What's Right About barnesandnoble.com

By Yi-Hsin Chang (TMF Puck)

(September 20, 1999) -- In the go-go world of Internet IPOs (initial public offerings) and seemingly sky-high valuations, we often overlook the exceptions to the rule. barnesandnoble.com (Nasdaq: BNBN) is a prime example of an Internet IPO gone wrong.

Take a look at this chart. It's not a pretty sight. As you can see, the stock peaked at $26 5/8 right after going public in late May. It has since traded in the $15 to $20 range (a roughly 25% to 44% drop from the high), often below its initial offering price of $18 a share. True, the markets have been turbulent in the last few months, but barnesandnoble.com's shares clearly have underperformed the S&P 500 and rival Amazon.com (Nasdaq: AMZN) in the short time barnesandnoble.com has been traded publicly.

It's puzzling that barnesandnoble.com (let's call it bn.com for the sake of brevity) has fared so poorly. To begin with, it's got a strong and well-known brand name. Its parent -- or at least one of its parents -- from which its name is derived is the nation's largest bookseller, with more than 1,000 brick-and-mortar Barnes & Noble (NYSE: BKS) and B. Dalton stores in 49 states and the District of Columbia. As if that isn't enough, bn.com's other parent is none other than German media giant Bertelsmann AG, the world's third largest media company, with significant interests in books, magazine and newspaper publishing, music, television, film, radio, and online properties. Barnes & Noble and Bertelsmann each own a 40% stake in bn.com.

Perhaps the name itself, barnesandnoble.com, which takes six syllables to say, is simply too long. After all, the meat of it is three words scrunched together and therefore hard to read, and you can't NOT say the "dot-com" part because you have to distinguish between the online venture with the brick-and-mortar operations. Amazon.com is typically referred to as "Amazon," which is just one word and is very easy to remember and spell. (Interestingly, even if you misspell bn.com's name in its URL -- "barnesandnobel.com" instead of "barnesandnoble.com" -- you still get to the right place.)

Maybe investors don't view bn.com as a pure Internet play. Maybe its tie to a brick-and-mortar chain turns off some investors, consciously or unconsciously. It could be that Barnes & Noble's 40% stake in bn.com is too high a percentage for investors to view the online bookstore as a distinct and separate entity. Perhaps bn.com's brand name -- one of its key strengths -- is also its Achilles' heel.

Many traditional companies that have significant online properties -- including Microsoft (Nasdaq: MSFT) and Walt Disney Co. (NYSE: DIS) -- have not been rewarded the same lofty valuations enjoyed by the likes of Amazon, Yahoo! (Nasdaq: YHOO), and eBay (Nasdaq: EBAY). Even search engine and portal company Infoseek (Nasdaq: SEEK) has been "punished," at least in part, because of its link to Old World media giant Disney.

Instead of trying to pinpoint exactly why investors haven't greeted barnesandnoble.com with open arms, let's focus on reasons that make bn.com an attractive stock.

Looking at the aforementioned chart of bn.com's trading history, it's safe to say that the shares are not overvalued. Let's not forget that the stock was originally priced at the top of the $16 to $18 range set by lead underwriters Goldman Sachs and Merrill Lynch after being raised from an estimated range of $11 to $13 a share. The proceeds from the IPO totaled $486 million after commissions and the exercise of the over-allotment option (meaning there was great demand for the IPO), making it the biggest-ever Internet IPO. Incidentally, Barnes & Noble recouped its $100 million investment in bn.com when Bertelsmann came on board as a partner.

Interestingly, Barnes & Noble employees bought 4.5 million, or about 16%, of the shares sold in the IPO. Some executives and board members actually sold a small portion of their Barnes & Noble stock options to purchase stock in bn.com. Like insider selling, insider buying says a lot about the company. For one thing, it shows confidence on the part of management that bn.com will succeed. Leonard Reggio, chairman and CEO of Barnes & Noble and chairman of bn.com, bought 2.3 million shares, or 8%. You could say he put $41.4 million where his mouth is.

With such an expression of confidence from management, it's reasonable to assume that bn.com will be around for three to five years and beyond. As I mentioned before, bn.com has ample backing and strong ties to two powerful organizations, Barnes & Noble and Bertelsmann. In fact, bn.com has yet to take full advantage of its relationship with the parental units. Imagine clicking on bn.com to check book availability at your nearby Barnes & Noble store before you actually drive over in your car. Or perhaps Barnes & Noble stores could more actively direct customers to the bn.com website, especially for out-of-print or hard-to-find books -- two areas where bn.com excels thanks to an extensive and well-established network of independent booksellers.

In July, bn.com reported a smaller-than-expected second quarter loss ($22 million or $0.17 a share vs. $23.7 million or $0.21 a share a year ago -- analysts had predicted a $0.24 loss) as revenues more than tripled to $39.1 million from $11.4 million for the same year-earlier period. During the quarter, the company added half a million customers, bringing the total number of accounts past 2.2 million. In July, bn.com had close to 4.8 million unique visitors, making it the fifth largest shopping website, according to market research firm Media Metrix. (Amazon had 11.5 million unique visitors that same month.)

barnesandnoble.com recently launched an innovative program called "MybnLink," in which customers can earn a 5% commission on sales when their friends, family, or colleagues buy bn.com products using a personalized link. This is taking the all-important publicity through word of mouth to new heights. In another brilliant -- not to mention socially conscious -- move, bn.com is encouraging customers to donate those proceeds to one of five national charities. In addition, bn.com is giving 1% of MybnLink sales to First Book, a nonprofit organization that distributes books to disadvantaged children.

MybnLink is only the latest addition to bn.com's wide range of services. The online bookseller has had an affiliate network targeted more at entrepreneurs and small businesses wanting to sell books from their own websites. Of course, bn.com also has big-name portals as its partners -- including America Online, Microsoft's MSN, Lycos, and Snap. bn.com also runs a corporate book-purchasing program that helps companies manage and track corporate spending on books and magazines. Its customers in this barely tapped market include Toyota Motor Sales, American Express, Baxter Healthcare, and Gateway Country.

In July, bn.com redesigned its website and added music to its offerings. CEO Jonathan Bulkeley told the Fool in a StockTalk interview last January that, unlike Amazon, the company has no plans to become an online Wal-Mart. But that doesn't mean that bn.com can't further expand from its core competencies. The company already sells magazine subscriptions and software. It could very easily add Godiva Chocolates as well as Starbucks coffee beans and gift items -- both already available in the physical bookstores -- to its online product line.

In the end, barnesandnoble.com could win the online book war as market leader Amazon turns its attention to other areas of e-commerce, such as auctions, toys, and online drug and grocery stores. Just as shoppers turned away from real-world department stores in the past in favor of specialty shops, book lovers could very well flock to bn.com in search of the ultimate book-shopping experience.

A Motley Fool Coming Attraction:

In October, Yi-Hsin Chang visits barnesandnoble.com
company headquarters and reports
back on her findings.

Related Links:
-- barnesandnoble.com Message Board
-- Music e-tailing Heats Up - 7/7/99
-- barnesandnoble.com StockTalk - 1/20/99