Barnes & Noble Inc. is undervalued, we are told, and Indigo Books & Music Inc. is one of the cheapest stocks on the TSX, when its ample hoard of cash is taken into account. Could it really be a good time to buy bookstore stocks?
The answer may be “yes” – as long as they figure out a way to, you know, stop selling books.
First, let’s look at Barnes & Noble, now the unquestioned leader in U.S. book retailing with nearly 700 stores averaging more than 25,000 square feet. The company is also the creator of the Nook tablet, a spiffy e-reader designed to compete with Amazon’s Kindle.
Excitement over the Nook has led to a parade of big names taking an interest in Barnes & Noble in recent months. Media mogul John Malone of Liberty Media owns a chunk of the company, and had previously offered to buy more. Microsoft Corp. and educational publisher Pearson PLC have each taken large stakes in the company’s Nook Media operations, which also include a chain of college bookstores.
Those investments lead some to a sum-of-the-parts valuation that suggests Barnes & Noble’s sum – it’s been trading around $13 (U.S.), around half its 52-week high – doesn’t reflect its parts. By investing $89.5-million for 5 per cent of the Nook business, Pearson essentially valued just that division of the company at nearly $1.8-billion. Barnes & Noble’s entire market capitalization, including its retail stores, is less than $800-million.
If you accept the Pearson valuation, Barnes & Noble’s remaining 78.2 per cent ownership stake in Nook Media is worth about $1.4-billion, suggests analyst David Strasser of Janney Capital Markets; give the retail business a multiple of just three times its roughly $350-million in EBITDA, or earnings before interest, taxes, depreciation and amortization, he says, and you derive a value of about $2.5-billion for Barnes & Noble – $33 to $36 per share. (Mr. Strasser has a “buy” rating and $20 fair value estimate on the shares.)
The problem with this glowing valuation is pretty much every underlying metric of the Barnes & Noble business. The company posted an 8.2 per cent decline in same-store sales over the nine-week holiday season, through Dec. 29. The Nook segment saw revenue fall 13.1 because Barnes & Noble sold fewer of the e-readers, and garnered a lower average price for the ones it sold.
Mitchel Klipper, the head of the company’s retail group, inadvertently caused news Monday when The Wall Street journal quoted him as saying the company will have 450 to 500 stores 10 years from now. A company spokeswoman quickly noted the company has been closing about 15 stores per year for the last several years, and this would just continue the pattern.
It would really be news if Barnes & Noble acknowledged that the move to e-books should cause them to markedly step up their rate of store closures. As it stands, the company seems unprepared to adjust its costs to meet the reality of its declining sales. And further deterioration across its businesses may show that the market’s estimate of the company’s value is more appropriate than that of its big-name investors.
Indigo doesn’t have problems quite on the scale of Barnes & Noble. Its Kobo reader, which the company sold off in a lucrative deal early last year, seems more popular in Canada than the Nook is in the United States. Indigo is also making a slow but so-far successful effort to change the mix of products in its stores, selling gifts and other objects to its literate customers.
It’s still a bookstore at the core, however, as its sales numbers reveal. In the quarter ended Sept. 29, overall sales fell nearly 6 per cent from the year prior, with a 6.5 per cent same-store-sales decline in its superstores. (Indigo said the Fifty Shades and Hunger Games trilogies mitigated the decline to just 2.2 per cent in small format stores, since blockbusters help the smaller locations more.)
What is Indigo’s retail business worth? Well, shockingly, for parts of 2012, if you stripped out Indigo’s cash, the remaining business fetched well under a dollar. (Indigo’s roughly $200-million in cash worked out to more than $8 per share during the summer months, even as the stock traded around $9.)
The market seems to have realized that valuation was a little extreme; the shares are up more than 20 per cent since the summertime. At around $11 (Canadian), with just over $7.50 per share in cash, Indigo’s business is valued at less than $4 per share.
That may, or may not, be cheap; the company will release its holiday numbers as part of third-quarter earnings Feb. 5. Indigo generally loses money three out of four quarters and makes it all up at Christmas.
Analyst Robert Gibson of Octagon Capital believes the company can produce 42 cents per share of earnings this fiscal year and 62 cents the next, as sales of everything but books offset declines in printed volumes.
That seems the best, and most curious, path for Indigo’s investors: The company becomes Canada’s leading gift shop for people who read books, yet won’t buy them in bookstores.
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