Idea: LONG BKS (disclaimer: I currently have no position)
Barnes and Noble: BKS
Stock Price: $17.45
Market Cap: $1.03B
Enterprise Value: $954m

Having recently read Joel Greenblatt's "You Can Be a Stock Market Genius", I've begun searching for companies that seem to fit some of the criteria that he looks for.

1. Companies where one segment is dragging down the entire company
2. Companies that are heavily out of favor (he finds ideas on the front cover of the WSJ)
3. Companies navigating through significant change
4. Companies with aligned management teams


Barnes and Noble seems to meet most of the criteria listed above:

1. Barnes and Noble operates in 3 segments. Retail B&M, College B&M, and Nook. Here is a breakdown of the last two years of EBITDA for each segment.

Trailing 12 months:
Retail: $374m
College: $111m
Nook: $(475m)
Total: $10m

Trailing, Trailing 12 months:
Retail: $322m
College: $116m
Nook: $(262m)
Total: $177m

It is very clear that the Nook segment has been to blame for the dramatic decline in the company financials over the last few years. Without the Nook segment, what you have left is a no-growth/declining B&M business that has generated $485m EBITDA in the last year.

2. Barnes and Noble has been called out as one of the primary victims of the "Amazon-effect" as well as a B&M retailer that is getting crushed by "showrooming"

3. Barnes and Noble has recently been through talks of selling/restructuring the Nook business, a potential buyout of the B&M business by their founder, and the resignation of their CEO.

4. Their CEO has recently resigned. The founder owns 30% of the outstanding shares. Owning 30% of the shares, he clearly has a strong incentive to turnaround this company and push for decisions that improve the financial performance of the company.

Valuation:

First I wanted to establish a range that the Retail and College segments are worth. I think a fair comparable for the B&M division is Best Buy (no growth/declining B&M retailer). Best Buy currently trades at 5.6x TTM EBITDA. If we give the Retail division 3.5x EBITDA and the College division 5x EBITDA, we arrive at a $1.9B value for these two divisions. I would argue that the Retail division could deserve more than 3.5x for the following reasons:

1. This company has been distracted by the Nook division for the last several years, likely resulting in less attention being focused on the Retail division (possible opportunity to optimize the chain)
2. The founder has previously expressed interest in buying out the retail division. It feels very unlikely that a potential buyout would go through at such a depressed valuation (3.5x)
3. Barnes and Noble Retail operates on 5 year leases. This flexibility should allow them to properly scale down the size of their B&M presence and prevent any significantly losses in problem stores going forward.

The Nook division is losing money hand over fist. I don't even want to try to place a value on it. My thesis relies on the elimination of the Nook division.


Making Connections:

I see a lot of similarities between Best Buy and Barnes and Noble. Both companies have been under very doom and gloom headlines for the last several years. Best Buy was under poor leadership that was distracted by new small format stores, expensive store remodels, and International expansion. Through all of this, they lost focus on the segment of the company that was their most profitable, Domestic Big Box stores. Since bringing in new leadership, Best Buy has frozen new small format store openings, frozen expensive store remodels, divested their International business in Europe, and focused on cutting SG&A and improving domestic performance. During that time, the stock has risen from $12 - $30. It feels like Barnes and Noble could see similar results by focusing on optimizing what made them great to begin with. A 5x EBITDA valuation for their B&M segments would give them a value of $2.5b, about 150% upside to the current stock price.

Questions:

1. Can BKS spin off or eliminate the losses in the Nook division?
2. Do they have the leadership team in place to simplify the business and focus on optimizing their B&M stores and website?

Conclusion:

If BKS can eliminate the losses in the Nook division, the stock is trading for 2x EBITDA and is significantly undervalued.

Analysis looks sound to me. Question is, will they simply throw nook in the trash/sell for a pittance, or try to keep it going? If the later, it's going to get ugly.

very surprised that the Nook is doing that poorly. the company still seems okayish except for that.

5x EV/EBITDA for a bookstore with declining comps with a dwindling store count is an absurd valuation. The bulls on this stock are not thinking about the stock that way. Here is what the bulls think:

1) Microsoft and Pearson (who both invested heavily in Nook media) think there is value in the Nook biz. Microsoft wants access to content and Pearson wants access to the college bookstore business. Even though its a money loser, it is worth something. It will also hopefully stop losing money soon...

2) CEO who left was the NOOK guy. Apparently he spent 99% of his time not thinking about the BKS store. New plan is to stop losing money in NOOK by only making e-readers and letting someone else make the tablets and B&N brands them and puts its software on there.

3) Bookstore really has no competition anymore (Borders bankrupt last year) and can be run cash flow positive for many years in the future.

The bear case looks like this:

1) Microsoft is terrible at allocating money and doesn't care about B&N today. There were reports that they had the opportunity to acquire the rest of Nook media and didn't. They also didnt even bother pre-installing BN software on the Surface which boggled my mind.

2) The NOOK will continue to be an EBITDA drag and the existing base of NOOK users will rapidly move on to other tablets. Management too stubborn to fold a losing hand.

3) Bookstore only has 3-5 years of positive cash flow left before its just not a viable business anymore.

Careful with the thought process that Riggio is your friend as a shareholder. Riggio is Riggio's friend. He offered to buy the bookstores away from BKS because he thought he could get them cheap, not because he wanted to help BKS shareholders. He was probably proposing to swap his stake in BKS plus cash for the stores, leaving current BKS shareholders with....? Also the idea that you can separate NOOK from the rest of the company I don't really buy. You sell the NOOKs inside the stores. You get the content from the same relationships the stores have with the publishers. Plus NOOK is losing money so who is going to pay the bills if there are no stores? If Microsoft passed...

It's certainly an interesting stock with lots of potential, but I think you should keep digging into the real issues going on here.

I think you bring up some valid points. I have concerns as well and hence no position but like you pointed out, there is definitely huge potential.

BKS is probably best looked at as a turnaround story. Your point about 5x EBITDA being an absurd valuation assumes that the stores are in perpetual decline. Clearly, if you think B&M bookstores are not viable going forward, this investment is not for you. My theory is that with the right management team and laser focus on store optimization, perpetual decline may not be the reality. I want to try and get a better indication about where the executives plan to place their bets going forward before jumping in. This is one I am watching closely because as soon as the direction becomes more clear, we know what the stock could potentially run up to.

yeah BCI12, can you look back and calculate ebitda decline rates for each divison for the past 3 years? if you can see the rate of decline it helps put a proper multiple on it.

What world do you live in where you don't think a B&M book store is going to be in perpetual decline?

Sometimes industries are out of favor for a good reason. You can't just buy something that no one likes and tell yourself that your value investing. You have to have a compelling thesis for why everyone is wrong and have the data to back it up.

You're using a lot of buzzwords but I have a feeling that you have no concept of what they mean in reality. You can't just have laser focus and raise your margins 10%.

something in perpetual decline could still be good value. hence my question on rate of decline the last 3 years

Here are the last four years of EBITDA by segment (in millions):

FY13
Retail: 376,090
College: 111,458
Nook: (480,418)

FY12:
Retail: 317,129
College: 115,947
Nook: (261,712)

FY11:
Retail: 259,066
College:113,446
Nook: (209,124)

FY10:
Retail: 328,368
College: 21,150
Nook: (68,498)

The more important question is whether BKS can maintain profitability while in decline (example. WDC)

I don't want to come across as someone claiming to have all the answers. I am certainly not an expert on this stuff. My interest in value investing was sparked by Ahnuld and his PRSC thesis several months back (I haven't been looking at this stuff for very long)

I used "laser focus" to represent the shift in company priorities away from Nook and back toward stabilizing the stores. Wasn't trying to imply that laser focus = automatic growth. When a company spends years pushing the Nook, it feels inevitable that aspects of the B&M business have likely been pushed to the back burner.

sorry, these numbers are in thousands not millions.

Sure something in decline can still have value. I'm just disagreeing with OPs main thesis taht the B&M business will not be in perpetual decline. His only reasoning being that the company will start to focus on B&M. That is the reasoning that I take issue with.

BKS may be good value. I have not done work on it. However, I can tell when someone does not have good reasons for investing.

Doesn't look very in decline to me.

Even adjusted for inflation, it doesn't seem that bad. What caused the drop from fy10 to fy11?

if this is true ill have to take a closer look. at first glance its looking like a clear buy

Noob clarification: Since the Nook is in parentheses, does it mean that it continues to lose more and more money year over year?

Yes. (x) = -x

their B&M profits really shot up the last 3 years. And revenue is barely declining. Where do you find those ebitda numbers?

it seems like they could do the NOOK business right. And it basicly failed because its not easy to use, has alot of hiccups and is not as attractive for authors then the kindle. Devil is in the details, and it seems like they messed that up. The shopping experience is also not as easy. Which is major on amazon. I probably bought a few books i shouldnt have. One click and its on your device without hiccups.

What is weird tho is that they are a bookstore and seem to be messing this up. Shouldnt they do this better then amazon by now?

Another weird thing is that they bring out tablets, Who buys these things? You either buy a ereader for reading because they are easier on the eyes (no background light) or you buy an ipad or samsung tablet. They seem to be much better at making those tablets. And you get much more content int he app stores. And you can read your books just the same on those devices too. Didnt those amazon tablets also have pretty dissapointing sales? So it seems to me unless B&N has unique content or a better user experience over amazon that NOOK business is pretty much dead?

Question: Any idea why the Nook losses mounted so much in 2012? Did they commit significantly more capital to it through either development or marketing and sales stayed low, or did sales drop off dramatically from years previous? Or did they commit dramatically more floor space in stores and count all the store expenses on a % floor space basis?

Seems to me those are critical questions to determine if the nook was actually losing money hand over fist or if it is taking more blame for the poor performance. (if nook takes 30% of floor space, turning that space into books isn't going to increase sales 30% imo)

10-K from 2012 and 2013. They list D&A and OI by segment.

In FY13 the Nook segment was hit with approx $200m in inventory write downs and $20m in goodwill impairment. Backing out these two would put the segment loss more in-line with the $260m loss in FY12.

hey, been doing more work on it and I think your marketcap is wrong.

Liberty owns some prefs that are convertible into common at 17$ a share. so 58 + the 12 million liberty shares means 70mm shares outstanding, roughly 1.26 billion market cap.

If the deal is that Liberty would have to pay the $17 to BKS when they converted, then only the current share price minus $17 would count in essence since BKS's cash on hand would go up by $17 per converted share. Since price is only $18.10 as of today's close, that's not much of an adjustment.

you're thinking of options. for prefs or convertible debt, the company already has the cash. in the case of convertible debt, it goes from debt to equity so it doesnt change the ev/ebitda equation but here the prefs are in equity so it wasnt being counted anywhere.