After Skyrocketing, Is Barnes & Noble Ready For A Death Spiral?

Barnes & Noble surged after news broke that it was letting go of its NOOK segment's employees. Is this train of thought rational or is the company ready to go under?

Feb 13, 2014 at 12:30PM

It's official, folks! On Monday, Feb. 10, 2014, Barnes & Noble (NYSE:BKS) announced that it was letting go of its entire staff who were associated with the company's NOOK e-reader. The device was originally created in an effort to move away from a brick-and-mortar business model as competitors like Amazon (NASDAQ:AMZN) slowly ate away at Barnes & Nobles' traditional business model. 

However, in the face of rising competition and while dealing with mounting losses in trying to fend off the Kindle and the Apple iPad, the company seems to have finally thrown in the towel. In response to the news, the bookstore's shares rose by nearly 9%, which signals that shareholders who were once enthusiastic about the device are now thankful to be rid of it. What does this really mean for the business? Is this the beginning of a resurgence for the world's largest bookstore, or is it a sign of its demise?

Once a rising star, the NOOK became a burden too heavy to bear
Between 2010 and 2012, Barnes & Noble saw its revenue rise 23% from $5.8 billion to $7.1 billion. Roughly $828.1 million (or 64%) of this revenue growth came from the company's NOOK segment. Over that three-year time-frame, the company's e-reader saw its sales rise from $105.4 million to a whopping $933.5 million.

By 2013, however, the NOOK segment began to fall back significantly, as evidenced by its 16% drop in revenue to $780.4 million which brought the company's revenue for the year to $6.8 billion. For the year, the segment reported an operating loss of $511.8 million. The primary reason behind the company's falloff in sales and wider operating loss chalks up to increased competition.

While Amazon has yet to release official sales figures for its Kindle, Morgan Stanley estimated that in 2013, the device and any of its associated products and services would make up 11% of Amazon's revenue and 23% of its operating income. Using these figures, we can estimate that total revenue from the Kindle would have come out to $8.2 billion, while operating income from the device would amount to $171.4 million.

What does this mean for Barnes & Noble moving forward?
Unfortunately, the decision to cut off the NOOK segment will likely mean that Barnes & Noble will see less revenue, but there is some upside. Had the company not been burdened with the device in 2013, it would have had fundamentals that were significantly stronger than what it reported.

Instead of the $6.8 billion in revenue that the company reported and its operating loss of $220 million, the company would have reported sales of $6 billion and operating income of $291.8 million. The 5% operating margin that would have been earned by Barnes & Noble isn't great, but it's far better than the -3% margin reported by management.

Moving forward, Barnes & Noble will be able to focus more on its brick-and-mortar business, but the real question that remains is what the long-term impact of this decision will be. With its own e-reader seemingly out of the game, will the company be able to hold off the rise of e-books or will it collapse like Borders did? The answer might surprise you.

Despite Morgan Stanley's forecast that Amazon will have sales of $10.7 billion in 2014 (inclusive of all Kindle products and services), the picture for physical books doesn't look dismal. In 2012 alone, an estimated 557 million hardback books were published, up 6% from the prior year. This suggests that the advent of the e-reader may have more to do with getting those who previously didn't read to dive into the world of literature, or it may imply that individuals who read e-books also take up their physical counterparts. Either way, it doesn't look like the book industry will die just yet.

Foolish takeaway
Considering the data from Barnes & Noble's NOOK segment as well as the continued success of physical books, it doesn't look like the company or its shareholders have anything to fear yet. If anything, management's decision to axe the program might allow it to innovate in other ways that can create long-term shareholder value.

Ultimately, anyone who does decide to jump into the company's shares should consider that a change in consumer sentiment away from physical books to digital content could be drastic and could have adverse consequences for the business. However, as we saw after news broke of the company's decision to go NOOK-free, the payoff for having a long-term, Foolish outlook on the company could mean more money in your pocket.

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Daniel Jones has no position in any stocks mentioned. The Motley Fool recommends The Motley Fool owns shares of and Barnes & Noble. 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.

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