Will Splitting From Nook Be Good for Barnes & Noble?

The struggling Nook tablet brand will be spun off from parent company Barnes & Noble  (NYSE: BKS  ) . This frees the book retailer, which has plenty of problems to solve in its core business, from a once-promising product line that has became a drag on profitability.  

The company announced the move in a press release about its 2014 financial results. The move is being done "with the objective of optimizing shareholder value," and the company expects it to be completed by the end of the first quarter of next calendar year. CEO Michael P. Huseby explained why the separation was taking place in the release.

In fiscal 2014 we have taken certain actions to strengthen the company, including the ongoing rationalization of the Nook business, growing the college business through new contract acquisitions and increased offerings to students and faculty, and initiatives to improve retail's sales trends. Our fiscal 2014 results and solid financial position at year-end reflect the positive impact of those actions. We believe we are now in a better position to begin in earnest those steps necessary to accomplish a separation of Nook Media and Barnes & Noble Retail. We have determined that these businesses will have the best chance of optimizing shareholder value if they are capitalized and operated separately. We fully expect that our retail and Nook Media businesses will continue to have long-term, successful business relationships with each other after separation.

How is Nook doing?
While the rest of Barnes & Noble has stabilized, the Nook segment has been in a free fall. The Nook business, which includes digital content, devices, and accessories, had revenue of $87 million for the quarter and $506 million for the full year, decreasing 22.3% for the quarter and 35.2% for the year. Those numbers are even worse when you consider that fiscal 2014 was 53 weeks long, compared to 52 in 2013. That extra week contributed $9 million in additional sales. 

Device and accessory sales were $25 million for the quarter and $260 million for the full year, declining 30.1% and 44.8%, respectively, due to lower selling volume and lower average selling prices. Digital content sales were $62 million for the quarter and $246 million for the full year, declining 18.7% and 20.6%, respectively, due primarily to lower device unit sales. Nook lost $56 million in the fourth quarter and $218 million for the full year.

The most troubling number here is that content sales are down, meaning that the lower hardware sales are not because customers already own a device and are happily using it. Tablet and e-reader makers like Barnes & Noble and Amazon  (NASDAQ: AMZN  ) generally make very little, if anything, from hardware sales. The money instead comes from selling books, movies, music, and apps.

How is Barnes & Noble doing?
The company's retail segment, which includes the bookstores and BN.com businesses, had revenue of $956 million for the quarter and $4.3 billion for the full year, increasing 0.8% for the quarter while decreasing 6% for the year. The inclusion of the 53rd week added $57 million in additional sales. Core comparable-store sales, which exclude sales of Nook products, decreased 1.9% for the fourth quarter, which the company blamed on "severe" February weather. Core comparable-store sales declined 3.1% for the full year.

The retail segment turned a yearly profit of $354 million -- a decrease of 5.9%, which the company blamed on the lower overall sales volume.

Barnes and Noble's college segment had revenue of $298 million for the quarter and $1.7 billion for the full year, increasing 18.2% for the quarter, while decreasing 0.9% for the year. The bonus 53rd week contributed $15 million in additional sales.   

The college division turned a $115 million profit -- a number that increased 3%, year over year, which the company attributes to higher margins and net new store growth.

What's clear is that Barnes & Noble has at least stabilized its traditional book-selling business but it has not found a way to lure people to its tablets and e-readers. The question that remains, however, is with customers opting for e-books, do physical bookstores have a future? Yes, Barnes & Noble sells toys and some other product lines. But its giant, expensive retail stores are still largely book-driven, which seems less viable as we move further into a digital reading world.

Is this split a good idea?
In the short term, it should improve the balance sheet for Barnes & Noble, though it's hard to see how Nook -- which struggled while being owned by a major retail bookstore chain -- will survive on its own. Perhaps Microsoft (NASDAQ: MSFT  ) , which invested $300 million with Barnes & Noble for a 17.6% stake in the company's Nook business unit in October 2012, will be interested in taking full ownership of the brand and recast it as a low-cost Windows 8.1 tablet. That ship may have already sailed as Toshiba announced a low-end, sub-$200 7-inch Windows 8.1 tablet, making the need for Microsoft to create one less pressing.

The real concern for Barnes & Noble is long term, since being a retail bookseller seems a bit like manufacturing sewing machines or selling magazine subscriptions. The company's core business has declined and that trend is unlikely to reverse. You can't put the Amazon genie back into the bottle, and bookstores are likely to face the same ultimate fate as record stores. Spinning off Nook may minimize losses and buy the company some runway, but there needs to be a plan that goes deeper than controlling costs to eke out tiny profits on declining sales.

The failure of Nook will ultimately hasten the failure of Barnes & Noble, as essentially every tablet customer using an Amazon Kindle, an Apple iPad, or a tablet running Google's Android has a bookstore in their home already. To combat that, Barnes & Noble needs more than just slightly bigger profits. The company needs to find a direction that makes it something other than what it is now. 

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