A Samsung Nook Can Justify A Buy For Barnes & Noble

| About: Barnes & (BKS)
This article is now exclusive for PRO subscribers.

Summary

Barnes & Noble's nook has been dragging down the bookseller for years.

The next Nook will use the hardware from Samsung's Galaxy Tab 4.

This is the company's best decision yet for Nook, and could finally be the solution in lifting the company off the ground.

Introduction

Despite having a successful bookstore business of nearly 700 stores, Barnes & Noble (NYSE:BKS) has suffered from a continuous failure in creating a successful e-reader, the Nook. After making big changes to the Nook business, the retailer has recently announced an arrangement to outsource the hardware to Samsung (OTC:SSNLF) (OTC:SSNGY), who has experience in making some of the world's most popular devices. For the last several years, the stock has been a trading machine with no real direction. Nook has been dead weight, and thanks to the latest agreement from Samsung, Barnes & Noble may have its best chance yet in finally lifting the company off the ground.

The dragging nook

Despite the company's survival through the fall of many booksellers over the last decade, its Nook division has held it down, while causing massive frustration. By the time the Nook was launched at the end of 2009, Amazon (NASDAQ:AMZN) had already released several versions of the Kindle, and it wasn't long before Apple (NASDAQ:AAPL) changed the tablet world with its iPad a few months later in the following spring. At that point, the highly competitive market and the advantage of its rivals tore the Nook apart. Nook lost the company hundreds of millions, and last quarter, the declining business posted an overall Nook revenue decline of 50.4%, down to $157 million.

Digital Content Is Still Captivating

Aside from the undesired Nook tablet, the sector as a whole contains some captivating digital content. There are over three million titles available, including leading magazines and newspapers, and the broad selection doesn't end there. The bookseller is even working on an expansive international catalog. Barnes & Noble really, really wants this business to succeed, and has been doing everything from making tablets to attaining as much content as possible. If we break down Nook's performance further, we see that devices and accessories declined by 58.2% to $100 million due to lower unit sales and lower average prices. On the content side, we see a subtler decline of 26.5% to $57 million, which was stated by executives to be due to lower tablet unit volume sales.

Digital content sales feed on the sale of digital devices like how creamer relies on coffee sales. They're complements. Last year, Barnes & Noble only launched a single E-ink reader, compared to the prior year, where it launched two tablets, the Nook HD and HD+, which are nearing a long two years into its cycle. When you consider that there were significantly more devices sold and available in the year-ago period, a 26.5% decline can represent that the business is holding up its own fort and just needs a compelling tablet to improve its sales.

Changes in the Nook business

As the inexperienced Nook lost the bookseller millions by trying to compete with superior devices by Amazon, Apple, Samsung, and even Google (GOOG, GOOGL), the company has gone through many changes to keep the business alive. Since fiscal 2014 began, the company has reduced Nook's headcount by 26%, with the elimination of 190 Nook positions. In addition, the sector has been operating under a new management team, whose efforts have allowed the sector as efficiently as possible. As a result, the company narrowed its EBITDA loss by 68% from the prior year. Barnes & Noble is not going to give up on the area, and as one of the last major bookstores, it plans to provide books to its customers in all formats, digital and physical.

A Samsung Nook is the best idea yet

When Nook was first launched, Amazon had already gained two years of experience in the area and was coming up as the underdog; and the underdog it stayed. As compelling as the Nook was after its launch, it was highly inferior to the competition, and its software was buggy and choppy, with complaints from both customers and reviewers.

Source: Bloomberg

The upcoming Samsung Nook will be based on the 7-inch version of the Galaxy Tab 4 pictured below; a 10-inch version will later follow. Below, I put together some specs that you can use to compare the current Nook HD to the Samsung Galaxy Tab 4. At the same MSRP, the Samsung tablet is lighter and thinner, while sporting more processing power, RAM, and internal storage, in addition to front- and rear-facing cameras. The Nook HD is still decent, but it required huge investments for development by Barnes & Noble, while Samsung just made a new version of its tablet. By switching to Samsung, customers are more likely to engage in the newer, more prestigious e-reader, and Barnes & Noble wont have to worry about launching the latest, cutting-edge technology.

Pricing will be very important

I would prefer not to bore you with more specs and review-like details, but the Nook was a flop, and understanding how Samsung's tablets compare to the competition will be important in visualizing the potential.

In the chart below, I added the specs of the Kindle Fire HD and Kindle Fire HDX, Amazon's competing 7-inch tablets. The Kindle Fire HDX costs 65% more than the lighter Galaxy Tab 4, and only features slightly more RAM, processing power, and a higher-resolution display.

A Samsung Nook at a price point of $200 could be very advantageous to Barnes & Noble, but I expect a price point below $200. This may be possible, as the Tab 4 currently costs $180, while the HDX costs $244 on Amazon. If available at an attractive price, the Samsung Nook will easily bring more readers into its ecosystem, especially the millions who visit the hundreds of stores scattered around the world.

Revenue Impact

By agreeing to purchase 1 million tablets from Samsung over the first 12 months, which includes the 7- and 10-inch versions, B&N is confident in its new approach. Assuming an average price of $200 each, if B&N meets its goal, it will generate $200 million in addition to the proceeds from accessories, its E-ink reader, and the current Nook tablet that it is liquidating. It is unclear what margins of the sales will look like, but I am confident that the bookseller will reach its goal, thanks to a high-quality, affordable tablet. This will ultimately restore the Nook business and allow digital content sales to prosper, giving the company its greatest competitive edge against Amazon yet.

Things are great outside of Nook

Thanks to the focus of the new Nook management team, Samsung has worked on reducing inventory and stabilizing the business, saving it from losses on the same level as before. As a result, without withdrawing from its $1 billion line of credit, it doubled its cash to $490M from the same year-ago period. The company's educational toys and games division has increased by 12%, with the company outperforming the industry. Even as the leader of the collegiate market, the bookseller is still focusing its efforts in the right direction by investing in rentals, which showed a 63% year-over-year increase as a result of students finding comfort in rentals.

Conclusion

There are many investors that have urged for Barnes & Noble to cut Nook, but the stubborn company continues to persevere. The bookseller believes that its success as a bookstore is reliant on its ability to offer books in all formats, paper and digital. I find that the Samsung-based Nook is one of the greatest steps that the company has made for the division. By eliminating the worry of trying to compete with the greatest tablet makers in the world, the company has significantly lightened its shoulders and positioned itself to generate a successful e-reader business.

A word of caution

Although I am optimistic about the long-term outlook of the stock even at its current levels, I advise caution due its performance as a consistent trading machine with a wave-like chart occurring for several years. Having risen 25% in the last month, I think that there is a potential for a minor slide, but again, in the long run, I believe that even its current levels represent a significant upside.

Here are some charts to see the trends (1 month, YTD, 5 years) I discussed above:

BKS Chart

BKS data by YCharts

BKS Chart

BKS data by YCharts

BKS Chart

BKS data by YCharts

Disclosure: The author is long BKS. 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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.