I love bookstores. I love a good cup of coffee and a nice book. One of the nicest bookstores in my neighborhood is the Barnes and Noble (BKS) on Santa Monica's 3rd Street Promenade. I'm a huge customer, both of coffee and of expensive technical and travel books.
But as an investment, Barnes and Noble is a mess rapidly sliding off the edge of a cliff. Problems include a bad business plan, bad financials, competition from Amazon (AMZN) and repeated attempts by the owners to sell the business before it collapses.
The Business Model Doesn't Work
Barnes and Noble's basic business is sort of a department store sized book shop, with comfy chairs, music department, a few cards and games, and a nice coffee shop run in association with Starbucks (SBUX). They are pleasant, the selection of books good, and the chain has spread with about 1300 shops (including college stores) nationwide.
Barnes and Noble created some ill-will in the book industry by coming in and underpricing other neighborhood stores. In Santa Monica, for example, Barnes and Noble set up shop across the street from the "Midnight Special Bookstore" and down the block from Borders, both of which eventually went under.
The owners of the Midnight Special complained that Barnes and Noble had better wholesale deals that gave them an unfair pricing advantage.
The tables have turned. Amazon (AMZ) offers the same books as Barnes and Noble, frequently at a third to half the price.
For example, I have a copy in front of me a computer programming book called "Practical Rails Social Networking Sites." I originally bought it at Barnes and Noble for full list, which was $44.99. The same book is available on Amazon for $4 (including shipping). I picked this book at random, but it makes the point pretty strongly. Barnes and Noble isn't able to compete with Amazon online pricing.
Barnes and Noble's Online Strategy Is Failing
BKS president Leonardo Riggio gets it. He knows they're getting killed by Amazon. There's even a smartphone app called "Price Check", which allows shoppers to come into the store to view stock, scan a barcode and immediately buy online from Amazon.
BKS has started their own online site, and while competent, it's just not as good as Amazon. Amazon has more stuff, more vendors, marginally better prices, and a huge headstart.
The website cannibalizes Barnes and Noble bookstore sales too. You might feel guilty about going into a Barnes and Noble store, checking the books, and then ordering online from Amazon. Will you feel the same guilt if you order from BKS online?
Barnes and Noble is stuck between a rock and a hard place. They can't compete with the online vendors, yet when they open their own website, they are competing with themselves and undermining their own business.
There are also huge expenses in setting up an online book selling system. Amazon is a lean, mean, book selling machine. Barnes and Noble is, well, they've got good coffee and nice comfy chairs. When it comes to online, they're getting killed.
Ebooks Won't Save Barnes and Noble
In 2009 BKS started promoting "electronic books" as the new wave of technology that will save them. Amazon had been selling them since 2007.
The problem is that far from being the financial savior, Ebooks are a swirling maelstrom of red ink. Creating the Ebooks system has been hugely expensive, including the development of Android based readers to read those e-books.
For every dollar in sales BKS makes online, they spend $1.50.
That just doesn't work.
The more they sell the more they lose.
Ebooks aren't really compatible with Barnes and Noble's brick and mortar core business.
If Ebooks did turn out to be hugely profitable, there's nothing to prevent individual publishers, or even authors, from producing their own eBooks and selling them directly to consumers.
So even if the business itself booms, there's nothing to ensure that Barnes and Noble has will ever benefit.
Despite all the flaws, Barnes and Noble's bookstores actually do still make money. Traditional books sales are going down, but between now and the end of the decade there's still plenty of money to be made.
What the accounting shows us, is that rather than saving the company, their expensive forays into online marketing are killing an otherwise profitable business.
Owners Trying to Sell BKS
It's always interesting to see what the "insiders" are doing with a stock. At BKS it's no secret. They want out.
Leonardo Riggio, president and largest (30%) shareholder, started by selling his chain of educational bookstores to BKS, for a little over $500 million in August 2009. This move was widely criticized, and eventually Riggio was forced to return part of the sale price.
At the same time Riggio was battling an unfriendly takeover attempt from Ron Burkle, who succeeded in buying 19% of the company before being stopped by Riggio's poison pill. If Burkle bought more than 20% of the shares, Riggio promised he would flood the market with new shares, making Burkle's investment worthless.
The poison pill is unfair to smaller investors, because it denies them the opportunity to sell their shares to the highest bidder. Many think this ought to be illegal.
Ignoring the ethical issues, Riggio is probably kicking himself today for not taking Burkle's money. BKS is down by more than half since that time.
In the mean time, Barnes and Noble started losing money, and had to cancel its dividends
In 2010 Riggio announced that BKS was "seeking a buyer" and claimed that Barnes and Noble was "Significantly undervalued."
A buyer appeared in the form of Liberty Media, that offered $17 a share for the entire company. A few months later, after some due diligence and some careful thought, they backed out and instead provided a $204 million dollar loan guaranty, with interest and an option to convert to shares, if the business goes well.
Losses continued to mount.
Microsoft to the Rescue
After burning all the cash they'd gotten from Liberty Media, Riggio needed more cash to keep the company, and found it in an unlikely partner: Microsoft.
Press releases proudly announced that Microsoft had agreed to invest $300 million for a 17.6 percent stake in a new Barnes & Noble subsidiary that would focus on B&N's Nook digital and college businesses. In exchange, Barnes & Noble agreed to load its Nook digital bookstore with Windows 8. Riggio did the math and proudly announced that Barnes and Noble must now be worth more than a billion dollars.
Which is all fine, except that nobody has explained how this is going to result in the sale of more books. That's the business they use to pay the rent. To date, the deal with Microsoft has not brought in a single penny of new business for Barnes and Noble.
For investors, the money from Microsoft actually dilutes their share. It isn't clear how much dilution has really occurred, because the money is invested in a spin off company that hasn't actually been spun off yet.
Skeptical investors would point out that Microsoft's agenda isn't about profit, it's about promoting Windows 8. The $300 million cash infusion has certainly helped BKS, if nothing else by keeping the stores open for another year.
Other Similar Businesses Have Failed
In the last ten years we have seen Borders, Walden Books, Brentanos, Crown Books, and B Dalton slowly slide into bankruptcy, along with an uncounted number of "ma 'n pa" local shops.
Some, such at the Brentanos on Opera Boulevard in Paris, were near legendary and cannot be replaced. See the article "La Fermeture d'une libraire mythique" in Figaro. They will be missed.
We know what it looks like when a book store is going bankrupt.
First there are rumors, and the stock of the latest books and videos doesn't seem to get refreshed. Then there are a series of sales with ever escalating discount percentages. Finally the going out of business sale, the 90% discounts, the sale of fixtures and furniture, and the promises that the business is only being consolidated, with stock moving to another store on the other side of town. Then that other store closes too, and next thing you know, the entire chain is gone.
Borders offers an instructive example. Even as the stores were being closed one after another, management was upbeat, and if you were to believe their press releases, they'd never seen better times.
Just before they shut doors forever, we saw press releases proudly proclaiming that "William Ackman said in a filing that his firm Pershing Square Capital Management is prepared to fund an offer for Borders to buy Barnes & Noble for $16 a share. The deal would value $963.2 million." (Ackerman was at that time 1/3 owner of Borders.)
A couple of weeks later they were closed.
Barnes and Noble Joins the Big Swirl
At the local Barnes and Noble in Santa Monica, books are getting scarce. I notice that the shelves are further away from each other than they used to be. They aren't stocking as many books.
The computer section is down to two shelving units. There used to be about nine units full of computer books covering a third of a floor.
Half the first floor is filled with, well, other stuff that isn't books. Three or four games and a couple of popcorn necklaces and a poster and some cards substitute for a section that once had three shelving units full of New York Times Bestsellers. Did they think nobody would notice?
Up the street in West LA, the Barnes and Noble at the Westside Pavilion is now some kind of furniture outlet. On Yelp: everything is crossed out and it says "Heads up! Yelpers report this location has closed."
The biggest Barnes and Noble in Seattle, where I grew up, located by the University of Washington, closed recently. Last I looked they were putting in Room & Board, a Midwest home-furnishings chain.
Word has come now that Barnes and Noble in Santa Monica isn't renewing the lease. Hmmm. This is the kind of store that really ought to be a success. Nice building, massive foot traffic, lots of customers. And they are closing.
They don't close top grossing stores on a whim. One store shuts over a rent dispute I believe. But this, well, it's a lot of stores, and it's the ones that ought to be doing well.
Yet the price of the stock is up about a third from six months ago.
The hype around Barnes and Noble is amazing. A ten dollar stock loses a dollar a share, year after year, and they say "this is great" and "we're going online" and people keep buying their stock.
But they're losing money, they're closing stores, they're raising money to keep the doors open, and the primary mover and main stockholder is doing his best to sell the company.
That's why I'm taking a short position on Barnes and Noble.
Disclosure: I am short BKS.
Additional disclosure: I have an investment position that is consistent with the views stated in this article.