For the past couple of weeks I have been looking at different booksellers, including Barnes & Noble (BKS) and Borders Group (BGP). Most of the news that I get on this pair is in terms of losses and how they plan on turning those losses around.
At first I looked at BGP, with its stock price newly above $1 per share, but in my research I kept coming back to BKS as a possibly much stronger short candidate. With a price of around $16 and a market cap of almost a billion dollars, compared to $1 a share for BGP and a market cap of about $75 million, there is clearly a lot more to be made by shorting BKS if it implodes than with the BGP, possibly a dead company walking.
BGP moved up in price by about 30% due to the possibility that they may be able to do some restructuring of finances. BKS was also up on Friday but only about 1.5%, and I find it interesting that they would be higher at all. In my opinion, BGP being able to stay afloat longer would be a net negative on BKS.
BKS is an almost billion dollar seller of books and content in both retail and online. As of May 2010, BKS operated over 1300 bookstores. Part of the BKS company is “B&N College”, which has its focus on college related sales and accounts for about 25% of total revenue.
BKS appears to not be having success in the retail environment based on a statement made on page 5 in its last annual report "repositioning its business from a store-based model to a multichannel model....." My understanding is that means retail is "dead" for BKS and they are putting their bet that they can continue to go forward, setting up a webstore to sell the product. In doing so, BKS reduced the store base by about 100,000 square feet, or about 1.5% of the total they had two years previous.
This is a reverse of the statements made in the 10-k (annual report) filed 4/1/2009. In that report, on page 3, BKS states that in 2009 they would add more store size to their base. Obviously the retail landscape in general has changed dramatically from the start of 2009, but will it improve going forward? I suggest that for book sellers the retail environment will not improve and that the physical delivery method of books will face increasingly stronger headwinds going forward.
With new technology in ebooks and growing acceptance of electronic format for books which can simply be downloaded (for a payment and including free), it appears to me that physical book stores will turn into a much smaller share of the market as time goes on. Amazon (AMZN) and Apple (AAPL) appear to have greater name recognition at this time, giving them greater ability to monetize the change over to electronic delivery on content.
The barriers of entry into the space appear to be very minimal as well. The cost of setting up a well designed website that takes payments and allows downloads is not beyond the ability of any good college student web designer. BKS does have a product called the “Nook Color”, currently at a price of $249, but it competes against a $139 Amazon Kindle and an iPad for $479. People who are looking for cheap would seem to gravitate towards the Kindle, and those that are not price sensitive would seem to want the latest greatest “i” thing. However, the Nook has won some awards, including cNet and “The Best Dedicated eReader” by the Associated Press, so it cannot be totally dismissed.
My belief is that products like the iPad, and others like it, will come down in price to the point that dedicated devices will eventually disappear. This will leave sellers electronic books in the awkward position of having a commodity product whose sales are based largely on price, which is rarely good for margins. BKS not only sells its Nook in its own stores, but also at Best Buy (BBY). Today I stopped at the local Best Buy to have a look at it. I found it among several other products on the shelf, but it was given a fair amount of shelf space. The presentation from the display unit was less than inspiring but better than at least one other product. The Nook does appear to be selling well and has its fans, but overall I think the product will face a tough road forward.
Competition comes from both bricks and clicks: Borders, WMT and COST sell physical books and Amazon sales are on the internet. There are also several lesser known companies both online and retail. Looking at the sales numbers and patterns, it appears that more store closings are on the way.
I took a look at Edgar Online to find out the numbers and to see how closely the top and bottom line match up with my theory that physical delivery may have seen its best days already.
The stockholders’ equity was listed as (fiscal and not calendar years):
- 2007: $1,164,865,000
- 2008: $1,074,720,000
- 2009: $921,614,000
- 2010: $901,818,000
- 2007: $5,139,618
- 2008: $5,286,674
- 2009: $5,121,804
- 2010: $5,810,564
Earnings per share:
- 2007: $2.31
- 2008: $2.08
- 2009: $1.33
- 2010: $0.64
These numbers indicate to me that sales are not yet a problem, but the quest to turn the sales into profit is headed in the wrong direction. Taking a closer look at the last 10-Q filed 12/9/10 (.pdf), page 14 states that sales at retail and online have fallen while BKS College has added to sales (B&N College acquisition was completed on September 30, 2009). BKS shows an operating loss for the latest quarter. BKS does have the possibility of being bought out if they can find someone that believes that the end of the physical delivery model is not near the end, or if BKS can turn its online business into a profitable venture going forward. Even serious talk or rumor could send the stock much higher if the massive 42% short ratio tries to cover at once. Holding short has also not come without a price in terms of dividend payments (technically in lieu of).
It appears that BKS has about 52 cents per share in cash and a negative cash flow, so shorts may have paid out the last of dividend payments. If the shorts do not get squeezed soon from a buyout, it does appear to me that they will ultimately be proven to have made a profitable trade. I will be looking in the coming week for a short entry and with options available, I will be looking to sell premium, provided implied volatility justifies the possible take-over risk.