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BARNES & NOBLE: A BETTER STOCK PLAY?

It may have more upside potential now than Amazon

Amazon.com (AMZN) may have an advantage over bricks-and-mortar retailers, thanks to the economics of selling goods online: the ability to reach a mass audience with a virtually unlimited, searchable selection of products -- without incurring huge overhead costs. But unfortunately for investors who didn't get in early, Amazon's stock price already reflects much of the company's potential. At more than $200 a share, shares of the fast-growing but still money-losing company may offer more risk than reward.


In that light, Barnes & Noble (BKS), which may seem somewhat stodgy compared to the Internet upstart, starts to look attractive. It, too, is selling books online -- albeit far fewer of them than Amazon. But it also has more than 1,000 retail stores selling books over-the-counter. And while the money-losing Web site has been a drag on the company's overall earnings, Barnes & Noble is solidly profitable on an annual basis. "You get a retail and an online presence with earnings," says Ken Shapiro, a private money manager who has been buying Barnes & Noble for accounts at his firm, Condor Capital in Martinsville, N.J.


Barnes's stock price is certainly more reasonable than Amazon's. BKS has hovered around 30 in recent weeks and closed on Dec. 2 at 31 1/2, down 35% from its 52-week high of 48. Merrill Lynch analyst Daniel D. Barry believes the stock is undervalued and set a 12-month price target of $50 in a Nov. 20 report.


REAL VIRTUAL LOSSES. The problem -- and the opportunity -- for BKS shareholders, is that the huge expense of operating and marketing barnesandnoble.com, is hurting earnings and obscuring the impressive growth at Barnes & Noble superstores. The top bookseller in the U.S., Barnes's retail operation is split about evenly between superstores and mall stores under the B. Dalton, Doubleday, and Scribner names (although the bulk of profits come from the superstores). It is on track to sell more than $3 billion worth of merchandise in calendar year 1998 -- still a far sight more than the $540 million Amazon is expected to sell.


The company's biggest problem is that its Web-site expenses are eating up profits from the bricks-and-mortar stores. Third-quarter results looked particularly dire (although the company usually makes all its money in the fourth quarter): On Nov. 19 Barnes reported a loss of $4.6 million, equal to about 7 cents per share, which was about 4 cents worse than consensus analysts' estimates. Larger-than-expected Internet losses added up to 18 cents per share.


By contrast, net earnings from the traditional retail business were up 120%, to $0.11 per share. Superstore sales rose 11%, to $554 million. The company has expanded gross margins for its retail business for seven consecutive quarters by selling a higher-priced mix of products through its superstores and improving its efficiency in book distribution and other areas. And Barnes recently announced a plan to purchase Ingram Book Group, the world's largest book distributor, for $600 million. The acquisition, which includes 11 distribution centers, should allow Barnes to deliver books faster and cheaper.


If Barnes & Noble still had only its traditional retail division, Merrill's Barry estimates that it would trade at about $47 a share. Its valuation would then be comparable with that of other high-growth retailers, his Nov. 20 report noted.


SPIN-OFF REDUX? Oddly, while pure Internet plays are trading in the stratosphere, Barnes isn't getting much credit from investors for its Internet division. Despite its third-quarter loss, barnesandnoble.com did $17.2 million in sales -- a 300% increase from the corresponding quarter last year and up 38% from the second quarter. Now, Barnes is doing what it can to minimize losses and unlock some of the value of its Internet division. In mid-November, it completed the sale of half of barnesandnoble.com to German media giant Bertelsmann for $200 million. So Bertelsmann now gets half the losses. In 1999, Barry estimates, those losses will total $84 million, up 71% over 1998's losses.


The key to unlocking the Web site's value is to spin it off, many analysts believe. Barnes's management hopes to sell part of the Internet business through an initial public offering in early 1999. If the IPO, originally set for late summer '98 but delayed because of the stock market sell-off, gets a reception anything like that of other Internet IPOs, it should give BKS a big lift. On news of the impending IPO, S&P's equity research group raised Barnes to a strong buy. "Once spun off, barnesandnoble.com's startup losses will no longer obscure BKS's retailing results," S&P analyst William Donald wrote on Aug. 24, before the IPO was delayed. (He reiterated the strong buy after third-quarter earnings were released.)


Although Barnes & Noble and Amazon.com are often compared, in a few years they may not be in such direct competition. Amazon's game plan is to morph from an online book seller into an Internet mass marketer that sells a range of products. But Barnes & Noble remains rooted in the book business.


If E-commerce grows exponentially in coming years, as expected, the book business isn't a bad place to be. Demographics are in its favor, thanks to rising educational levels and an aging population. And while Amazon clearly has the lead brand name with today's Internet audience, some analysts believe that when mainstream Americans start flooding online, Barnes & Noble will be the name they turn to for books. Amazon's sales may grow faster. But given the newbie's sky-high stock price, right now Barnes & Noble seems a better buy for investors.

By Amey Stone in New York



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