Yesterday, Barnes & Noble Booksellers (BKS) released Q3 2013 earnings data and guidance numbers for Q4 that were far below expectations. The company reported revenue of $2.2 billion and a loss of .18 cents per share while the consensus was $2.4 billion and a gain of .58 per share. Yet despite having missed revenue expectations by $2 billion and earnings per share by $.70, shares climbed 3.35% throughout the trading day and an additional 1.54% after hours. If the market behaved like computers, this would not have been the outcome.
With an earnings report at this level of inferiority and a slumping business, BKS shares should not have climbed at all, but shares should have plummeted. Seven out of the last 8 quarterly earnings (including Q3) for BKS reported negative numbers and 5 of them had been negative surprises. Also, the company has a one year growth rate of (7.89%) and as of yesterday, BKS harbors over $700 million in debt and has only $214 million of cash at hand. Just looking at these numbers, I would find it extremely difficult to convince myself to invest in this company.
I think the major driver of BKS shares right now is still news that Leonard Riggio, the main shareholder in BKS, is talking with BKS board members about taking the Retail Bookstore division of the company private. Investors are considering this move to be the saving grace for BKS, and the market hopes that once BKS becomes just Nook and college, the company will then continue to thrive. However, in my opinion, if this move does take place, the resulting BKS or Nook Media will not be very successful. This is why:
If you look at the company's Q3 earnings data, BKS derived the grand majority of its revenue from its retail operations- $1.5 billion out of $2.2 billion to be exact or 68% of the total pie. Additionally EBITDA for the retail sales in Q3 2013 was $212 million compared to $197.6 million from the same quarter a year ago. So, one way you can interpret this data is that the retail division is not doing that bad as EBITDA actually grew $14.4 million or about 7%. Then if you consider the potential Riggio move, BKS would be losing its major source of revenue, and the only source of revenue that witnessed growth in Q3 year over year. The Nook division had a net decrease of 129.9% in EBITDA and the College division decreased 3.6% EBITDA. Furthermore, in the 13 week period ending on January 26 2013, operating margins for the Nook division was -29.9% compared to the 33.2% margins of the retail division. Also, during that same period, the Nook division spent 64.5% of the sales on selling and administrative expenses whereas the Retail division had similar expenses account for only 19.2% of retail sales. Lastly, Nook sales for the past holiday season have performed much worse than BKS themselves expected, and sales have been so low that the company had to offer customers extremely discounted offers to remove inventory. From the most objective standpoint, the numbers tell us that the retail division is actually much more successful and efficient than the Nook division. So when investors jumped on the train expecting Riggio's move to take the retail division private, I am perplexed because it seems like he's taking the good part with him and leaving investors the scraps.
In the event that BKS does not go along with taking the offer from Riggio to take the Retail division private, two things will happen. First, share prices will drop significantly as the sentiment that was built from the news will disappear and then transform into negative sentiment. Second, after the initial market outcry has been settled and things become more rational, the company will begin usual operations again. The company will try to keep the sale of physical books and goods alive, improve upon the e-media selection for the Nook, and attempt to increase Nook Sales. However, BKS has shot itself in the foot by staying with the sales of physical books this long. Consumers are quickly leaving paper books as they prefer the ease of reading from multi-book reading systems on their tablets, phones, and computers. So even though retail is surviving now, the division will no longer be profitable in the future as demand will disappear. Additionally, based on the Nook situation described above, I expect that BKS will not make enough revenue or obtain critical mass of market share to compete with Amazon Kindle (AMZN) and the Apple (AAPL) iPad. Lastly, during the conference call today, the executives at BKS stated that the College division has signed a contract with Pearson Education and partnered with more schools to expand upon their business, but those are false hopes in my opinion. Sure, the College division may have more opportunities to sell its goods, but the cold hard truth is that students no longer want it. Students are not all wealthy, and they are not all stupid. Students are quickly realizing that Barnes & Noble rips them off in price and book buy-backs, and they would rather purchase the books online on Amazon or community websites, share with a friend, or take hand-me-downs from their older friends. However, I also realize that Microsoft (MSFT) and Pearson's Education have invested in Nook Media, the Nook division of BKS, and together the two third party investors own 22% of Nook Media. My opinion on that matter is that even with the investments, it will be difficult to win a critical mass of users when Amazon kindle and the iPad readers have been already established in many consumer households.
The bottom line is that whether or not BKS retail goes private, the end result for BKS will be a bad one. And contrary to what the masses think, I believe BKS will have more lifespan if Riggio does not take retail private. So like I said previously, I still believe BKS is an excellent short candidate.