|Shares Out. (in M):||64||P/E||25||0|
|Market Cap (in $M):||1,687||P/FCF||0||0|
|Net Debt (in $M):||-74||EBIT||361||0|
We believe the spinoff of Barnes & Noble College will highlight the value of the individual segments of BKS. Currently, the earnings power of these segments is being obfuscated by losses in the Nook segment and investments in the College digital platform, Yuzu. As these segments are separated, the pro forma entities can provide more optimal capital allocation and get a more appropriate shareholder base. The Retail segment, which is not growing its store count, will generate significant cash flow and focus on minimizing Nook losses and stabilizing the core business. It is currently unlevered and will generate significant free cash flow, allowing it to return significant capital to shareholders. The College segment will be the growth business, and it will invest in opening new stores and expanding its digital offering.
B&N Retail includes 648 bookstores as of May 2, 2015, primarily under the Barnes & Noble Booksellers trade name; Barnes & Noble bookstores generally offer a dedicated NOOK area, a comprehensive trade book title base, a café, and departments dedicated to Juvenile, Toys & Games, DVDs, Music, Gift, Magazine and Bargain products. The Company closed 16, 15, and 12 stores in each of FY2013, FY2014, and FY2015, respectively.
B&N College operates 724 stores nationwide, of which 154 stores are co-branded with the universities’ names and Barnes & Noble name. These stores are operated under 453 contracts, which can cover multiple stores and include over 5 million students and faculty and alumni. The Company opened 39, 14, and 24 net new stores in each of FY2013, FY2014, and FY2015, respectively
The Nook segment includes the Company’s digital business, which includes the Company’s eBookstore, digital newsstand and sales of NOOK devices and accessories through B&N Retail and B&N College.
After acquiring the education business in 2009, BKS combined the business with the Nook segment and incorporated it under the name NOOK Media in July 2012. In the following months, Microsoft acquired a 17.6% interest and Pearson acquired a 5% interest in NOOK Media. Because NOOK Media was a separate entity with outside shareholders, this limited BKS's flexibility in regards to how it could optimize its operations and capital structure. We believe the first significant step was taken in the transformation of BKS in December 2014 when BKS acquired Miscrosoft's and Pearson's ownership in NOOK Media. This gave back to BKS operating control of its assets and the flexibility to combine the Nook consumer business with retail, where there's significant customer overlap. With the integration of Nook and Retail, BKS is able to operationally integrate Nook with retail, which has helped to stem losses at Nook (see below), streamlining and consolidating systems and processes, such as back-end infrastructure and the newly launched BN.com, in which the Company now offers physical and digital products. The repurchase of the Nook Media stake also eliminated BKS's obligation to MSFT to expand nationally, which would have been a large drain on capital to the Company
The separation of Barnes & Noble college from the core retail segment will highlight the value. Currently, the earnings power of these segments is being obfuscated by losses in the Nook segment and investments in the College digital platform, Yuzu. Once these segments are separated, the pro forma entities can provide more optimal capital allocation and get a more appropriate shareholder base. The Retail segment, which is not growing its store count, will generate significant cash flow and focus on minimizing Nook losses and stabilizing the core business (It is currently unlevered and will generate significant free cash flow, allowing it to return significant capital to shareholders). The College segment will be the growth business, and it will invest in opening new stores and expanding its digital offering
|Entry||07/30/2015 08:39 AM|
Sorry but I accidentally posted the write-up only partway complete, so here is the rest of the thesis:
Barnes & Noble Retail (ex-Nook) will generate significant cash flow and can potentially take on leverage, which represents a big opportunity to return capital to shareholders. A multiple of 6x EBITDA for this segment represents an EBITDA - Capex multiple of 8x and a FCF yield of nearly 9%. Because the Company has not been opening any new stores, we believe Retail will return significant free cash flow to shareholders in the form of dividends and share buybacks. Additionally, due to its stability, we believe the Retail entity can sustain leverage of 2-2.5x EBITDA. At 2.5x debt / EBITDA, the Retail segment could repurchase 45% of its stock. Importantly, the Company has not discussed capital allocation for either of the pro forma entities. The Company will disclose its capital allocation policy when it announces pro forma capital structures in the coming weeks.
We believe Barnes & Noble Retail (ex-Nook) is a stable business and has opportunities to grow EBITDA. Over the past several years, the Company has made a concerted effort to diversify into toys & games by exiting portions of music, DVDs, and non-literary fiction. We believe this segment now represents 20+% of total sales, and it has grown by 12% and 16% in the last two years, respectively. As the company continues to de-emphasize physical Nook sales (which is showcased in the better areas of the store), we believe there is further opportunity to drive growth in this segment of the business.
SG&A represents 23% of sales for Barnes & Noble Retail, and the Company admits comparable companies run at 19% of sales. This is a $160+ million cost opportunity for the segment, or nearly 50% of current EBITDA. The Company has closed stores at a declining rate over the past several years and only closed 1.8% of the store base in FY 2015. With fewer than 20 stores that are unprofitable, we believe the number of store closures will continue to decline. BKS recently did a complete overhaul of its website, BN.com; this has materially improved the back-end (saving costs) and should help drive digital sales. While e-books were once thought to be a category kiler and experienced significant growth in 2008-2012, e-books have since proven to simply be a category within books, with e-book market share flat-to-down over the past 3 years. The net result of BKS's operating initiatives and industry dynamics has been improved performance, with core same-store sales (ex-Nook) at +0.5% in FY2015. The Company expects these dynamics to continue and guided to core SSS growth of +1% in FY 2016.
BKS has materially reduced Nook losses, and we believe the Company is taking the appropriate steps to further minimize losses and get closer to breakeven. BKS has managed to decline the Nook EBITDA loss from nearly $400mm in FY 2013 to $86mm in FY 2015. The EBITDA loss of $14.8mm in FQ4 2015 significantly outperformed analyst expectations and represents the smallest Nook loss since it has been disclosed. The Company has achieved these results by eliminating advertising fees, eliminating consulting fees, cutting the employee count in half, and moving into a new headquarters that is half the size of the previous building. Another material cost reduction initiative has resulted from de-emphasizing its focus on new Nook devices. After several device launch failures, the Company entered a partnership with Samsung in June 2014 to develop a co-branded Samsung Galaxy Tab 4 Nook tablet. This strategy to partner with Samsung helps the Company more properly forecast demand and share the risk of new product launches. Originally, Samsung agreed to purchase a minimum of 1 million devices within 12 months of launch (August 2014); however, as sales have come in below expectations, the agreement was later extended to June 2016.
Despite weak sales as a result of underperformance from the Samsung partnership (total segment sales were down nearly 50% in FY2015), the Company has continued to streamline costs and focus on higher margin content sales. Content sales were primarily responsible for the segment's gross profit increasing to 77% in FQ4 2015 (and over 60% for FY2015) versus FY2014 gross margins of 25%. We believe the Company will continue to cut costs and focus more on content than devices; as the segment continues towards breakeven, we believe the entire retail segment, whose multiple is currently being punished by the inclusion of Nook losses, will re-rate higher.
We believe Barnes & Noble College will continue to grow its footprint and will benefit from an independent management team that can focus on growth without the burden of Nook losses. Barnes & Noble College and its competitors will continue to benefit by taking share from the 52% of colleges and universities that operate their bookstores themselves. BKS College operated bookstores represent only 18% of all college and university affiliated bookstores in the United States. Historically, new store openings have been an important driver of growth in BKS College’s business, and the pace of new store openings is accelerating. In FY 2015, BKS College opened 48 new stores (6.7% of the store base) versus 30 new stores in FY2014. Accounting for store closures, BKS College has increased its store base by 12% over the past 3 fiscal years. In addition to new stores, the Company is working to increase same-store sales in its college stores. BKS College experienced 0.1% growth in FQ4 2015 and has guided for 1% SSS growth in FY2016.
BKS College is currently investing heavily in its digital platform, which masks underlying EBITDA without generating incremental revenue. BKS College has invested $22mm and $26mm in Yuzu, its digital platform, in FY2014 and FY2015, respectively. Yuzu is BKS's most largest organic growth initiative and significantly reduces EBITDA, as it currently does not drive any standalone sales. Because research analysts are valuing BKS College based on EBITDA multiples, we believe the Street undervalues the College business.