Buy Barnes & Noble At A Deep Discount

Oct.16.13 | About: Barnes & (BKS)

Introduction and Thesis

In this article, I explain why Barnes & Noble (NYSE:BKS) is well positioned to turn around in the next year and remain a stable and profitable company. The consensus among many investors is that bookstores will gradually become obsolete, as traditional books are replaced by eBooks, and Barnes & Noble will follow Borders into bankruptcy. As evidence, critics point to BKS's negative net income for the past three years. However, I will argue that the economics of BKS's bookstores are strong, and the potential sale of Nook Media would unlock value for BKS investors. Additionally, Barnes & Noble's bookstores have a sustainable niche position, which will continue to be profitable far into the future. Taking these factors into account, my estimated intrinsic value for BKS is $23-$28/share.

Company Profile

Barnes & Noble is the nation's largest book retailer, known for its expansive upscale stores. Besides a wide variety of titles, authors, and categories of books, the stores also offer Nook eReaders, magazines, newspapers, and café items. It currently operates 675 retail bookstores and 686 college bookstores in all fifty states, totaling 18 million square feet.

The Threat of eBooks

Many investors are concerned that eBooks will soon make print obsolete. However, the traditional book industry is mature rather than shrinking. Total sales of traditional books may continue a slow decline for the next few years as eBooks continue to gain traction, but this trend should level off. When eBooks first came to market they saw huge growth fueled by early adopters. The industry is now struggling to convert more readers to eBooks. According to a survey by Bowker Market Research in 2012, 59% of Americans have "no interest" in eBooks and only 16% of Americans have ever bought an eBook. Even more telling is that 90% of Americans who have bought eBooks continue to buy traditional books as well. This suggests that eBooks may be seen as a supplement to traditional books rather than as a replacement. Most of the growth of eBooks has been in the adult fiction genre. Other genres continue to be dominated by print. Total B&N bookstore sales have slightly decreased over the past few years as the company has closed a few of its unprofitable locations, (a value enhancing move). Same-store sales (excluding Nook) actually increased by 1.4% in 2012 and stayed flat in 2013.

Why Barnes & Noble Won't Share the Same Fate as Borders

Barnes & Noble will not follow Borders into bankruptcy because its stores are far more profitable and it is now the only game in town for brick and mortar bookstores. In the last few years before Borders closed, its same-store sales were decreasing greater than 10%/year, as compared to Barnes and Noble's roughly flat sales growth. Borders had sales per square foot of $173 in 2010, as compared to Barnes & Noble's sales per square foot in 2013, which was 49% higher at $258.

Amazon will remain a tough online competitor, but brick and mortar stores offer a much greater opportunity to explore and discover new authors and titles. Additionally, as brick and mortar stores drive online sales, publishers and authors are incentivized to make sure their books are on the shelves at bookstores. Amazon may steal some sales from Barnes & Noble, but it is in the best interest of both Amazon and publishers to make sure that Barnes & Noble continues to act as their showroom. This fact may help Barnes & Noble negotiate lower costs of inventory with publishers, especially now that they are the only national bookstore chain remaining.

Financial Overview

Barnes & Noble breaks down its sales into three segments: B&N Retail, B&N College, and NOOK. The sales breakdown is as follows:


Sales %

Gross Margin

B&N Retail



B&N College









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Note the large negative contribution the NOOK segment is currently making to BKS's gross margin. Once SG&A, D&A, and interest expense are taken out of gross margins, this company is losing money, as shown by their Income Statement for the past three years:












Gross profit
















Interest (Expense)




Income taxes (benefit)




Net Income (loss)




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Now let's take a look at the balance sheet. The company has been paying down some of its long-term debt. However, it is worth noting that BKS has sold minority stakes in Nook Media (comprised of the NOOK and B&N College segments) to Microsoft and Pearson PLC, which leaves BKS with an 87.2% majority stake in Nook Media. If total sales continue to decrease, working capital will be a source of cash flow for shareholders.



Current Assets:

Cash and cash equivalents



Receivables, net



Net inventory



Prepaid Expenses



Total Current Assets



Noncurrent Assets:

Gross Property and Equipment



Less accumulated D&A



Net property and equipment



Total Assets



Current Liabilities

Accounts Payable



Accrued Liabilities



Gift card liabilities



Total Current liabilities



Long-term debt



Deferred taxes



Other long-term liabilities



Redeemable preferred shares



Preferred membership interests in Nook Media



Total Liabilities



Shareholder's Equity

Total shareholders' equity



Total liabilities and shareholders' equity



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Lastly, let's look at the Statement of Cash Flows. BKS has an average CapX/Depreciation Ratio over the last three years of roughly 0.61. As BKS is no longer investing in new stores, this trend should continue to be a source of cash. Slightly decreasing inventories should also supplement cash flow.




Net income




Operating Activities:





Adjustments to net income




Adjustments to AR




Changes in liabilities




Changes in inventories




Changes in other operating activities




Cash flow from operating activities




Investing Activities:





Other Investing Activities




Cash flow from investing activities




Financing activities

Dividends paid




Sale purchase of stock




Net borrowings




Other financing activities




Cash flow from financing activities




Change in Cash




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Investors often have a hard time valuing companies with a profitable segment, and losing segment, giving value investors a great opportunity to buy at a discount. Together, the segments produce poor results as shown above. However, to understand the true value of the business, a sum-of-parts valuation method must be used. Currently Barnes & Noble is organized as two entities: Nook Media, which contains the NOOK and Barnes & Noble College segments, and Barnes & Noble Retail. However, let's start by grouping the bookstores (B&N Retail and College segments), and finding their value.

The Barnes & Noble bookstores are a mature and profitable bookstore chain. Below are the combined earnings of B&N's Retail and College segments, as if they were a standalone company. These numbers are taken directly from BKS's SEC filings, which break down revenues and costs by segment, plus the assumption of a 35% effective corporate tax rate:








Cost of Sales and Occupancy




Gross Margin




















Interest Expense




Pretax Income








Net Income




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Net income for the company's bookstores is very positive and growing, though I would not expect that growth to continue. To be conservative, we'll use average earnings for the last three years, which was $117MM. Benjamin Graham suggested using an 8.5 earnings multiple for a no-growth company, but we'll use 8 for a quick and conservative valuation. This gives us a value of $936MM (or $16/share) for the bookstores, which is 17% greater than the current market value of the entire company. Essentially, investors are getting a free option on the additional NOOK segment.


Best Buy

Office Depot

Office Max



Family Dollar Stores










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EBITDA multiples are another good measure of sum-of-parts value. Unfortunately, as the only remaining national bookstore, there are no close comparable companies to BKS, so we will look at other mature retailers.

The bookstores' average EBITDA over the past three years was approximately $430.4MM. After subtracting net debt, preferred and minority interests totaling $705MM, we reach a fair value of equity. Using these numbers, we can calculate the following for the values of the bookstores:









Implied EV








Implied Equity Value








Est. Share Price








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Again, this is considering the value of NOOK as only an option. A sale of the segment would be the quickest way for shareholders to capture its value. Microsoft and Google are rumored to have interest, but there is no concrete evidence that the unit will promptly be sold. However, as shown by the valuation above, the bookstores have a standalone value far in excess of the current total market capitalization.


Barnes & Noble's bookstores remain very profitable despite its highly unsuccessful Nook Media division, which has driven down earnings. The economics of bookstores remains strong, and as the only major player left in the industry, Barnes & Noble stands to benefit. 95% of Barnes & Noble's bookstores were profitable last year, and net income would have been approximately $157MM without the NOOK segment. My estimation of Barnes & Noble's intrinsic value is between $23-$28 leaving investors roughly 100% upside.

Disclosure: I am long BKS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.