Barnes & Noble Still Has Potential
Bookseller Barnes & Noble seems to have a lot wrong with it. In its most recent earnings release, the company reported declining sales in every segment, with a net sales decline of 8% year over year. With revenue from both physical books and e-books declining, it's easy to write off the company as the next Borders. But I think there's more potential here than first meets the eye.
The retail business
Sales at Barnes & Noble's retail stores fell by 7.5% year over year -- the result of store closures, a 4.9% decrease in comparable-store sales, and lower online sales. This decline in sales was offset by a focus on cutting costs, and as a result the earnings before interest, taxes, depreciation, and amortization generated from the retail business actually rose by 21.2% compared to the same period last year.
The common argument against Barnes & Noble is that e-books will eventually kill off physical books entirely, making the failure of the retail business only a matter of time. This assumes that demand for physical books will fall to zero, and I think that's a bit pessimistic. Even with the proliferation of e-books over the past few years, people still buy books.
The more likely path is that demand for physical books will continue to decline but eventually stabilize. When this stabilization will occur is the big question, but Barnes & Noble's retail business is profitable even with slumping demand. There's no reason that Barnes & Noble can't continue to generate profits even as revenue declines.
The college business
Along with retail bookstores, Barnes & Noble operates a chain of college bookstores. The college business is very seasonal, as most books are bought at the beginning of each semester, and last quarter included the beginning of the fall semester. Sales fell by 4.6% year over year, but the EBITDA generated during the quarter was more than twice that of the retail business. Clearly, textbook sales are a big source of profit for Barnes & Noble.
One of the reasons that sales declined was an increase in textbook rentals. Since rental periods typically extend for a full semester, revenue from these rentals is deferred and amortized over the rental period. This pushes back some of the rental revenue to the next quarter, leading the sales decline to appear worse than it really is. Textbook rentals grew by 63% year over year, with margins rising as well.
Textbook rentals have become a big business, with competitor Chegg having its IPO less than a month ago. Chegg generates about $200 million in annual revenue, although growth has been slowing as e-books have no doubt pressured the company's core business. Chegg isn't profitable yet, and the company has been shifting to offer more high-margin education services.
Barnes & Noble's goal is to become the the main provider of educational content and services, with new, used, rental, and digital materials, and it will be difficult for Chegg to compete. Chegg's stock is down considerably from its IPO price, as investors appear to have little faith in the company. For Barnes & Noble, the college business is a real bright spot.
The Nook business
The Nook segment consists of both devices, like the company's e-readers and tablets, as well as digital content. Device sales fell by 41.3%, fueling a 21.2% decline in content sales during the quarter. In total, the segment saw sales fall by 32.2% year over year.
The good news is that losses decreased, with EBITDA increasing from negative $51.4 million in the second quarter of last year to negative $45.2 million in Q2 of this year. This was a result of lower markdowns and reduced expenses.
In my opinion, Barnes & Noble should have never started selling tablets. E-readers make sense, as the company is first and foremost a bookstore, but there's no competing with Amazon.com on the tablet front. While the company announced earlier this year that it was looking for a partner to manufacture Nook tablets in the future, thus cutting costs, during the conference call it was reiterated that Barnes & Noble is in the device business to stay.
The ideal path forward would be to stop making tablets and focus exclusively on e-readers. Barnes & Noble makes solid e-readers, with the new Nook GlowLight getting good reviews and costing the same as the ad-supported Kindle Paperwhite from Amazon. The company is right to say that selling e-books depends on selling devices, but those devices need to be aimed at strictly e-books in the first place. Selling tablets does Barnes & Noble no good.
If the company stops taking losses on tablets and instead focuses on e-readers and ebooks, the Nook division could someday become profitable. There's certainly potential here.
The bottom line
While Barnes & Noble's earnings report may not look good, there is plenty of potential for the company. The retail business has remained profitable even as revenue has declined, the college business is solid, with textbooks rentals growing fast, and Nook-related losses are falling. With the right focus, Barnes & Noble could save itself yet.
The article Barnes & Noble Still Has Potential originally appeared on Fool.com.Fool contributor Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.