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Barnes & Noble Inc
Stifel Financial Corp
When Barnes & Noble (BKS) announced on Jan. 5 that it may spin off its Nook e-book unit into a separate business, investors didn’t take the news well: Shares of the largest U.S. bookstore chain tumbled 17 percent, erasing $139 million in market value. The prospect of the company spinning off its fastest-growing business—which has grown to $1.5 billion in annual revenue since its November 2009 launch—made shareholders downbeat about the future of Barnes & Noble’s 700 brick-and-mortar bookstores. William Lynch, the company’s upbeat chief executive officer, says investors who panicked got it all wrong.
Whatever happens with the digital unit, he says, its future will still be intertwined with the stores because that’s where a majority of Nook devices and accessories are sold. “They’ve been nothing short of vital,” he says. A possible separation of the digital business “doesn’t mean that Nook and Barnes & Noble sever the relationship. In fact, it’s just the opposite. We have plans to expand the footprint of Nook in our stores. We are doubling down.”
Management wants the financial markets to give a higher valuation to the Nook’s e-reader and digital bookstore franchise than is now reflected in Barnes & Noble shares, which have slid about 50 percent since June. One scenario is that Nook would become a separate company. The newly independent Nook would then sell a minority interest to investors through an initial public offering, hoping to be valued more like a tech company, according to a person familiar with the situation who declined to be identified because the talks are private. Barnes & Noble would remain majority owner, and the value assigned to the Nook shares would then be better reflected in Barnes & Noble’s stock, says the person.
Barnes & Noble’s stock price of about $11 a share accounts for the value of its retail and college bookstores without the Nook business, says Stifel Nicolaus (SF) analyst David Schick. One reason: Despite the e-reader’s sales success, the company has been losing money because of the heavy investments Nook needs to compete with larger rivals. The retailer sells about 25 percent of all the digital books in the U.S. and trails only Amazon.com (AMZN), which has far more resources to invest in its rival Kindle brand. Apple (AAPL) also is expected to increase its marketing of digital books and magazines this year through its iBooks software and iPad tablet. “It’s a really tough environment for them,” says Michael Souers, an analyst for Standard & Poor’s (MHP) who recommends selling Barnes & Noble shares.
The company has been trying to combat the industry’s ongoing decline in sales of physical books by diversifying its in-store offerings. To build the digital business, B&N has installed what it calls Nook boutiques in 40 large stores, with more to come later this year. The boutiques can be as large as 2,000 square feet and offer in-person customer service that Amazon can’t. The glowing Nook sign, flat-screen monitors, and minimalist design look more like part of an Apple store than a book chain. There are Nook counters in the rest of the stores.
The in-store promotion helped sales of devices, which range from the $99 black-and-white Nook Simple Touch to the $249 color Nook Tablet released in November, to jump 70 percent during the holiday season. Meanwhile, sales of digital content, including e-books and applications, more than doubled.
While one part of the store is going high-tech, another is looking more like a preschool. The retailer has expanded its assortment of toys and games at all stores and has opened play areas, complete with Legos, in 30 locations. Sales of toys and games in stores rose 30 percent during the holidays after a 48 percent bump the previous year. The areas, which average about 3,000 square feet, also offer children’s books and introduce kids to digital reading at their own Nook testing tables. Since releasing the Nook Color in 2010, Barnes & Noble has been a leader in digital books for kids.
The failure of rival Borders Group last year put about $2 billion in annual revenue up for grabs, helping Barnes & Noble increase holiday sales of printed books at its stores for the first time in five years. And the shops’ free wireless Internet access, cafes, and play areas promote longer stays—and more chances to sell the Nook. “If I were starting an e-reader business, the one thing I would want is to have a counter in the front of the 700-plus Barnes & Noble stores, so I can market to the 70 million people who go into those stores every year,” Lynch says.
The bottom line: Barnes & Noble is considering a spinoff of its Nook e-book unit as a way to boost shares, which have fallen 50 percent since June.