no margin of safety to make a valuation case on.

    Variant View: You cannot look at BKS on a consolidated basis. The bookstores are quite profitable, but the cash flow is being reinvested into growing Nook market share while the eBook industry is still in its infancy and sticky customer relationships are being formed. If for whatever reason the Nook failed and was shut down you would still have the profitable bookstores. If you shut down the Nook, BKS would be trading at 3.5x EBITDA.

     

    Short Thesis: Nook is not worth much because it is losing money and has deep-pocketed competitors.

    Variant View: The argument that there is fierce competition in the eBook space is as true today as it was in 2010 when AMZN had ~100% market share. This did not prevent Nook from going from 0% market share to 25% in 2 years. The physical retail store presence is a large competitive advantage for the Nook that BKS has been able to leverage to grab share in this fast growing market. You do not need to assume further share gains in this fast growing market for the Nook to be worth a lot of money as a separate company or as a partner to a strategic investor.

     

    Short Thesis: the recent anti-trust lawsuit and partial settlement over eBook price-fixing means that AMZN will be able to sell eBooks at a loss and drive out the competition (mainly the Nook).

    Variant View: the anti-trust settlement is clearly not a positive and introduces uncertainty over the next 6 months in terms of how the eBook pricing regime will evolve. 3 of the big 5 publishers which represent ~30% of trade books have agreed to it, while Apple and the other publishers are going to fight it out However, the conclusion that AMZN will pursue a scorched earth pricing strategy and successfully destroy the competition is misguided. A key industry dynamic that is critical to understand is that the publishers despise AMZN because of their attempt to cause eBook price deflation while also trying to dis-intermediate the publishers with their own in-house publishing effort. Read Jeff Bezos’ annual letter where he spent half of the entire letter talking about their publishing business, then think about what your reaction would be if you are a publisher. Because of this antagonistic relationship, the publishers are hell-bent on ensuring that there are several healthy customers, primarily BKS as the last physical bookstore of scale as well as the biggest competitor to AMZN in eBooks. This was the entire reason for forcing agency pricing scheme in the first place; to level the playing field for new entrants. The publishers will be doing everything possible to ensure that BKS is a healthy competitor that can serve as a governor on AMZN’s potential to destroy the traditional publishing business. In what form this support for BKS and other competitors is still uncertain, but as an example, there is a specific clause in the anti-trust settlement agreement that expressly allows a publisher to support bricks and mortar stores (ie BKS) with promotional and marketing dollars.

     

     

    Financials & Valuation

     

    We arrive at a $37 sum of the parts valuation for BKS by using our CY12 estimates and putting 3.0x EBITDA on Retail, 4.5x EBITDA on College, and 1.0x platform sales on Nook. From this $3.3 b EV we subtract net debt and pension of $240 mm, deferred rent of $160 mm, and our estimate of Nook losses until breakeven after-tax of $200 mm. This arrives at an equity value of $2.7 b or $37/share after fully-diluting the shares outstanding to 72 mm due to the Liberty Media convertible preferred.

     

    Obviously the most contentious part of this valuation is what the Nook is worth. It’s not worth zero just because they are currently spending through the opex line to grab market share in a rapidly growing space. We think 1.0x sales is conservative if it were to trade to a strategic or be IPO’d. There are no great comps but we found several data points that we think are relevant: 1) Kobo is a smaller ($100 mm of sales) eReader platform that was sold to Rakuten in Japan for 3.0x sales  2)  NFLX traded as low as 1.0x sales when it was at $70 and the world thought the company was unprofitable and in a death spiral  3) LXK is priced to go out of business at 7x EPS and 0.5x sales. Additionally our conversations with bankers and cap markets suggest 1.0x would be conservative; rather, 2-3x sales could be on the table if properly marketed. Every ½ turn of sales is worth $13/share. 

     

    Another way to frame the valuation is to think about what you are currently paying for the Nook at the current BKS price of $11/share. We think the core business ex-Nook is worth $11/share which means you are paying nothing for the Nook today. That strikes us as a particularly asymmetric risk/reward.

     

     

    Management & Board

     

    Management and the board are an important element of the story to BKS.

     

    Len Riggio is the founder of BKS and owns 30% of the shares out. He has created a lot of shareholder value over time through the success of the Barnes & Noble concept, the acquisition and growth followed by a spin-off of Game Stop, the IPO of B&N.com during the tech bubble followed by its buy-in post the bubble, and now the successful ramp of the #2 eReader platform which will be partially monetized this year. He made what must have been an excruciatingly hard decision to take all the cash flow the bookstores generated for the last 2 years and invest it in the Nook start-up which will speed up the disintermediation of his core bookstore business. Not many management teams can destroy a sacred cow like this (ie Borders).

     

    John Malone via Liberty Media has a $200 mm convertible preferred that they completed in the Fall of 2011 that converts to 16% of the fully diluted shares at $17/share. Note that this preferred investment followed a terminated sale process where Liberty bid $17 for the entire company in May 2011. We believe the sale process was not terminated because Liberty found something they didn’t like but rather that the financing package that was offered to Liberty was pulled in the market melt-down in the summer. Liberty has 2 board seats (Greg Maffei & Mark Carleton). Malone has one of the best track records in the media business and we take his involvement in BKS seriously. We do not think it was a coincidence that only 4 months after the Liberty investment the company announced their intention to monetize a portion of the Nook business. Trackers, spins, and financial engineering that create shareholder value is vintage Liberty Media.

     

    Mike Huseby was recently hired as the CFO of BKS which we think is another confirmatory data point to the Nook monetization thesis. Huseby was previously the CFO of Cablevision where he had extensive experience with trackers, spin-offs, leverage, share shrink, and MBO’s.

     

     

    Risks

     

    The biggest risk to our investment thesis is the future of the Nook and the execution of the Nook monetization. We could be wrong on the industry dynamics and Nook’s competitive positioning vs. AMZN. The market doesn’t give BKS credit for the Nook value today and without an event to illuminate the perceived value it is unlikely that the market will change its mind for the foreseeable future.

     

    The Retail bookstores could decline faster than we expect and our DCF value could be optimistic.

     

    The College bookstores could be less stable than we believe, most likely due to incremental pressure from digital textbook substitution. We think digital textbook disintermediation for college-level students is still several years out and even then will have a slow adoption curve.

     

    Len Riggio has a mixed track record on corporate governance. Many investors believe the sale of College bookstores to BKS was not done on an arms-length basis. BKS also adopted a poison pill to fend off Ron Burkle in 2010. We are not concerned about this risk given Liberty’s involvement on the board.  

     

     

    Catalyst

    The key catalyst is the monetization of the Nook. BKS announced strategic alternatives for the Nook in January and we believe there is a parallel process being run now to investigate potential strategic interest as well as prepare for a partial IPO of the Nook.

     

    A secondary catalyst is separate segment financial reporting for the Nook which we expect in June on the Q4 earnings release. This will allow the market to more clearly understand the cash flows from the Bookstores vs. the Nook, which currently is jumbled into both the Retail segment as well as the B&N.com segment. We expect to see more SoP analysis from the sell side following this disclosure.

     

    While we aren’t expecting it, we could see a potential bid for BKS from Liberty Media & Len Riggio again. They made an offer to buy BKS at $17 in May 2011 that we believe was pulled due to the credit markets falling apart that summer. Given the credit markets have now recovered to frothy levels we believe the original financing plan is now viable again (4x debt/EBITDA).

    Messages


    SubjectDisagree.
    Entry04/22/2012 10:37 PM
    Memberruby831

    I argue the long and short thesis on BKS is more nuanced than your write-up suggests – BKS is more (or ‘less’) than just a dying business:

    Regarding Nook valuation:

    -       The valuation based on $1.5bn-sales is one of a number of ways to value the asset. I think the company’s revenue reporting policy has distorted how analysts have measured the value. According to BKS press release dated 2/21/2012 states, “The consolidated NOOK business is expected to generate approximately $1.5 billion in comparable sales this fiscal year.” BKS then says, “BN.com and NOOK comparable sales reflect the actual selling price for eBooks sold under the agency model rather than solely the commission received. Additionally, it includes all deferred eReader device revenues, and includes device sales to channel partners on a “sell-in” basis net of estimated returns.”

    -       Since publishers get 70% of revenue and BKS gets 30%, I would argue you should apply a multiple to $450mm (30% x $1,500) rather than the grossed up $1,500

    -       Revenue includes deferred eReader device revenues and revenues BKS estimates based on its own estimated returns on devices sold through its channel partners. I would argue this portion of the revenue deserves a lower multiple. The revenue is not a sure thing, and I consider the accounting policy aggressive

    -       You cite market share figures for eReader devices. Are eReaders losing popularity in favor of tablets with eReader capabilities? BKS has a ~3% share in the tablet market and is facing heavy competition. BKS Nook eReader did very well initially, but the influx of competitors changed the landscape. BKS noted the decline in its Holiday sales results press release dated 1/5/2012: “Although Barnes & Noble was the first to the market with a revolutionary color eReader and has since introduced NOOK Tablet, which has exceeded expectations, the Company over-anticipated the growth in consumer demand for single purpose black-and-white reading devices this holiday.” BKS has held up market share in eReader space well – but that’s now in a market where competitors have moved towards tablets instead of eReader product development.

    -       The Kobo read-across is not apples-to-apples in my opinion. First, Kobo was purchased by Rakuten for deployment in areas where BKS and AMZN are not strong – Japan primarily, plus Singapore, UK, Australia, New Zealand, and Canada. Second, the transaction occurred when consumers favored eReader devices, before wider adoption of multimedia tablets like Kindle Fire, iPad, Nook Color, etc.

    -       Do you think the customer stickiness related to Nook is valuable now that customers can access the Nook library on virtually any device with the Nook app? If I previously owned a Nook but decided I wanted to read on an iPad for example, I can still access my library. Does the app risk pushing the Nook device to obsolescence?

    -       Perhaps most importantly, I have had trouble valuing the Nook business partly because I don’t think it could be shut down as easily as many suggest. The company still has the website business, bn.com, which has had very significant cash losses forever – while it was public, while it was part of the BKS corporate structure, all before the Nook existed. If BKS shut down the Nook, do you think BKS could run its website profitably? Furthermore, Would you expect costs go up or down for BKS standalone physical only business if bn.com were shut down given warehousing, sourcing, and shipping costs are shared? If it could not, would consumers be less likely to purchase books at the physical stores with no complementary website?

    -       Is the Nook business feasibly and legally separable from the parent company? In its filings, BKS says increases in its asset-backed revolving credit facility are due to increased investment in the Nook business. Would lenders vote against a spin or divestiture if it was not in their favor? Also, how can BKS separate Nook from bn.com financials given the two are interdependent entities?

    -       Finally, how do you consider the potential for market share erosion from tablets rumored to come from Google, smaller version of iPad, etc? If these are at lower price points meant to compete with Amazon Kindle, couldn’t BKS value proposition quickly erode? Would that impact your view of the 2014 inflection point / turn to profitability?

    I’ve addressed most comments to Nook given you cite that as the central BKS asset. However, the other assets are facing a changing landscape too, which might alter your valuation. While I agree the college bookstore business is higher quality than the superstores business, the transition to rental textbooks from purchased textbooks is threatening the “stability” of the college segment’s earnings, in my opinion. Sales are declining – BKS notes this in a few different ways, suggesting either normalized EBITDA is lower or the “quality of earnings” is declining.

    -        Page 30 of the latest 10Q states, “Prepaid expenses and other current assets increased $51.0 million or 43.1% to $169.5 million as of January 28, 2012, compared to $118.5 million as of January 29, 2011. This increase was primarily due to an increase in the B&N College textbook rental business.” Note “other current assets” have increased 43% year over year both as of Q2 and Q3 – while sales have not.

    -       Page 34 states, “B&N College sales decreased $15.3 million, or 2.8%, to $524.6 million during the 13 weeks ended January 28, 2012 from $539.9 million during the 13 weeks ended January 29, 2011. The decrease in sales was primarily due to a higher mix of textbook rentals, which have a lower price than new or used textbooks. In addition, a portion of textbook rental sales are deferred over the rental period. Comparable store sales, however, for the 13 weeks ended January 28, 2012 were flat.” (Note comparable store sales were flat because BKS reports comparable sales figures as if the product sold at the purchase price, not the fractional rental price”

    A few final points:

    -       You treat the preferred shares as diluted (72mm) instead of the book liability of $192mm. Note the preferred shares pay interest of 7.75%/year and have a conversion price 55% above current market levels. There are two ways to look at this – either 17% dilution of value, or debt that is equivalent to $3.20 in negative equity value per share

    -       I see you included deferred rent as negative equity. You may consider including the gift card liability as well given this was an issue in the Borders bankruptcy process. As of January 2012, BKS had $368mm in gift card liability (page 17 of latest 10Q), an increase from $301mm as of 1Q. I wouldn’t treat the full amount as negative equity given I’m sure a number of extant gift cards have long been lost, but it’s certainly a liability up to $6/share in negative value, or more than half the current share price

    -       A big red flag:

    1) Page 7 of second quarter 10Q: cash flow statement shows “Acquisition of Borders Group, Inc. intellectual property”: $14,528 cash inflow

    2) Page 7 of the third quarter 10Q: cash flow statement shows “Purchase of Borders Group, Inc. intellectual property” of $(14,528). now it's a cash outflow?

    3) There is no note in the latest filings to disclose the previous mistake. Somehow, the balance sheet balanced both times – very fishy. Yes, now they have a CFO so this type of error won’t happen again, but at some point the company needs to explain to investors how they balance the books.

    Value the business on normalized earnings assuming the Nook business does not succeed. That's the crux of the 'short' argument, in my opinion.

     
    EBITDA - "Normalized"  
    Superstore ex. Nook $250
    College 100
    BN.com ex. Nook (100)
    EBITDA $250
    Maintenance CapEx (100)
    EBITDA - Maintenance CapEx $150
    Fair Multiple 6 x
    Enterprise Value $900
    Net Debt and Pension 240
    Preferreds 192
    Deferred Rent 160
    Gift Card Liability (50%) 184
    Implied Equity Value $124
    Per Share $2.07

    SubjectRE: RE: nook app
    Entry04/25/2012 07:57 AM
    Memberzzz007
    DRM for books is definitely going the way of the dodo bird.  You can already get DRM-free Kindle files using torrents on the net.  There is no holding back digital and what it either has done, or will do, to all media.  If you're so inclined, you don't have to pay a dime for any entertainment-oriented media if you don't want to.  Music was the canary.  All else will follow.
     
    Ironically, value-added news (like NYT, WSJ) may end up being the best positioned of all media ultimately to squeeze a dime out of Internet users, as there will always be people willing to pay for immediate access to timely information.  Books, media, and movies, on the other hand, have no monetizable timeliness component.

    SubjectRE: jgalt - Nook, etc...
    Entry04/25/2012 10:26 AM
    MemberRotin
    Nook value - There are plenty of fast growing tech stocks that lose money because they are spending to grow. Please show me a growing tech company that trades for < 1x sales.
     
    I agree that devices will get more competitive over time. That does not mean a device manufacturer is worthless, and it does not mean getting a royalty on content purchases is not worth a lot.
     
    Apple's textbook efforts are targeted at K-12 for now, not college. Of course, over time digital textbooks will take share. That is many years away, and when it comes, the campus bookstore does not go away. And it's not obvious to me that BKS/Nook will not have a role to play in digital textbooks when they do come.

    SubjectRE: finn - nook app
    Entry04/25/2012 10:31 AM
    MemberRotin
    If they ran off the Nook business, you would have a stream of cash flows from content purchases that I think would be worth a couple hundred million dollars. It is somewhat dependant on how the pricing regime shakes out over the next 12 months in the wake of the FTC lawsuit.
     
    Obviously this is not going to happen, but its a good way to frame why the Nook is worth more than zero.
     
    I believe this is a razor/razor-blade model in the near term ie the device is a way to get people to use the Nook app.  

    SubjectRE: RE: jgalt - Nook, etc...
    Entry04/25/2012 11:14 AM
    Membermikeperry22
    In response to:  

    "Please show me a growing tech company that trades for < 1x sales."

    CDON SS trades <0.6x NTM sales.  40%+ organic growth in dominant ecommerce business in its geography and international expansion accelerating that growth and creating large sales upside optionality from its core organic growth.  It is also spending money on the international expansion currently, depressing its current earnings and creating the opportunity to buy something like this for the multiple of a shrinking bricks and mortar retailer...
     
     
     

    SubjectRE: Response to Disagree
    Entry04/25/2012 12:09 PM
    Memberruby831

    On some points, we will have to agree to disagree, but here are a few responses worth considering:

    1)      “Market share” or “percent of a total” means little when that “total” is in decline. The last reported earnings, as I quoted below, illustrate the decrease in eReader purchases in favor of tablets. We are looking forward, not behind. Kindle Fire was not around during the Nook’s prime. Apple has yet to release a lower price point iPad. I have no problem with your optimism that BKS will be able to maintain market share in the eReader and tablet space, but this will require increasing investing to keep up with competition, so I would encourage you to rethink your estimate of the 2014 fulcrum (It certainly feels like BKS has been saying “in two years from now” forever.) A multiple on revenue makes little sense to a value investor if the costs to support that revenue will increase over time; this is our expectation. And we don’t think the Kobo transaction is a just comparison

    2)      Why do you say “B&N.com ex-Nook pre-corporate was and is profitable”? If it is, where are these profits (and how do you value them) in your scenario where Nook is simply shut down if it fails?

    Standalone data from 1999 to 2003 before the acquisition (yes, we are aware profitability then is not a good indicator of profitability now, but let’s start somewhere and then consider Amazon + BN.com’s “fast and free shipping” over the last three years doesn’t help margins). 1999: $123mm loss from operations. 2000: $299mm loss from operations. 2001: $251mm loss from operations. 2002: $74mm loss from operations. 2003: $45mm loss from operations. (If you look over the filings, note ‘shipping revenue’ contribution). The first holiday season in which bn.com provides data – Q3 2010 (ending 1/30/2010), shows negative $32mm EBITDA. Then things start getting uglier. EBITDA of bn.com (which includes allocated Nook expense): negative EBITDA of $205mm. The first 9 months of this year? Already negative $211mm EBITDA, before any capex to support the digital platform or eReader and tablet device development. Your valuation table assumes only $200mm more to support Nook until it becomes profitable, and you also assume bn.com is profitable? What am I missing? In the gap between 2003 and 2008, BKS started offering free 2 day shipping (so no shipping fee contribution to revenue) and Amazon started flexing its muscles.

    Yes, with respect to my valuation table, I also understand the company is worth more if it doesn’t lose money in .com excluding Nook (ex corporate? which goes where exactly?), but I was also very generous in my other earnings and multiple. You argue for a 3x EBITDA multiple on retail – and I used a 6x EBITDA less maintenance capex. Using your multiple, where do we stand? Either way, the crux of your argument is you pay the stock price for the physical stores and get the Nook business for free. As we illustrated, we think you pay $2 for BKS ex Nook, and $9 for the Nook opportunity, which to us is, as you said, an asymmetric risk/reward

    3)      College segment – the accounting shows the quality of earnings has declined. I understand the accounting. Understand that students are now paying $30 to rent a textbook. Remember when you were in college and had over $500 a semester in textbooks? That is no longer the case. Digital textbooks add additional pressure – no one is studying chemistry from a Nook

    4)      Yes, the gift card liability has been a gift to BKS. That’s the point! They have *already* received $6/share in cash for services that have yet to be delivered. It’s not a problem until it becomes a problem – it was a problem for Borders. As the company shrinks (which is almost a given), GAAP earnings overstate true economic earnings because no cash is received as gift cards are redeemed.

    5)      You cite LXK and its multiple. It reported results this week – the “7x multiple” means little if earnings are declining quickly

    6)      Back to the Nook: If they lose on the hardware sale, they must make the profits on the sale of eBooks during the “lifetime” ownership. We believe they will make lower profits over time due to competitors (ie Amazon) and people will replace their devices much more quickly than BKS has implied (closer to 2 years versus 3.5-4 years). If you don’t make money, the business isn’t worth anything.


    SubjectExponentials & Nook value
    Entry04/25/2012 01:23 PM
    Memberjgalt
    Rotin,
     
    Thanks for all your responses. I hope you are right in your thesis but urge you to consider the following: the adoption curve for new technologies is exponential, but it looks linear at first. Once you hit the "elbow," you're done.
     
    Thirty steps linearly gets you to 30. Thirty steps exponentially takes you to 1 billion. In 2006, I watched Bill Ackman get up on the stage of the Value Investing Congress to pitch his very favorite idea: Borders. Back then, there was no Amazon Kindle or iPad. 
     
    I would argue that a marginal product like the Nook (it's not as popular as the iPad or the Kindle) would be the first to lose in the next round of innovation. Just imagine Christmas shopping season in 2012 or 2013, in which the new new iPad or Kindle X will be offering a product with more features and better screen technology than the Nook can afford to invest in. 
     
    You also write that "If they ran off the Nook business, you would have a stream of cash flows from content purchases that I think would be worth a couple hundred million dollars." What stream of cash flows from content purchases? If I own a Nook, what keeps me from saying, "Gee, this thing is out of business, let me go get a Kindle"? Especially if I can read the Nook books on the Nook app in another device. Then there would be no stream of cash flows -- these just got truncated as I migrated to another platform. 
     
    What prevents Apple from pursuing the college textbook market, or another innovator from offering an iPad app allowing students to rent textbooks on their iPads? (Have you seen, say, a biology textbook on the new retina display? It is better than the real thing.) Again, I think the adoption here will be exponential and that it will happen much quicker than you expect. Just my 0.02.

    SubjectRE: RE: RE: Exponentials & Nook value
    Entry04/25/2012 03:12 PM
    Memberruby831
    the answer is never simple. now that competition has heated, most devices restrict your ability to purchase content via an app, but not necessarily to access content via the app. for example, apple won't let you purchase books on the nook app on the iPad, but it lets you access your library, so users have to go to bn.com, purchase the book on the website at a computer, and then access the content via the nook app on the ipad.

    SubjectFellow BKS BUll
    Entry04/27/2012 04:42 PM
    MemberReaper666
    I was about to post BKS myself, it's the idea I got into VIC with about a year ago.  I think Rotin is being conservative, I think the run-off is worth much more than a couple hundred million we are talking about roughly $300 million in content revenue with very little cost.  It may be closer to a billion.
     
    On digital pricing, I know Amazon's philosophy has been lower prices to knock everyone else out in the past but I do think this at least could be different.  This is set up to be a great razor/razor blade model why would Amazon destroy that with a 60% share to gain share and turn the business model to something far less desirable.  They will never get 100% of the market because Apple will always be there.
     
    There is still the upside from the Nook going international.
     
    The stores are a great expererience, could they shift sales to another area, as they are doing with educational toys and games? Not saying it will happen but I have seen more shocking things.
     
    Bottom line the business is volatile, a small change in expected customer acquisition costs, books and apps purchased, life of customer yields a large change in value and in a new industry those numbers are changing rapidly.  But to me the bottom line is if you are short BKS, you really need to be pretty close to 100% right the Nook has to be value destroying, the book store has to turn down faster than 3X would indicate.  If you are at all wrong then there is great value in BKS shares and that is how I would define margin of safety.
     
    FYI:  I'm glad I don't have to deal with the flack of posting this myself, good luck Rotin.

    SubjectBKS and MSFT Form Strategic Partnership
    Entry04/30/2012 06:55 AM
    Memberrfmedallion85
    Nice timing.
     
    Barnes & Noble Inc. (NYSE: BKS) and Microsoft (NASDAQ: MSFT) today announced the formation of a strategic partnership in a new Barnes & Noble subsidiary, which will build upon the history of strong innovation in digital reading technologies from both companies. The partnership will accelerate the transition to e-reading, which is revolutionizing the way people consume, create, share and enjoy digital content.
     
    The new subsidiary, referred to in this release as Newco, will bring together the digital and College businesses of Barnes & Noble.  Microsoft will make a $300 million investment in Newco at a post-money valuation of $1.7 billion in exchange for an approximately 17.6% equity stake. Barnes & Noble will own approximately 82.4% of the new subsidiary, which will have an ongoing relationship with the company’s retail stores. Barnes & Noble has not yet decided on the name of Newco.

    Subjectbks
    Entry04/30/2012 08:03 AM
    Memberjhu2000
    wow, great call

    SubjectRE: Congrats
    Entry04/30/2012 10:45 AM
    Memberruby831
    congrats on msft deal.

    SubjectRE: RE: RE: RE: Pearson investment in NOOK - BKS
    Entry01/03/2013 10:58 AM
    Membercuyler1903
    That's fair.  They should really split this into 3 separate companies, not 2.  Let college stand on its own as well...
     
    Good luck and looking forward to seeing how it plays out.
     
    Cuyler

    SubjectRE: BKS Chairman Looks at Bookstore Buyout - WSJ
    Entry02/25/2013 09:18 AM
    Memberspike945
    do you have thoughts on the proposed sale?
     
    the two businesses seem best to be held in separate hands.   what the true value of Nook/College is hard to tell.

    SubjectBKS Chairman Looks at Bookstore Buyout - WSJ
    Entry02/25/2013 11:58 AM
    Memberspike945
    thanks.  i think i am with you on the value of retail - whether it's 12 or 13 doesn't matter.  it's all about what the value of the rest is worth.
     
    the best thing they can do (in my opinion) is to get another few investors in the Nook to show the market that the valuation isn't fake. 
     
    much appreciated.

    SubjectKS Chairman Looks at Bookstore Buyout - WSJ
    Entry02/25/2013 12:19 PM
    Memberspike945
    agree 100%.
     
    i'd take 750mm for their entire stake right now.  Heck i'd take even less but i have no attachment to the business.

    Subjectwhy overpay
    Entry02/25/2013 12:33 PM
    Membertyler939
    W have seen with dell and bby that founders are not interested in overpaying, at least not lately.  Why do you believe the bid will be $12+?

    SubjectDust off?
    Entry12/20/2013 02:36 PM
    MemberMJS27
    Anyone still paying attention here?
     
    The stock has taken a dive recently following SEC accounting investigation headlines... obviously never a good thing, but it seems like the issue is/was NOOK expenses being improperly attributed to retail, which maybe makes NOOK worse than it otherwise would be, but would make retail better than it otherwise appears.
     
    Anyway - when Burkle first invested in BKS, his thinking was that there were alot of levers that could be pulled to improve operating metrics and cash flow.  It seems as if management has been pulling those same levers as EBITDA in the retail section has been improving (2011 267k, 2012 324k, 2013 376k) as the company has focused on cash flow and reduced its foot print.  Worth noting is that 35% of their store leases are up in the next 2 years giving them more opportunity to right size operations.  In the original write up Rotin suggested a 3x EBITDA multiple was appropriate for this melting ice cube.  If you put that multiple on FY '13 numbers, you get to the current enterprise value.  If you think a business that has been stream lining operatings and successfully growing EBITDA deserves a higher multiple than 3x - like maybe 4x - you have a 33% margin of safety before even considering the college business and the NOOK business (which may be worth zero, and will undoubtedly be a cash burner for the forseeable future.)
     
    Sales and gross margins have been improving at the College business as well, but increased SG&A tied to "digital higher ed initiatives" have been a slight drag on EBITDA.  In theory this increased spend will better position them for the future, but if we adjust the original multiple down from 4.5x EBITDA to 3x, we get ~$330M of value, or 33% of the current EV.
     
    Recall that GME is a BKS spin off and assume that Riggio noted with interest how GME - also considered a melting ice cube - has used buy backs to their advantage, and it is not hard to see the retail/college business as being worth significantly more than the current EV.
     
     
    NOOK of course is the major problem here...  it would be great if it would just go away, or if they would just finally spin it off so that the core business could see the light of day.  The fact that Riggio just sold 2M shares makes it seem as if the spin isn't imminent.  He did issue a statement that the shares he sold had a cost basis in the mid $30s and the sale was to offset other taxable gains which seems to make sense.  Would be great to see him buy them back after 30 days.
     
    Past talk of MSFT buying the rest of NOOK seems more unlikely than ever in the immediate future given their lame duck situation. 
     
    Regardless, throughout most of this thread the value of NOOK was considered to be a major piece of the puzzle, but it now seems like even if NOOK is worth $0 there is significant upside.  Of course it could very easily be a case of good money thrown after bad going forward, but at some point it seems that the large equity stake of Riggio would make him step in and say "enough is enough."
     
     
    Anyway - just my quick thoughts - anyone else keeping an eye on this one?  
     
     

    SubjectRE: Dust off?
    Entry12/20/2013 02:38 PM
    MemberMJS27
    sorry - EBITDA for retail numbers should be millions, not thousands

    SubjectRE: RE: Dust off?
    Entry01/14/2014 04:12 PM
    MemberMJS27

    http://www.sec.gov/Archives/edgar/data/890491/000115752314000052/a50779744_ex991.htm

     from the recent 8k recapping holiday sales - "Core comparable bookstore sales, which exclude sales of NOOK® products, decreased 0.2% as compared to the prior year."

     Nook sales were predictably a disaster, although management is pointing to the lack of a new introduction.

     EBITDA at the bookstores has been increasing at a respectable clip while sales appear to be stable.

     GME and BBY, both of which have been painted with the same brush as BKS as declining businesses that will lose out to the internet etc both trade around 6x EBITDA give or take.

     Put a 6x on BKS FY13 retail EBITDA and it gets you to an EV of 2.25B, vs current EV of 1B.

     College is worth "something" too.

     Of course, GME and BBY are currently able to buyback shares, while BKS is spending money on NOOK rather than buybacks at the moment.

    however this is likely to change as BKS is likely to complete the long anticipated spin of the NOOK/college business within ~3 years b/c there is a put in place.

     http://www.sec.gov/Archives/edgar/data/890491/000095015712000191/form8k.htm

    At this point BKS will likely start aggressively buying back shares resulting in a higher multiple and higher EBITDA/share.

    There is no way to know how much cash BKS will burn on NOOK in the mean time, but the owner operator situation makes me think that the process will at least be rational.

    Figure it takes the market 2 years to figure out that there is a 3 year clock ticking on the spin off and the possibility of a double in 2 years starts to take shape.

     

    Some of my favoirte VIC members were previously involved in the discussion here – I’d love to hear any thoughts.

     
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