Name the Trickiest Potential Buyout Bet: Dell, Best Buy, Or This Company
Barnes & Noble (BKS) may be the latest company whose major shareholder hopes to take it private in order to execute some kind of major turnaround and strategic overhaul out of the public eye, and like Dell (DELL) and Best Buy (BBY), the company certainly needs the attention. In spite of the fact that the bankruptcy filing by Borders Bookstores in 2011 left Barnes & Noble as the last major national bookstore chain standing, the company so far hasn’t been able to juggle the mix of bricks and mortar bookstores (with ‘real’ books), e-book retailing and selling new e-reader/tablet devices.
Like Dell and Best Buy, Barnes & Noble’s stock has suffered. But in the days since word began to leak out that Leonard Riggio, the company’s chairman, would present an offer to the board, it has soared 13.25%. At one point even changed hands for $16 a share, a level it has touched only a few times – and briefly – in the last six months. For much of that time it has traded between $13 and $15 a share, and before word of the potential buyout offer emerged, had been hovering toward the bottom end of that range, as seen in this stock chart.
Clearly, investors are hoping that a deal of some kind will take shape, and that Riggio will end up as the owner of the retail book retailing division. That would leave current shareholders in possession of the company’s Nook e-book division, which has never made money for the broader company even as the company’s board and management insist that e-books are the wave of the future and oversaw a redesign of the stores to include a giant in-store Nook boutique in many of them.
But this transaction may prove trickier to understand and for an investor to navigate than either of the other major potential leveraged buyouts of Dell or Best Buy. In Dell’s case, the main bone of contention is whether Michael Dell and his private equity backers are paying a fair price for the company; in the case of Best Buy, whose founder Richard Schulze has hit one roadblock after another in his attempt to cobble together a buyout for the electronics retailer, the question is whether the underlying business can be valued in such a way to make it appealing to the lenders he would need to put together a deal.
The issue is that Barnes & Noble has become two businesses in one over the course of the last four years, and during that time – since the first Nook made its debut in late 2009 – the distinction between the still-profitable physical book retailing division and the digital reading/tablet operations has become more acute. The company has recognized this, increasingly separating the two businesses. Nook has attracted independent investments from the like of Microsoft (MSFT) and Pearson PLC – neither of which, presumably, found the idea of investing in the parent company and the ‘old fashioned’ business of book retailing all that alluring.
Part of the challenge will be for the Barnes & Noble board to determine what represents a fair price for that old-fashioned part of the business, especially since the buyer is an insider. It may be the profitable part of the business, but negotiators for Riggio can and will point to the fact that e-books appear to be the wave of the future, as well as to the decline in the overall stock price for the company. Barnes & Noble is planning to release its earnings for its fiscal third quarter on Thursday and has warned the market that it expects a loss on an EBITDA (earnings before interest, taxes and depreciation) basis from its Nook division in its fiscal year that will be even larger than the $262 million EBITDA loss recorded in the previous year. Clearly, Nook is weighing on the company’s financial health.
But book retailing is far from being an easy gig these days. True, a large majority of Barnes & Noble’s retail outlets today are profitable, but more store closings are in the offing and the recollection of the death throes of Borders are all too vivid. At this point in the cycle, it’s hard to determine which has less upside potential: the bricks and mortar business, locked into a fierce battle with Amazon (AMZN) (of the same kind that Best Buy has virtually lost) or the Nook division, fighting off competitive threats not only from Amazon’s Kindle devices but also Apple’s (AAPL) iPad. All that will make it harder for the two sides to reach an agreement – and make it more important for the company that they do so.
The Nook has been a boon for Barnes & Noble’s revenues but has weighed on its profits. With a sizable enough sale price for the bricks and mortar operations, the rump of the company that remains may have enough capital on hand to stop development costs and the constant need to innovate from being as much of a financial drain, thus perhaps allowing more of those revenue gains to flow through to the bottom line for investors.
But that doesn’t mean that a post-buyout Barnes & Noble (or whatever the surviving Nook-based company is renamed) will be an attractive investment. First, there is the fact of that competition: currently, the iPad’s main rival is Amazon’s Kindle, not the Nook, and there are a bunch of other devices making inroads onto the market. Rightly or wrongly, consumers just don’t seem to view the Nook as a tablet to the same extent that they are willing to treat the Kindle as one, even if the Kindle doesn’t offer all the bells and whistles of an iPad.
Buying Barnes & Noble at anything close to its current PE ratio means placing a bet on two separate outcomes: firstly, that the board can extract a hefty price for the physical book retailing assets from Riggio and secondly, that management is able to do whatever it takes to turn the Nook into a viable rival to both the iPad and the Kindle. History suggests that the odds are against that happening. Short-term trends don’t favor taking a big bet on Barnes & Noble either. With earnings due out on Thursday, and the company already having taken steps to caution investors against being too optimistic, the stage is set for a rapid turnaround in investor sentiment.
Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at firstname.lastname@example.org.