Should You Follow John Malone Out the Door at Barnes & Noble, Inc?

Source: Barnes & Noble.

Times are tough for bookstore giant Barnes & Noble (NYSE: BKS  ) , as evidenced by declining overall sales and uncertain prospects for its Nook unit. Once a bright spot, the Nook has struggled to maintain market share in the e-reader segment against more popular devices from technology giants Apple and Amazon.com (NASDAQ: AMZN  ) . The latest bit of bad news was the sale by John Malone and his Liberty Media (NASDAQ: LMCA  ) empire of most of its sizable stake in the company, a move that sent Barnes & Noble's share price down by 10% in early April.

That said, Barnes & Noble is the lone remaining bookseller with a national domestic footprint that turns a profit in its stores, albeit at a declining rate. This implies that there is some value in its brick-and-mortar units. So, after losing roughly a third of its value over the past five years, is the company a good bet?

What's the value?
With the demise of Borders in 2011, Barnes & Noble sits alone atop the retail bookstore business, with a little more than 660 stores across the country. The company is also the king of the college bookstore segment, operating a similar number of stores that cater to approximately 4.6 million students. 

Unfortunately, being the top dog in a declining business hasn't done a whole lot for Barnes & Noble's investors. Shareholders have suffered negative cumulative returns over the past few years, due to shrinking margins in the company's core book business, as well as from growing operating losses in its e-reader segment.

In 2014, the negative business trends have continued unabated for Barnes & Noble, highlighted by a 9% top-line decline that was a function of sales decreases across its business units. While the company's profitability was much better than the performance in the prior-year period, the weakness could be attributed to cost cuts in its Nook e-reader segment, where it is moving to an outsourced business model. On the upside, though, the improved profitability has led to improved cash flow for Barnes & Noble, helping to push its balance sheet into a positive net cash position.

Where to go from here?
It's hard to clearly see an endgame for Barnes & Noble, although a reduced presence in the e-reader device market is almost assured, given the company's recent moves to outsource device production. The company never really had a chance in the device arena, once Apple and Amazon.com entered the fray with their iPad and Kindle tablet franchises, respectively, which are supported by their huge R&D programs and powerful ecosystems.

Amazon.com, in particular, has been a thorn in Barnes & Noble's side, due to its ability to cultivate an unmatched book marketplace, including providing an outlet for aspiring writers to showcase their wares through the Amazon Publishing operation. The company is also not afraid to use its cash hoard to enhance the value of its ecosystem, to the detriment of competitors. Its 2013 acquisition of Goodreads is a perfect example. Goodreads is a 25-million-member website that allows book lovers to congregate and provide recommendations to fellow members.

Keeping a horse in the race
Barnes & Noble is undoubtedly an intriguing story, with its national store footprint and the solid cash flow characteristics of its retail and college segments. However, with Barnes & Noble's customer volumes and profit stream seemingly declining year after year, you should probably be looking for an indirect way to play the company's upside, like through an intermediary such as Liberty Media.  Despite selling most of its shares in Barnes & Noble, Liberty Media did maintain a position in the iconic bookseller, hoping to profit from any future upgrade in the company's prospects.

More important, a position in Liberty Media provides exposure to the superior capital allocation skills of John Malone and his deputy Greg Maffei, who have shown an ability to create value for shareholders throughout business cycles. Case in point is their investment in Sirius XM Radio for a pittance during the throes of the financial crisis in 2009. This is a decision that has paid off handsomely for Liberty Media shareholders, thanks to Sirius XM's strong subscriber and operating profit growth over the past few years.

The bottom line
While Barnes & Noble seems to be a cheap stock, John Malone's pruning of Liberty Media's position in the bookseller should give you pause, since he probably knows more about the company than you or I do.  A better bet would be Liberty Media, which gives exposure to Barnes & Noble, while providing diversification from the other eggs in Liberty Media's basket.

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