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Note: This story originally appeared on BW Online's Daily Briefing on June 10, 1998.

If you listen to Internet stock analysts as they talk about booksellers, you'll hear how (AMZN) has gained such a hold on the online business that even the aggressive entry of Barnes & Noble (BKS) into E-commerce hasn't been able to dampen its growth. Amazon stunned the investment community with first-quarter revenues of $87 million. That was enough to earn it a third-place ranking in bookstore sales behind Barnes & Noble, which sold $666 million worth of books in the quarter, and Borders Group (BGP), which sold $545 million worth.

Internet analysts also like what Barnes & Noble has accomplished in terms of brand-building since launching its site in March, 1997. It sold $9.4 million worth of books online last quarter. But these analysts practically write off Borders, arguing that its entry into online retailing has been marketed too little and comes too late. Just last month, Borders announced a preview version of its site, which emphasizes music and video sales as well as books. "Every month they wait is putting them behind the eight ball," says Ryan Jacob, portfolio manager of the Internet Fund, who is still waiting for Borders' full-fledged launch.

William Blair's Internet analyst Abhishek Gami sums up the bookselling scenario with this analogy: Barnes & Noble and are like McDonald's and Burger King, slugging it out on competing street corners in the center of town. Meantime, Wendy's (i.e. Borders), has opened up shop in a quiet area and isn't spending on promotion. "It may be profitable, but will it ever get to be the size of the other two competitors?" asks Gami. "Probably not." Ultimately, he thinks Borders' late entry to online will hurt its growth rates.

At least that's how the Street's Internet-watchers see things. But check in with traditional retail analysts, and you'll hear almost the reverse assessment of the three largest booksellers. Borders is the one many retail mavens like best, in part because its conservative, earnings-driven management has taken a more cautious approach to opening up new superstores and expanding online. Of the three, Borders is rated highest by the analysts surveyed by First Call. It gets a score of 1.4, (on a 1-to-5, best-to-worst scale), while and Barnes & Noble earn scores of 1.8.

Traditional retail analysts (who often don't cover Amazon) also like Barnes & Noble, but they wonder if the company really needs to spend so much on online marketing. Not long ago, Barnes & Noble guided analysts to reduce their earnings estimates because of its increased spending on the Internet, "which makes some investors nervous," says Christopher Vroom, an analyst with BT Alex Brown. On May 21, Barnes & Noble reported a loss of $3.3 million, or 5 cents per share, for its fiscal first quarter, thanks to the $8 million net loss, or 12 cents per share, from its division.

While impressed with's growth rate, the retail analysts scoff at the kind of thinking that has given Amazon -- which isn't expected to make money until 1999 and lost $27.6 million in 1997 -- a $2.2 billion market cap. In fact, that's just a bit less than the capitalization of Barnes & Noble, which last year earned $64.7 million, or 96 cents a share. Both Barnes & Noble and Borders, which earned $80.2 million in 1997, are expected to grow at around 25% a year long-term, while is expected to grow at 100% a year. Vroom rates Barnes & Noble and a buy, but he gives a strong buy to Borders.

In truth, there is room in the growing market for books for all three to do well. The population is aging and getting more educated -- two demographic trends that lead to more book buying. The superstore format championed by Barnes & Noble and Borders has been tremendously successful. Superstores now sell 14% of all books, and that number should increase to 50% ultimately, predicts Vroom. "They are still in the very early stages of market share growth," he says. He also expects 15% of book buying to migrate online, where he thinks Amazon will maintain its dominant sales position.

Which stock should you buy? Clearly, the three top booksellers have very different strategies and which one comes out on top will depend largely on whose management has the most accurate vision of the future of online retailing.

If you aren't sure the Internet is all it's cracked up to be, go with Borders. "Its management is perceived by Wall Street to be more bottom-line oriented," says William R. Armstrong, a retail analyst with Fahnestock & Co. "If the Internet turns out to be a profitable way to sell large amounts of books, then Borders is going to look like they missed the boat," he says. "If it [the Net] is a white elephant, they are going to look smart for holding back the throttle."

However, if you believe in your gut that online has the potential to capture a huge segment of the book market, then is the clear choice. It has much lower costs of doing business than the other two and is also growing much faster, says Jacob. It's a pure play on E-commerce, so Wall Street doesn't care if it earns money yet, as long as revenues keep soaring. "Now is the time to invest in the brand and distribution rather than focusing on showing profits," says Jacob.

The middle-road choice is Barnes & Noble. It's already the world's largest bookseller and is pursuing both retail expansion and Internet strategies aggressively. Says Jacob: "People think it's the only company that can give a run for the money" online.

Another plus for shareholders: Many analysts believe that Barnes & Noble may spin off its Internet business. "It's very logical," says Vroom. "The company is structured in a manner that would make a spin-off easy," since its subsidiary is run separately from its stores. Such a division could make it easier for the company to raise capital. "In essence," says Jacob, "[] is making the parent company look bad."

A spin-off would also clearly raise the value of, since it would likely be valued solely on revenue growth. "Even accounting for the fact that is new and smaller, it isn't getting near the valuation Amazon is getting," says Armstrong. "One way to capture that is to spin it off as a stand-alone entity." also may be able to stop charging sales tax if it separates from its parent, which would give its online sales a boost, Jacob adds.

Of course, all three booksellers share the risks of any growth company. Conventional wisdom is that the U.S. support about 1,300 superstores, says Armstrong. That means Barnes & Noble and Borders can expand for three to five more years before the U.S. market is saturated, which would slow growth dramatically. The potential for online book sales is another wild card. "Analysts hate to say they don't know," says Armstrong. "But it really is just too early to say."

By Amey Stone
Associate Editor
Business Week Online

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Updated June 18, 1998 by bwwebmaster
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