Barnes & Noble's hard turns should worry investors

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For much of the year, major investors in Dell have been complaining that Michael Dell is trying to walk off with his namesake company with a bargain-priced going-private bid.

The grim news at bookseller Barnes & Noble is that its founder may not have found the company worth buying at any price.

Len Riggio, the company's chairman and largest shareholder, had said in February that he was mulling a bid for the company's retail bookstores. Barnes & Noble's digital-reader business, Nook, would remain with the company.

Tuesday, as part of the company's dismal earnings announcement, Mr. Riggio said he is suspending his bid. "I believe it is in the company's best interests to focus on the business at hand," he said.

For much of this year, Barnes & Noble's shares were buoyed by the prospects such a split-up might bring. A number of big names, such as Microsoft and cable mogul John Malone's Liberty Media, have invested in the Nook. If Mr. Riggio paid a fair multiple for Barnes & Noble's retail stores, other tech types might then buy the unprofitable Nook business. Most of these dreamy scenarios resulted in predictions that Barnes & Noble's shares could at least double.

Things look very different now. The retail segment posted a revenue decline of nearly 10 per cent in the first quarter that ended July 27. Comparable-store sales, revenue from locations open at least one year, fell 9.1 per cent including Nook devices, 7.2 per cent without them. The company noted that last year included megahits The Hunger Games and Fifty Shades of Grey, but even excluding those, the drop was 2.9 per cent.

Here's the problem with falling sales: Barnes & Noble has a large cost base thanks to nearly 700 large-size superstore formats. As sales fell by more than $110-million year-over-year in its retail division, the company couldn't cut costs fast enough to maintain its previous level of profitability. The retail segment's EBITDA, or earnings before interest, taxes, depreciation and amortization, fell more than 15 per cent, to just under $65-million.

The value case for Barnes & Noble goes something like this, as articulated in the Wall Street Journal's Heard on the Street column Wednesday: the retail segment had $363-million in EBITDA in the last 12 months. Put a multiple of five times that, and Barns & Noble fetches $26, versus the sub-$15 trades after news Mr. Riggio was suspending his bid.

The problem, of course, is that it seems EBITDA is declining, not growing. The minimal multiples Barnes & Noble is getting show the market believes the trend of shrinking sales and profits will continue.

The next chapters in this story may be deeply troubling for investors who are hoping for a turnaround.