The Barnes & Noble Nook Is Cooked: It's Time To Short

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Barnes & Noble (NYSE:BKS) reported an unexpected second-quarter profit on the basis that selling and administrative expenses decreased by $29,474,000 from the second quarter of 2013. Based on their own forecasts of a significant decline in retail sales for the current financial period, Barnes & Noble got ahead of the game by cutting back the hours of its own employees. It was quite easy for Barnes & Noble to implement the cutback in hours given that most of its employees are part-time workers.

In addition, Barnes & Noble is engaged in a long-term effort to implement a significant cutback in its own stores. Currently, 673 Barnes & Noble stores are in operation as opposed to 689 just one year ago. Barnes & Noble retail CEO William Klipper had declared earlier this year that their total number of stores would be reduced to 450-500 stores in a decade.

The aforementioned expense decline outweighed the 8% degeneration in total revenue. Yet investors' concern over the sales decline clearly outweighed any relief that a 13.2 million dollar profit was incurred. Barnes & Noble shares fell by nearly 4% upon release of the report. As the following charts indicate, their concern is completely justified.

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This is the second quarter sales for Barnes and Noble by division.Click to enlarge

This is a comparison of Barnes and NobleClick to enlarge

Barnes & Noble's greatest concern should be for their Nook division. As seen in the chart above, the Nook's overall sales for the first two quarters has fallen 34% from the fiscal year of 2013. Additionally, the Nook division's revenue declined by 32.2% from the same period a year ago. This was a greater decline for the 20.2% drop during the last fiscal quarter.

In particular, Nook tablets, e-readers and other accessories were down by just over 41% from one year ago.

When a MLB pitcher gets himself caught in a jam, he is usually visited by either his catcher, the pitching coach and/or the infielders in order to be given a word of encouragement or to discuss any potential adjustments that need to be made. Sometimes, the manager will even take it upon himself to visit the pitcher to accomplish one of the aforementioned tasks. There are those times in which the pitcher will accept the advice, calm himself down and limit the amount of damage that takes place in the inning.

Then there are those times in which the pitcher will continue to miss the strike zone in spite of the advice. He may give up back-to back walks, throw consecutive wild pitches or serve unintended batting practice to the other team. Thus, the manager has no choice but to pull the pitcher from the game.

If the Barnes & Noble Nook were a MLB pitcher, it would be pulled from the game and sent to the minors.

Earlier this year, Barnes & Noble executives acknowledged that it was time for a change in course after the Nook division fell by 34% in the fourth quarter of 2013. Back then, it was acknowledged that the Nook had become too costly to produce. Shortly after, William Lynch resigned on July 8th 2013. Given that Lynch was a key component of the Nook's launch, this sent a strong signal that this could be the beginning of the end for the Nook.

The failures of the Nook have continued in spite of the fact that the firm has continually cut prices to take market share away from the iPad as well as to keep up with the Kindle and Google Nexus.

Yet, the price cutting continues. At the end of October, the prices for nine inch Nook HD tablets were slashed to $149 from a price of $269 last year. The seven inch Nook HD cut back its price from $199 to $129. On Black Friday, the Nook Simple Touch's price was cut from $79 to $39 while the Nook's HD price was slashed from $129 to $79.

As you can see on the charts below, the Nook has made no gains whatsoever in terms of market share.

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Is the E-Book Trend in Decline?

The viewpoints on the current state of e-books vary greatly. Some are of the belief that the prospects of an e-book decline are real while others are of the opinion that the e-book decline is greatly exaggerated.

The following first quarter e-book sales growth chart indicates that the e-book may be possibly reaching the maturity stage of its potential growth.

This is a chart that compares the first-quarter annual growth of the E-book over the past five years.Click to enlarge

Overall, e-book sales growth for the first half of 2013 increased by 1% over the same period last year. In April, e-books declined by 0.1% from the same period in 2012. This was the first time ever that e-books have declined on a year-to-year basis. This should be of some concern to Barnes & Noble executives who have hinged their long-term store cutting store strategy on the long-term viability of digital media.

The following charts from Nielsen Media Research illustrate the beginning of a trend of stagnation in terms of the percentage of customers who buy and read e-books.

This is a chart that illustrates the percent of book buyers who have bought an e-book as well as book-buyers who have read e-books on a daily or weekly basisClick to enlarge

This is a chart that illustrates the E-Book share of all New Books that are sold.Click to enlarge

Yet, there are viable reasons to suggest that the notion of an e-book decline may be over-exaggerated.

- The 5% growth in the first quarter for e-books occurred in spite of the fact that trade sales were down 5%.

- 2012 e-book sales received a major boost from the incredible success of the Hunger Games and Fifty Shades of Grey Trilogies. There has been no such blockbuster this year.

E-reader sales are not faring much better. E-reader sales declined by 28% in 2012 and was forecasted to decline by 27% in 2013.

The increased vulnerability of the e-book and e-reader may only seek to speed up the oncoming demise of the Nook. However, one should disabuse themselves of the notion that the aforementioned factor is a direct cause of the Nook's issues.

It seems that the inevitable will occur. Things have not progressed since Microsoft's (NASDAQ:MSFT) 300 million dollar investment in the Nook business last year. While Barnes & Noble executives acknowledge the struggles of the Nook business, it appears that they have not developed a single viable plan going forward. It seems that they are content with proceeding full speed ahead with a subpar product that is bringing down the value of its retail bookstores. There were reports that Microsoft was considering a full purchase of the Nook business. Yet, those rumors quickly died down.

The Nook is at a great disadvantage given that Amazon's (NASDAQ:AMZN) audience outweighs Barnes & Noble's online audience by over 120 million visitors.

Is it any wonder why the blog 24/7 Wall Street ranked the Nook #2 on a list of brands that are set to disappear next year?

Just like the regular seasons of the Knicks, Nets, Mets, Jets and Giants, the Nook is finished. Barnes & Noble should seek to sell the Nook division immediately. I doubt that Barnes & Noble will find many potential suitors.

Furthermore, Barnes & Noble should consider a reduction in their long-term store-cutting strategy and focus on coming up with an effective digital plan. The present slowdown in e-book growth will benefit Barnes & Noble's brick and mortar stores in the short term. Thus, this will give the company more time to craft a digital strategy.

Bottom Line

It's time for investors to short Barnes & Noble right now. In spite of the fact that Barnes & Noble has gained just over 13% in the last four weeks, it is now considered overbought due to a relative strength index that is slightly over 70. A stock with a relative strength index near the benchmark of 70 is usually due for a sell-off.

Additionally, analysts are predicting a blue Christmas for Barnes & Noble in terms of earnings growth. Analysts forecast an earnings decline of 228% for the current fiscal year. Most importantly, Barnes & Noble has no plan to rid themselves of a Nook product that has dragged revenues down in spite of numerous price cuts.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.