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Bookstores' next chapter hard to read Add to ...

The prospect of a merger between Barnes & Noble and Borders Group has added an intriguing plot twist to the continuing saga of the retail book business, but analysts are still unsure whether the traditional players in the fast-evolving industry can craft a happy ending to their turbulent story.

The stocks of the two big U.S. bookstore chains jumped this week following news that Borders' biggest shareholder, hedge fund Pershing Square Capital, has offered to finance a $960-million (U.S.) merger with Barnes & Noble, its larger competitor, at $16 a share. Investors' excitement over the potential deal also triggered a retreat in the share price of Canada's big publicly traded book retailer, Indigo

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Though it's far from certain that such a deal will get done - Barnes & Noble, which has been up for sale since August, is believed to have several bidders kicking its tires - investors nevertheless reacted enthusiastically to the possibility that the two struggling competitors might combine forces, shrink their number of stores and trim their costs as they struggle to transform their business against the fast-growing threat of digital books.

"You've got to think it would at least buy them some time," one industry analyst said.

That time is needed for the companies to move away from their old business model and fully embrace the future - a future where books exist only in digital form, bought not off a bookshelf but off the Internet, contained not between covers but in the microchips of electronic reading devices.

The digital revolution is hitting the book business faster than a lot of industry watchers predicted - and that has built a hefty amount of uncertainty into the stocks of book retailers, which have seen their stock prices dwindle to bargain levels over the past year.

"The problem is an accelerated adoption of e-books and the increasingly competitive nature of the e-book space could materially obscure near-term earnings visibility," RBC Dominion Securities analyst Tal Woolley wrote in a recent research report on Indigo.

Indigo's Appeal

Analysts consider Indigo easily the most attractive stock in the small North American book-retailing space. The company offers growing earnings and a healthy 3-per-cent dividend yield.

By comparison, Barnes & Noble and Borders both lost money last year. Analysts say Indigo has been quicker than its U.S. counterparts in seeing the threat of e-books, and moving into non-book products such as toys, as well as developing its own digital strategy with its 59-per-cent-owned Kobo Inc. electronic-books subsidiary.

However, the competition in e-books is growing more fierce. In addition to Amazon.com and its successful e-book business built around its Kindle reader, Apple Inc. is also ramping up its e-book business, and Google Inc. just launched its online e-book store this week.





Adding to the confusion is the fact that Borders is a minority partner in Kobo, which not only sells digital books but has developed a downloadable e-reading software application as well as its own e-reader device. Kobo is in direct competition with Barnes & Noble's Nook e-reader, which would likely be the platform of choice for a merged Borders/Barnes company. "There is a concern [for Indigo] for sure," said Robert Gibson, analyst at Octagon Capital Corp.

But the digital-books race also brings opportunities. Mr. Gibson said analysts have routinely erred on the conservative side in their forecasts for growth in the digital market. He believes the digital sales numbers built into analysts' financial projections for book retailers are more likely to surpass the Street's targets than fall short of them. "This [digital]market is growing faster than anyone expected," he said. "There may be upside for everyone."

Still, the big question mark is how the market pie will get divided among the e-book competitors.

"The market is growing, but competition … is set to increase, too," Mr. Woolley wrote in a recent note.



Unfinished stories



Indigo Books & Music





Stores: 396 (various banners)



Wed. close: $15.01, up 21 cents



Trailing 12-month share profit: 99 cemts



Barnes & Noble



Stores: 1,350



Close: $15 (U.S.), down 56 cents



Trail. 12-month share loss: 79 cents



Borders



No. of stores: 1,000 (approx.)



Close: $1.38 (U.S.), up 10 cents



Trail. 12-mo. share loss: $1.70

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