Monday, November 9, 2009

A Sale at Barnes & Noble

The price war between Amazon (AMZN) and Wal-Mart (WMT) over best selling books got a lot of press recently. It hasn't done Barnes & Noble (BKS) shares any good.

Nevermind that Barnes & Noble is working closely with Wal-Mart and that best sellers account for only 3 to 5 percent of BKS' sales. Conventional wisdom says that BKS is the second coming of dinosaur Blockbuster Video (BBI).

People don't read any more, right? And Barnes & Noble = Books.

The longer I'm in this business, the more I realize that most investors don't look beyond the headlines. Amazon good. Barnes & Noble bad. Simple, except the truth threatens this world view.

Amazon has a sizable exposure to books too, yet it garners a ridiculous valuation. The case for going long BKS and short Amazon is effectively outlined in a recent Seeking Alpha article. Rather than reiterate the points of comparison, I'll focus on Barnes & Noble as a standalone investment.

Barnes & Noble is the premier brick and mortar retailer in a still fractured bookselling market. Borders (BGP) is overleveraged and struggling. Books-a-Million (BAMM) is in better shape, but is less than a tenth the size of BKS. In short, BKS has plenty of room to grow.

With 57 million shares outstanding and a recent price of $18.50 a share, the company has a market value of just $1 billion. This slight market cap results in a silly price-to-sales ratio of less than 0.20.

In recent years, Barnes & Noble has spent aggressively to upgrade its stores. Capex spending is now being throttled back and free cash is flowing. In fact, the company is expecting at least $100 million in reported free cash flow this year. Actual free cash flow should be much higher.

The company is budgeting $125 million in capital expenditures this fiscal year. Of that, $50 million is for new investments as opposed to maintenance. BKS is selling for 10 times free cash flow at most (and perhaps as little as 6 times).

The recent acquisition of Barnes & Noble College Booksellers should provide an added tailwind. In a slightly awkward (some might say incestuous) transaction, BKS bought College from the Riggio family, which also happens to run/control BKS with a stake of around 40%.

How's that for insider ownership?

Barnes and Noble paid $514 million for its corporate cousin. The transaction reunites the Barnes and Noble brand and adds an attractive, stable market for BKS. Before the deal, Barnes & Noble had annual sales of roughly $5 billion. College adds about $1.8 billion a year to the mix. So B&N College Booksellers represents about 25% of total company revenue. For this, BKS paid a reasonable $514 million (or 5 times EBITDA).

Recall that all of Barnes & Noble (including the College acquisition) is valued by Mr. Market at only $1 billion. So College represents 25% of sales and 50% of the value? Something's wrong!

With their College proceeds, the Riggio family could conceivably take all of Barnes & Noble private. Their deal closed just weeks ago, but the market has already handed the Riggio's a gift. An aside: Leonard Riggio is the founder of Gamestop (a former BKS subsidiary). His recent sales of GME shares easily provide the extra cash needed for such a purchase.

Something is going to give. Barnes & Noble shares should trade above $30 a share.

Despite the "Booksellers" tag line on every store, Barnes & Noble is far more than a bookstore. They are a very capable retailer with a bright future.

If only the market realized it.

Did I mention that BKS pays a healthy 5.5% dividend?

Barnes & Noble deserves more than a cursory read.


Disclosure: The author owns shares of Barnes & Noble.

4 comments:

  1. OK - now you make me want to buy BKS as well...

    ReplyDelete
  2. Hi, my name is Eric Kuang. I have a private matter to discuss with you, can you send me your email address to eric@gurufocus.com?

    Thanks,

    eric.

    ReplyDelete
  3. do you still own barnes and noble?

    ReplyDelete
  4. good job!dude. I am a value invstor. BKS is my favorite!This is Jay.Email me@ jshi_mail@yahoo.com. Let's talk about the recent buyout rumor. you wont be lonely...

    ReplyDelete