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Does This Bookseller Belong in Your Portfolio?

By Ryan Lowery - Sep 25, 2013 at 1:08PM

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As the popularity of tablets and e-readers continue to grow, B&N continues to lose focus.

As the retail book industry continues to change, Barnes & Noble (BKS), the nation's largest physical book retailer, has managed to outlast its competition such as Borders, which filed for Chapter 11 bankruptcy in February 2011. The demise of Borders was due mostly to poor management and a failed entry into the e-book market. Now, as B&N wrestles with its own management problems, it also struggles to find a balance between selling physical books and staying competitive in the e-book sector.

Struggles with a changing industry
By the time B&N released its Nook e-reader in November 2009, (AMZN -1.12%) had already gained a significant share of the market with its Kindle e-reader, which had been on the market since 2007. In 2010, Borders announced that it would also start selling an e-reader. However, it was plagued by delays, and the company struggled to compete with B&N and Amazon, which had both made massive cuts to the prices of Nook and Kindle. By July 2011, Borders had closed all of its stores.

Soon after, Amazon and B&N began marketing tablets with color displays, placing both companies in direct competition with the industry leader, Apple. It was another new frontier for B&N, who had also started selling more toys and games in its stores, while devoting less space to books, music, and DVDs -- the retail items it had built its reputation on. As B&N struggled to redefine itself, investors were taken on quite a ride. B&N shares were near $16 around the launch of the Nook, but just 5 months later they'd fallen to a low of $8.50.

The garage sale no one came to
In August 2010, B&N's board abruptly announced that the company was for sale. Offers were slow to come in though. In fact, the only real offer came from Liberty Media, which bought $204 million worth of interest-paying preferred shares that can be converted into common shares worth a 16.6% stake in B&N.

Then, eight months later, B&N separated its physical book business from its e-book business, and sold 17.6% of the newly created Nook Media division to Microsoft (MSFT -0.83%) in a deal valued at $605 million over five years. Microsoft's value in this deal is uncertain though as its Surface tablet is a direct competitor of Nook tablets. Conversely, it gives Microsoft some needed footing in the e-book market, as well as the growing e-textbook market.

In March 2013, B&N's chairman and largest shareholder, Leonard Riggio, announced that he was looking into buying B&N's physical bookstores. The news excited investors and shares rose yet again, returning the stock to 2009 levels. However, months went by with no news on the matter.

Earnings (and management confidence) continue to fall
Almost six months after Riggio hinted at an offer, on its August 20 earnings call, B&N said that it had suffered substantial losses related to Nook, reporting that profits had fallen 8.5% to $1.3 billion for the quarter.

B&N surprised those on the call when it stated that it would stop manufacturing Nook devices. This raised questions about a partnership with Microsoft. Without a dedicated device, a key problem is getting customers to purchase e-books on Surface rather than on Kindle or iPad, which are far more popular with e-book buyers. Furthermore, Amazon seems to be an unbeatable competitor for B&N and its partners. By most estimates, Amazon holds over 70% of the e-book market share, and about a 50% share for books sold online, both e-books and printed.

Even B&N's management seems to lack confidence in its future. In July, William Lynch abruptly resigned as CEO. Furthermore, two days after the earnings call, the company's retail chief, Mitchell Klipper, began selling off shares that equal roughly two-thirds of his holdings in the company.

After a $1 billion dollar loss on Nook over three years, the decision to get out of the device manufacturing business is a step in the right direction. Additionally, some shareholders have called for B&N to pay an annual dividend of at least a $1.50 a share, which would certainly make it a more attractive investment.

However, management is still a big concern. Some question whether Riggio has the best interests of this company -- or its shareholders -- in mind. Additionally, Klipper has stated that B&N will close a third of its stores over the next 10 years. Currently, B&N's retail division is making a profit, but those profits are eclipsed by continued losses from Nook.

While its Nook losses should level off now, B&N still faces financial challenges to its e-book business with increasing competition from Amazon and Apple, and the still unknown future for e-books in general. Without strong leadership, B&N could collapse just like Borders, and until its leadership is strengthened, it seems that your investing dollars are safer somewhere else.

Ryan Lowery has no position in any stocks mentioned. The Motley Fool recommends The Motley Fool owns shares of 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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