- Evidence is building that lack of ebook execution is detrimental to a print book operation.
- Barnes & Noble's digital efforts are severely lacking and this has started to bleed over to its print sales, where it continues to fall further and further behind Amazon.
- I am unconvinced that Barnes & Noble's liquidation value exceeds its share price at even these price levels.
- Most of Barnes & Noble's book value is in goodwill and trade name, which I do not believe can effectively be monetized.
- It is also possible it would have to write down its largest asset, book inventory, in order to liquidate it, making its liquidation value as low as $0.13.
Barnes & Noble (NYSE:BKS) shares have now fallen below $5 after earlier rising as high as $8 per share. As the first company to really feel the searing competition of the Amazon (AMZN) effect - along with defunct competitor Borders - B&N’s decline isn’t so surprising. But it can almost be easy to forget as Amazon conquers ever-more new worlds that there is one major competitor still standing in its original field of books.
With B&N’s $0.15 quarterly dividend intact for now, yields are approaching close to 13% on an annual basis. The question is whether these yields represent value - or a value trap.
A Wrong Turn
The book industry for some time has been trending towards its digital future. The primary difference between Amazon and B&N for the past few years has no longer been how they distribute physical books, online or in stores, but rather how they distribute books, physically or digitally. Amazon has led the way in digital with its Kindle platform, offering both cheap hardware and low-cost ebooks, published increasingly by independent authors outside the established publishing houses.
Barnes & Noble, meanwhile, went just the opposite way, recommitting to its symbiosis with the physical book market. It raised prices on ebooks to make them less competitive with print books, and at first it seemed to work. Although ebook revenues fell, overall revenues rose as physical book sales saw a big bounce in 2015.
It also continued to base its business around the Big Five publishers. As of its most recent Annual Report (June 2018), Penguin Random House accounts for 27% of all Barnes & Noble’s sales on its own, and the next four publishers combined account for another 40%.
Coming Off The Sugar High
B&N has hit renewed difficulty in recent years, however. Like a sugar high, the temporary boost to physical books has faded, leaving only the underdeveloped ebook operation in its wake.
Part of the problem is that the “ebooks are contained” narrative was never entirely correct. News stories about stagnating ebooks and digital fatigue and renewed physical sales were a dime a dozen for a while, but that was largely because independent authors had no way of being counted by traditional industry surveys. Major publishers were seeing falling ebooks and rising print books. But their overall sales weren’t growing very much, despite print books costing more.
When a proper way to survey independent authors finally showed up, we found out why. Bookstat is a new survey for all print and digital book sales that finally incorporates independent authors properly. Bookstat’s own independent figures showed that in fact, ebook sales never fell at all. If anything, growth has accelerated since Barnes & Noble’s paradigm shift. More ebooks than ever are being sold.
Nook Is Dragging Down B&N Retail
They just aren’t being sold by Barnes & Noble. In essentially trying to push customers into buying more expensive books from their authors, the Big Five publishers have instead pushed their readers into the arms of independent authors who are willing to charge far cheaper prices on books. This has indirectly hurt Barnes & Noble, which as I said relies on the Big Five and other traditional publishing houses for the overwhelming majority of its business.
Ebook stagnation has also bled over into the print arena. Increasingly, it seems to fall behind in one is to fall behind in both. As it continued to accrue market share in ebooks in excess of 70%, Amazon’s online print sales also rose 27% in 2018, while all other print outlets, both brick-and-mortar and online, fell 8%.
Barnes & Noble is hands down the biggest member of that “non-Amazon” category. This followed a 2017 holiday season where Barnes & Noble reported a 6.5% decline in sales. That rough Christmas led to a particularly harsh round of job cuts, as some of the chain’s most experienced store employees showed up to work one morning to be summarily told they no longer had a job.
Thus, reports of Barnes & Noble’s potential turnaround and outstanding value for investors seem to be substantially exaggerated. It is not entirely clear where B&N’s next phase of growth will come from, or how it can reasonably maintain its print operation with its digital operation so far behind Amazon. It seems to me only a matter of time before the dividend is cut or even eliminated.
Intangible = Unusable
The other big argument in Barnes’s favor is that its liquidation value alone is higher than its current share price, thereby offering upside to shareholders. B&N’s balance sheet lists assets over liabilities of $473 million, penciling out to over $6 per share on a $4.50 stock.
But I wouldn’t count on it. Take another look at the company balance sheet. Of $1.8 billion in listed assets, only $16 million of it is cash - less than 1%. Almost $400 million is intangible assets which are not only not liquid - they might not even have value at all.
Never mind the goodwill, which is $71 million of “assets” on B&N’s books that might as well not exist. The more salient detail is that of $309 million in other intangibles, $293 million of it turns out to be “Trade Name” value - another thing likely to evaporate upon a bankruptcy filing.
While someone may be more likely to buy from Coca-Cola or McDonald’s because of their brand, there is little reason to suppose B&N’s brand has any independent value once the stores that built that brand are closed. Unlike the unique tastes, recipes, and services of some brands, the books that B&N actually sells - the actual product - are not materially different in any way from the same books bought elsewhere. Indeed, that fungibility and consistency is precisely why Jeff Bezos chose books as Amazon’s first product category 25 years ago.
It's All About The Books
Hands down, the largest asset is its inventory of books, which is currently sitting at $1 billion - over half of the total, and over 70% of the tangible assets. While technically there are various contractual rights to “put back” some of this to the publishers, practically speaking, those publishers can’t afford to take back everything from a retailer as large as Barnes & Noble, the last of the great brick-and-mortar book chains. That leaves actual liquidation, which would have to be done at substantial markdowns.
Barnes & Noble accounts for inventory using the standard retail inventory method. Typically for books, that means being sold at wholesale for half of retail price, but B&N also sells movies and music whose wholesale margins are usually a little higher. For now, I will use 50%. That means that as long as B&N could sell books for 50% of list price in a liquidation, they’d get the full billion. What would the actual margin in a liquidation sale be?
For Toys 'R' Us, discounts of 50% to 70% were offered to close out the stores. If we midpoint that at 60%, then B&N will suffer a 20% loss on its inventory in liquidation. That pencils out to another $200 million in losses. Even if you think a liquidation wouldn’t be so bad, and we assume only a 10% haircut to values, the $100 million in inventory losses and losses on Trade Name and goodwill come to $464 million, leaving just $9 million in actual equity value - roughly $0.13 per share. If you take the full $200 million loss, B&N equity actually has no value.
And even if you assume no inventory losses at all, the intangibles alone are enough to take book value down to well below $2 - a fraction of what the stock is currently trading for.
I do not believe that B&N is on the verge of a turnaround, and I see a dividend cut at least in B&N’s future, if not a full-blown bankruptcy. If bankruptcy does happen, I am less sanguine than some that B&N’s entire inventory can be liquidated without further damage to balance sheet values. Nor do I see any ongoing value to the trade name independent of the stores that would have to be closed. As such, I am unconvinced of B&N’s value as either a going concern or a liquidation play. I will avoid B&N.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in BKS over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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