Barnes & Noble's 2 Simple Steps to Revitalization

After years of dilly-dallying with the Nook, Barnes & Noble needs to face facts and realize where its strength still lies.

Mar 18, 2014 at 10:08AM

At first glance, it seems like Barnes & Noble (NYSE:BKS) is confused about its long-term strategy. A mixture of digital and physical books has led the company into convoluted pricing systems and too many places to spend its own cash. Its Nook reader has languished while everyone else seems to have had digital success, and the cost of its failure has put extra pressure on the brick-and-mortar side of the business.

Unfortunately, the picture looks the same on second glance as well. Barnes & Noble looks increasingly like a cardboard box full of Legos -- all the pieces are in there, but they're obscured by excess.

Nook
Source: Barnes & Noble.

Barnes & Noble's successful business
Finding the nougat core of Barnes & Noble's business is as easy as reading the company's annual SEC filing from a few years back. "Barnes & Noble is the nation's largest operator of bookstores." There it is, right in plain sight. Barnes & Noble has outlasted Borders, shown up Books-A-Million, and continued to successfully sell physical books even as the digital wave sweeps over it.

Let's talk about what the term "success" means, though. Right now, it doesn't mean growth, it means survival. Barnes & Noble has continued to earn money through its retail and college divisions, but those earnings are declining. In the company's last reported quarter, the combined earnings before tax from those two divisions fell 6%. Even with the fall, though, the kernel of strength is visible.

Clouding the issue is the Nook and its abysmal performance. That division has been losing money hand over fist as sales have fallen and the business has backed off its initial grand plans for the hardware. Barnes & Noble seemed to take a page from the Amazon business plan -- sell things, make things, sell new things, repeat -- without having the stomach for income denial that Amazon maintains. Barnes & Noble wants to make money like a traditional business but tried to do it while growing a new, digital-style business.

Is there still value in Barnes & Noble?
In the same way that success is specifically defined for Barnes & Noble, "value" also needs to have a clear and narrow definition. First of all, the value in Barnes & Noble is dependent on its ability to mitigate the damage done by the Nook. The company trimmed -- which is to say fired -- its engineering staff earlier this year. This week, it announced that it was going to shift its Microsoft focus from the Windows Phone to the as-of-yet-undefined Microsoft Consumer Reader.

The next step is that Barnes & Noble probably needs to cut back on its physical footprint. While Amazon isn't unbeatable on all fronts, it has ushered in the death of the big-box store for most retailers. Barnes & Noble's costs for sales and occupancy have slowly crept up, hitting 68.8% of revenue for the first 39 weeks of the current fiscal year. For the same period in fiscal 2010, those costs accounted for 67.2% of sales. 

In order to unlock the value in this business, Barnes & Noble needs to make two difficult cuts. It needs to cut the Nook free, perhaps by giving it over to Microsoft as a brand, which would allow it to focus on digital content sales. Second, Barnes & Noble needs to trim its space back to drive down the costs of brick-and-mortar sales. Big-box downsizing has been popular for years, but for some reason Barnes & Noble never got the memo.

The company has a long way to go if it wants to keep its head above water, but it can make it if it focuses on one thing -- staying alive. If you're lost in the middle of the ocean, you don't need to try to turn the random bits of debris around you into a boat -- you need to use your strength to swim. Barnes & Noble just needs to push off from the float and start churning toward shore.

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Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Amazon.com. It also owns shares of Barnes & Noble and Microsoft. 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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