Barnes & Noble, better off without Nook & Malone.

Understanding both the bull and bear case – the theses of why other investors are positioned the way they are – has to be one of the most crucial principles of investing.

Every so often I read a press release or a headline that on the surface seems bullish/bearish for a specific equity. While it might be true on the margin, understanding what the bulls/bears are looking for might make that specific news relatively meaningless. This enables short term investors to trade and benefit, and even long term investors can “trade around” their core position and profit from this as well.

$BKS is a perfect example. In early February with the stock trading in the low teens, multiple news sources were reporting about how the company was laying off employees in their Nook division. I saw many people commenting on these articles that without the Nook, $BKS will become the next Borders or Blockbuster etc. $BKS’s supposed only shot of survival was their digital business, the future of books.

The reality however: For at least two years now $BKS bulls have wanted the company to wind down, sell, or spin-off the Nook. Why? Check out these two charts.

First let’s look at $BKS as a whole…

Barnes and Noble

Now, let’s see what happens when you take out Nook Media…

Barnes and Noble ex Nook Media

(A couple of points on the second chart. Barnes & Noble ex Nook Media also excludes the ~22% of BKS College that is owned by $MSFT & $PSO through their respective Nook Media stakes. Also, Retail revenues would be lower without the Nook business (as they sell nook devices in their retail channel, the company reports this as “elimination” in their filings), margins however would have actually been higher and the last two years of revenue declines would have been smaller.)

Without a doubt in my mind, this event, which was later confirmed in the company’s 10-Q, that the Board approved the move to “rationalize its NOOK business” on February 3rd – not coincidentally the day the stock bottomed – was not only a not a negative as many highlighted, it actually strengthened the bull case. (The market obviously agreed, and the stock went on a tear, rising 72% in the following month and half.)

Last Thursday, there were more headlines about $BKS. This time about Liberty Media “folding on their $BKS wager” and dropping one of their board seats. The stock fell over 20% in three sessions, as many in the media were saying how $BKS is done – even their largest outside investor (and most probably their wisest – Liberty is controlled by John Malone) is selling etc.

It’s OK to be uninformed,  it’s fine to just state facts, but why opine about the facts and how it relates to the company/stock if you have no clue? Actually, that’s fine too, it’s what makes markets inefficient and creates opportunities for the informed and educated.

Here are Malone’s comments on Liberty’s $BKS investment back in 2011…

“It would be a bit of a flier for us, on whether or not Barnes & Noble can play competitively with the likes of Apple and Amazon in the digital transformation”

On an absolute basis, I would be the first to admit, it’s hard to twist Liberty exiting as a positive, but is it a huge negative like people are saying? No, not in my opinion, and not at all for the upside of the bull case.

The bulk of Malone’s assistance to the bull case was for downside protection. He ensured that Riggio & Co would not do anything stupid or try to buy retail at too steep of a discount. (Liberty’s preferred shares came with veto power on any asset sale.)

Once it became clear that the Nook was winding down, why should he stick around? This wasn’t his style of an investment to begin with.

Having said that, Liberty did well on the deal. Their 185k preferred shares that they sold cost $1,000 each or $185M in total. They were receiving 7.75% in interest annually and they sold them for $1,355. My rough calculation says that’s about a 58% return in a little over two and a half years for a “failed” investment – the Nook optionality did not pan out as planned. Not too shabby.

On the other hand, think about the buyer. This was not a secondary offering where the company or existing shareholders sold these shares to the public. This was a privately negotiated transaction where on the other side someone actually plucked down $250M to buy these preferred shares. Their break even? $23.04 per share. (Each preferred share is convertible into 58.8235 common shares.) It wouldn’t surprise me if Daniel Tisch of the $L fortune was involved. He was the second largest shareholder at 8.4% (adding slightly to his shares according to his last 13G).

From the bear case perspective, the wind down of the Nook was a horrible development. They would rather see the company squander its cash in hopes of battling $AMZN / $AAPL etc. Malone’s exit is a win for them, I’d admit that, but it does not strengthen their long term bear case at all. Bears believe that the company is in a secular decline, where fewer and fewer people will buy physical books, so even the Retail business won’t be able to sustain its profitability. On that front nothing has changed. Malone was never there to milk the retail business.

Bottom line, not every press release, headline, report, or article, even if when isolated and on an absolute basis is actually a positive/negative, it still should not persuade action on its own. Know and understand the bull and bear theses. As investors, data and facts that change those are what really matters.

- Aron

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5 Responses to Barnes & Noble, better off without Nook & Malone.

  1. You comment as though these events occur on mount olympus. if you listened to the cc, you could have quoted management. They have no intention of managing the cash flow rich decline of retail segment, they will be using up “substantial” cash to invest in college division, “retooling” of NOOK, etc. Your whole article dismissed managment itself, and so your views are a bit bizarre.

  2. MicroFundy says:

    Daniel,

    Thanks for sharing your thoughts as well! ;-)

    It seems like you failed to understand the point of the post.

    I was simply stating the Bull case for $BKS. It obviously isn’t happening today – the Nook is still burning cash etc – or else the stock would be trading at 5x EV/EBITDA (ex nook) or ~$35 per share.

    My point was that once you understand the Bull case, it makes the Nook wind down an extremely positive event and even Malone’s exit, a non factor.

    In regards to management’s thoughts, I probably have listened to every call the last couple of years, but I’d much rather watch what they actually do and read the SEC filings stating actual Board decisions.

    - Aron

  3. MN says:

    I am encouraged by the actions being taken by Huseby and the board. Nook rationalization is the right step, perhaps needs to be more aggressive. Partners for Nook hardware should lower the cost structure meaningfully. With Liberty out, the ability to spinoff/split becomes easier. A Nook, College and Retail separation would be the most value creative, though more likely Nook and College stay together, especially if partners Microsoft and Pearson want such an outcome. Either way in the coming months BKS will see some corporate activity

  4. Peter Larson says:

    Most excellent piece. I’m glad some people can see the inherent hypocrisy.

    I’d like to add two things-

    1. Most of the Barnes and Noble bears are not really bears at all. They are simply Amazon fans who view Barnes and Noble as an obstacle, and not a separate entity to be understood on its own terms.

    2. If you go back and read Liberty’s initial investment agreement you will see that since mid-2013, BKS has had the option to convert the preferred shares into regular shares (i.e. stop paying dividends early) anytime the common stock rises above $25.5 for twenty (maybe 30? I don’t have it open) days. Since the stock was a hair’s breadth away from this target before Liberty sold, it is likely that this was Malone’s motivation. It had nothing to do with either nook or the core business.

  5. Pingback: Is Barnes & Noble the next Gamestop? | MicroFundy

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