Many people left Barnes & Noble (NYSE:BKS) for dead last year. Despite its position as the largest bookseller in the country, Barnes & Noble was an early victim of the rise of Amazon.com (NASDAQ:AMZN).
But Barnes & Noble compounded its problems in trying to keep up with Amazon. Instead of trying to maximize the value of its retail assets, the company distracted itself with a bid to follow Amazon into the tablet market. Now that Barnes & Noble is refocusing on its core business, its earnings results are improving rapidly. Indeed, the physical bookstore business could remain viable for many more years.
Getting off track
Barnes & Noble's recent troubles can be traced primarily to wasteful investments in the Nook platform. First, the company responded to Amazon's Kindle e-reader with the Nook line of e-readers. Then, when Amazon added tablets to its Kindle lineup, Barnes & Noble felt compelled to follow suit.
Barnes & Noble quickly became embroiled in a price war on this front, as deep-pocketed vendors like Amazon and Google have made it clear that they are willing to sell budget tablets at (or even below) cost. As a result, as tablets became a bigger part of Barnes & Noble's business in 2012 and 2013, losses mounted.
If investing heavily in the Nook had been sufficient to drive a big jump in digital content sales, it might have been a worthwhile venture. Instead, Barnes & Noble's digital content sales have been plummeting recently. Last quarter, digital-content sales totaled a paltry $57 million, down 26.5% year over year.
Part of this poor result can be explained by Barnes & Noble's retreat from the tablet market -- the company continued selling 2012 models last fall rather than rolling out successors to the Nook HD and Nook HD+. Since many Nook buyers will buy a bunch of content right after buying a new device, the lack of a device refresh certainly hurt content sales. But more broadly, sales growth in the e-book market is slowing.
Back to basics
In the last year or so, Barnes & Noble has started to return to its strengths: selling books and games, primarily in physical stores. The company is also increasing its focus on the collegiate market in areas like textbook rentals.
Last quarter, Barnes & Noble swung to a profit of $63 million, or $0.86 per share, after losing money in the prior-year quarter. Part of the improvement was due to a one-time charge related to the Nook last year, but Barnes & Noble also made good progress in its efforts to reduce Nook-related costs.
Through the first three quarters of Barnes & Noble's FY14, profitability in the retail and college divisions has remained solid despite a big drop-off in Nook-related sales (which made money for the physical stores but lost money overall). Meanwhile, lower losses in the Nook division have helped Barnes & Noble earn a pretax profit for the first time in several years.
This goes to show that while selling books in stores is a declining business, it's not going to disappear in a year or two. Core sales at Barnes & Noble retail stores have actually moved back toward the flat line recently, suggesting that a large group of customers still prefer physical books over e-books.
Barnes & Noble is not abandoning the e-book market entirely, as management believes that it's an integral part of being a bookseller in the 21st century. But the company has right-sized its Nook business by cutting its staff by 26% while working with other companies to develop new Nook-branded tablets without exposing Barnes & Noble to markdown risk.
These initiatives should hopefully help Barnes & Noble get the Nook business to breakeven in the next year or two. If that happens, Barnes & Noble stock could move significantly higher, as the core retail business (including college bookstores) remains quite profitable in spite of Amazon's best efforts to disrupt it.
Adam Levine-Weinberg is short shares of Amazon.com. The Motley Fool recommends Amazon.com and Google. The Motley Fool owns shares of Amazon.com, Barnes & Noble, and Google. 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.