In the past quarter Barnes and Noble (BKS) made a quarterly profit of 15 cents per share, much of this by tightening the belt and reducing sales expenses and inventory, and by reducing the investment in the money burning "Nook" products. Balancing the budget is commendable. They have made some right decisions. It's the only way the business can survive in the ever increasingly competitive market for retail books.
Where does this leave them as far as long range profitability and share value? Let's consult the most recent Financial Reports and the numbers for BKS reported on Google Finance.
Let's start out with some very optimistic assumptions:
Let's assume they are able to achieve the same efficiencies and profits for every quarter from now until the end of time.
Let's assume sales do not continue to fall
Let's assume that the business prospects are just as good as they are for Apple or Microsoft, and give BKS a price to earnings ratio of 13.
This gives us an annual profit of 60 cents and a stock valuation of 13 x $.60 = $7.80; this is about half what BKS is currently selling for, $13.78. Now let's start looking at some of the bad news.
First, sales are down, from $1.88 billion a year ago to $1.73 billion this most recent quarter. Most other book chains are seeing the same thing. How many bookstores have we seen go bankrupt in the past ten years? So perhaps the $7.80 valuation is high. A declining business, even if profitable, should have a lower stock valuation.
The profit numbers are also suspect. One quarter of profits doesn't make the year a winner. BKS lost $3.02 per share in the most recent year, up from a loss of $1.34 in the previous year and a loss of $1.22 the year before that.
Consider that the total of cashable assets, by which I mean current assets, cash and accounts receivable and prepaid expenses, but not including inventory, is $2,047 million (current assets) - $1,410 million (inventory) = $637 million dollars (cashable assets).
We must subtract from this those bills that need to be paid right away, the current debt of $1,700 million:
$637 million - $1,700 million = $1,063 million
What we see is an immediate budget shortfall of more than a billion dollars. The company is underwater.
Barnes and Noble's financial statements obscure these numbers by listing inventory as a current asset. That may be fine by accounting principles, but you can't pay your rent with a load of books. Also, if you are planning to stay in business, you are going to have to replace inventory you sell. I'm leaving inventory out of the cashable assets you can use to pay bills.
Does this mean BKS is out of business? Not really. The BKS core business of retail book sales is in fact profitable; it's the Nook that is dragging them down. It's an anchor they just can't shake loose. They've taken $300 million from Microsoft (MSFT) for Nook, they've made all kinds of promises to investors, and it's clear that they don't have a real plan to cut Nook free. Nook loses something like $500 million a year, and if spun off, would fold within a few months.
Where would that leave BKS? Well, it would be better off. Let's do a reality check. Do the numbers discussed here really match our gut sense of what is going on with BKS?
We have a declining but profitable retail book business. We have relentless pressure from Amazon (AMZN), and a problem with online books sales that cannibalize retail sales. We have the Nook segment, which started with huge promise but doesn't seem to be working out. We have a quarter of profits but a general trend of even increasing losses.
What does it add up to? It's ominous that 25.9% of the float for BKS is short sales.
Competitors like Borders have gone out of business. Those that remain, like Indigo Books (OTC:IDGBF) in Canada, are having a very hard time and are losing money. If you set aside the Nook, it's very hard to see much difference between the business models of Indigo, Borders, and Barnes and Noble.
BKS chair and chief cheerleader, Leonard Riggio, recently sold off 2 million shares for $27.6 million, a significant portion of his share of the business. He's well informed about BKS business opportunities, and selling.
Meanwhile stock touts like the folks at Zacks keep pumping out publicity releases that telling us that BKS is solid, profits are around the corner, and the stock is sure to hit new highs within the next year. That just doesn't make any sense. One wonders whether they may have some conflict of interest, because the advice is so incredibly bad, so incredibly in violation of basic rules of common sense.
When a sizeable group of investors are delusional about the price of a stock, when it appears that market manipulators are pushing prices up when in fact they should be falling, this an ideal opportunity for short sales. For BKS, short sales are so popular there generally aren't many short shares to be had. For the investor who wants to get involved in BKS, put options remain a good choice.
I have been following Barnes and Noble closely for several years. An earlier article discusses BKS and problems in their financial reports business model.
Additional disclosure: I have an investment position that is consistent with the opinions stated in this article.