The Hidden Value in This Failing Company


For Christmas, I thought about buying a Nook. I'm usually a few years behind the times on the technology that I own, and I thought maybe this time I'd get out ahead of the curve -- or at least on the curve. While I ended up deciding that I didn't have to have one, it looks as if Pearson did. The company just bought 5% of Barnes & Noble's Nook business unit .

The $90 million investment bumped Barnes & Noble shares up more than 4% on the day and gave investors a new lease on life for the oft-troubled retailer. AsThe New York Times reported, the investment prices the Nook division at around $1.8 billion -- twice the company's market cap. Pearson made a good call getting in on the Nook, and investors should do the same.

The value of the Nook
There are a lot of tensions in Barnes & Noble right now that make it hard to get a clear grasp on whether the company is worth investing in. On the bear hand, it's a big-box store in an era of big-box store extinctions. It's competing against for book sales, and against Amazon, Google, Apple, and just about everyone else for e-reader sales. Its nearest relative, Borders, died a painful death. Oh, right, and its retail revenue has been falling for years.

On the bull side, it's the only game in town, assuming you're sane and therefore have no intention of stepping into a Books-A-Million. The Nook has done surprisingly well against all those big names, and Barnes & Noble holds a quarter of the e-books market. And, while retail has gone the way of all flesh, the Nook has grown sales at a steady rate, now accounting for 8.5% of revenue. The main value that Barnes & Noble has seems to come from the Nook.

The best of the e-readers?
That the company gets so much value from the Nook, and that the landscape is so competitive, leads to lots of articles and analysis trying to determine whether the Nook is the best reader. The logic seems to be that only one can survive, or even thrive, and so investors need to pick The One. That's absolute rubbish. Who cares if the Nook is the best e-reader? It's a good enough product with an excellent market share, and the company behind it has set it up for success even if the rest of Barnes & Noble sinks into the deep, dark sea.

Right now, the company is "holding on to market share at the expense of profit," according to one Morningstar analyst, and that's fine by me. In fact, what investors have been hoping for is a spinoff of the Nook business, which would give it freedom to operate without having to support its ailing parent company and give the rest of Barnes & Noble a chance to focus on selling books -- ostensibly its main purpose.

If Microsoft -- which invested $300 million earlier this year -- and Pearson are right, then the Nook business is easily worth more than the rest of the business. If investors get in now, they may be able to reap large rewards when the company splits. Today, Barnes & Noble is trading at a pittance compared with its potential value. The worry is that the company doesn't have what it takes to survive in the current climate. But even if it were to go under, there could still be more value in the sale of its Nook unit than the whole company is worth right now.

Over 2013, I'm looking for Barnes & Noble to make serious plans for shedding the Nook business. While the company has said that sales aren't going to live up to expectations for this quarter, I'm hopeful that they'll pick up in the new year. The influx of cash from Pearson should give Barnes & Noble some more spending power to really push the Nook, and to set itself up for a positive 2013, at least from the Nook's perspective.

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