Barnes & Noble: Microsoft Investment Just The First Step In A Nook Separation

| About: Barnes & (BKS)

On April 30, 2012 investors in Barnes & Noble (NYSE:BKS) woke to the news that Microsoft was investing in the Nook business. The stock soared in the pre-market. From its closing price on April 27 of $13.68 the stock traded above $27 as short sellers scrambled to cover before closing at $20.75. This should not have been a total surprise. In January the company had indicated that they were looking at alternatives with respect to the Nook business. Further, Jana Partners, an activist investor, revealed a significant passive stake in the company, which brought additional investor focus.

Since then the stock has traded down to $15.90 per share. The decline from the April 30 pre-market levels of ~$27 to the current price can be attributed to several factors. First, the $27 price was elevated by short covering and once the shorts had covered the incremental buyers were gone. Second, long investors who were suddenly sitting on 100% gains took profits.

However, this does not fully explain the current price, which at $16 is once again absurdly cheap.

The long thesis is fairly simple and has been written about by others so I will only summarize it here. On a sum-of-the-parts basis BKS is cheap. The Nook is worth 1.5x sales of $1.5 billion, which equates to ~$30 per share. The book store business, which has been losing share to Amazon, is still profitable and is worth 3-4x EBITDA as they migrate to more non-book merchandise and close underperforming stores to maintain overall profitability. Put together the company is worth more than $30 per share, but trades at $16.

For everyone involved in BKS either long or short get ready to be startled again. The April 30th Microsoft announcement was just the first step. BKS has clearly demonstrated an understanding that the market is not valuing the company appropriately and I believe management will take further steps to separate the Nook business from the retail book store business. A split, spin or IPO makes sense. Further, I would not be surprised to learn more about the plans for this separation when the company announces fiscal fourth quarter earnings on June 19.

At $16 BKS is a compelling risk/reward trade.

Disclosure: I am long BKS.