Much ink has been spilt, many trees have died, and many watts have been consumed discussing the collapse of the traditional book industry, the rise of eBooks, and Amazon's "disruption" of hidebound retailers. While a fascinating topic of discussion, that is not the focus of this article. Instead, my question is much more pedestrian in nature: Does Barnes & Noble (NYSE:BKS) have a future?
Barnes & Noble's Operating Metrics Cast Strong Doubts
It is often easiest to start from a concrete, accounting perspective. Put simply, Barnes & Noble's management has failed to produce meaningful revenue growth in years:
B&N's operating margins are narrow, to say the least:
Perhaps most damning of all, B&N management has not produced positive net income in the last 3 years:
The above judgments could possibly be too harsh. Many companies have been on the receiving end of technological disruption and have survived nonetheless. IBM, Microsoft, and AT&T are still in business. The Wall Street Journal has weathered journalism's slow decline with aplomb. Merely noting the decline of print media need not mean the end of booksellers.
Unfortunately, B&N has no visible plans to address the shortfalls of its core business.
Barnes & Noble's Nook Line Has Been Poorly Executed
Faced with an existential threat from ebook sellers, we should first turn to B&N's efforts to develop this market. Unfortunately, the results have been grim.
B&N has little experience with technology and faces relentless competition from Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), and Google (NASDAQ:GOOG). All three competitors have core businesses that generate an order of magnitude more revenue than B&N, and all three sit on a veritable mountain of cash. Even if B&N's Nook were truly a superior product, Amazon, Apple, and Google could simply fling resources at their equivalents to keep Nook at bay. Amazon, Apple, and Google can cross-subsidize, where B&N cannot. On top of this, B&N has no competitive advantage in the software or high technology industry and also has no experience managing suppliers or contract manufacturers in this industry.
More importantly, B&N's Nook is not a superior product. From a technology angle, the Nook is simply another ersatz clone of the Kindle, iPad, and Nexus. A prospective consumer would struggle to distinguish the Nook tablet from the alternatives, and that consumer might also desire the versatility of the alternatives as well (one cannot easily customize a Nook). Additionally, B&N has not released a new tablet in over a year.
From a content angle, the Nook also fails to deliver superior results. When a consumer chooses a physical book, they own the book entirely. Beyond any kind of technical limitations (attempting to make physical notes in the "margin" of a Kindle is a poor idea), this sense of tangible ownership is important. When a consumer chooses an ebook through the Nook, they are instead leasing the content in perpetuity from B&N. Should B&N collapse or otherwise alter the terms of the lease, the consumer loses out. This lease arrangement thus adds an important element of risk to an ebook purchase: Consumers risk losing content or devices when choosing moribund B&N over healthy giants like Amazon, Apple, and Google.
In general, B&N's Nook is not meaningfully distinguishable from the competition, and B&N has no competitive advantage. All of the above points are borne out by B&N Nook sales declines in the past 3 years:
Thankfully, B&N finally announced on 25th June that it would spin off its Nook business as a separate company.
Barnes & Noble Will Struggle To Develop a Competitive Advantage Without the Nook
Assuming we write off the failed Nook experiment, B&N is back in a tough position. Management actively expects to close more stores (detailed further in its 10-K filing), and revenue is falling or stagnant overall. Print book sales have maintained their consistent decline each year. A potential investor is thus left to inquire, simply: "what does B&N do?"
First, B&N houses physical books for sale to customers. Unfortunately, it costs much more to develop a lush, pretty warehouse with carpeting, nice shelves, and friendly employees than it takes to operate an Amazon warehouse. B&N also has less experience managing supply chains and shipping arrangements than Amazon. Additionally, Amazon customers are not allowed to browse books in the warehouse before buying them. By this definition, B&N is simply a box that holds books.
Second, B&N guarantees (within reason) that a customer could enter the store intending to purchase a book and leave shortly thereafter with the desired book in hand. While Amazon has developed "Amazon Lockers" and same-day delivery, these services are not truly identical to a traditional purchase. B&N thus fulfills a somewhat valuable role as a purveyor of "books on demand," though one could reasonably question just how large this market is.
Third, B&N provides coffee, pastries, wireless internet, and comfortable chairs, all through its partnership with Starbucks. Partnership usually implies a symbiotic relationship, and, unfortunately for B&N, it's hard to justify what this service adds on its own. By this limited definition, B&N is simply an enormous coffee shop with a good book selection.
Fourth, B&N maintains "on-the-ground" knowledge about its customers' buying preferences. Unlike Amazon, which must interpret book demand from ad-clicks and browsing histories, B&N has direct access to consumers and the ability to tailor store selections, events, and promotions to local audiences. Unfortunately, B&N has squashed this valuable asset of store heterogeneity and access to information in favor of homogeneous stores featuring identical offerings and events. B&N could improve its sales by giving some operational, inventory, and event discretion to local management.
Fifth, B&N does operate a relatively stable and successful college bookstore business. Its college leases are long-term (several years), its consumers are a captive market with little choice in buying preferences, and each store is tailored to its location. Unlike the rest of B&N's business, its college stores have consistently earned approximately $1750MM in each of the last 4 fiscal years. B&N might thus succeed by devolving into a parasitic appendage on higher education.
To succeed in the long term, B&N will need to choose one of these areas, develop it with vigor, and transform its core business.
Barnes & Noble Management Is Not Poised To Succeed
Given the above possible competitive advantages that B&N could seize for its future without the Nook, a reasonable investor might question why management has made no steps forward on these initiatives. The answer is highly speculative, but a few observations come forward.
Senior management at B&N has little incentive to change its core structure. B&N's annual report correctly lists as a risk the ownership of 21.5% of B&N shares by its founding brothers, Leonard & Steve Riggio. Sometimes, having visionary founder can be a great asset, as any biographer of Steve Jobs will tell you (at length, one can safely assume). Unfortunately, as evidenced by Dell Computers, founders can sometimes become liabilities instead of assets. While we cannot know for sure, one suspects B&N's hesitancy stems from the 43-year tenure of its founders in key leadership positions.
One should also note that despite the rapid decline in Nook sales beginning in 2012, B&N leadership only announced the Nook spinoff in June 2014. It bodes ill for B&N that spinoff talks began in 2012 but required 2 full years of failing sales performance to bear fruit. Even after deposing their former CEO in 2013, management required 6 more months to appoint a new CEO, and 6 months beyond that to announce the Nook separation. One can assume it will require even more time to fully separate the business, given the historic speed of B&N's managerial corps.
In this time, B&N management has not meaningfully reformed any aspect of its core business or addressed any of the opportunities listed above.
Barnes & Noble Might Still Have a Future
Despite the voluminous points made above, there is still hope for this ailing company. Faced with the rise of the technology giants and the ebook market, B&N had 2 competitive options: 1) Rise to the challenge and build a reputation as the dominant ebook seller; or 2) flank its competition by fostering relationships with its communities. Having failed at the first goal, B&N might still have a chance with the second goal.
Despite writing off the Nook, B&N is still left with some strong assets. B&N has 1361 stores in total (700 on college campuses) across the entirety of the US. If B&N leveraged this diversity, local knowledge, and friendly staff, B&N might still have a chance to revive its sales. Imagine if store managers hosted events with local artists, tailored inventory selection to local preferences, redecorated stores around local tastes, and built a homely and friendly, "book club", atmosphere for visitors. While the details would be difficult and the road long, B&N could redefine itself as a conglomeration of "local" booksellers that smooth out business cycle fluctuations through profit sharing. While not likely, slim hope is better than nothing.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.