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Barnes & Noble Inc. Fights Back

By Adam Levine-Weinberg - Mar 5, 2014 at 4:19PM

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Barnes & Noble Inc. is learning to love its old-fashioned bookstores.

Many people left Barnes & Noble ( BKS ) for dead last year. Despite its position as the largest bookseller in the country, Barnes & Noble was an early victim of the rise of Amazon.com ( AMZN 2.80% ).

But Barnes & Noble compounded its problems in trying to keep up with Amazon. Instead of trying to maximize the value of its retail assets, the company distracted itself with a bid to follow Amazon into the tablet market. Now that Barnes & Noble is refocusing on its core business, its earnings results are improving rapidly. Indeed, the physical bookstore business could remain viable for many more years.

Getting off track
Barnes & Noble's recent troubles can be traced primarily to wasteful investments in the Nook platform. First, the company responded to Amazon's Kindle e-reader with the Nook line of e-readers. Then, when Amazon added tablets to its Kindle lineup, Barnes & Noble felt compelled to follow suit.

Barnes & Noble quickly became embroiled in a price war on this front, as deep-pocketed vendors like Amazon and Google have made it clear that they are willing to sell budget tablets at (or even below) cost. As a result, as tablets became a bigger part of Barnes & Noble's business in 2012 and 2013, losses mounted.

Nook tablets have been big money pits for Barnes & Noble. Photo source: Barnes & Noble

If investing heavily in the Nook had been sufficient to drive a big jump in digital content sales, it might have been a worthwhile venture. Instead, Barnes & Noble's digital content sales have been plummeting recently. Last quarter, digital-content sales totaled a paltry $57 million, down 26.5% year over year.

Part of this poor result can be explained by Barnes & Noble's retreat from the tablet market -- the company continued selling 2012 models last fall rather than rolling out successors to the Nook HD and Nook HD+. Since many Nook buyers will buy a bunch of content right after buying a new device, the lack of a device refresh certainly hurt content sales. But more broadly, sales growth in the e-book market is slowing.

Back to basics
In the last year or so, Barnes & Noble has started to return to its strengths: selling books and games, primarily in physical stores. The company is also increasing its focus on the collegiate market in areas like textbook rentals.

Barnes & Noble is refocusing on its physical stores.

Last quarter, Barnes & Noble swung to a profit of $63 million, or $0.86 per share, after losing money in the prior-year quarter. Part of the improvement was due to a one-time charge related to the Nook last year, but Barnes & Noble also made good progress in its efforts to reduce Nook-related costs.

Through the first three quarters of Barnes & Noble's FY14, profitability in the retail and college divisions has remained solid despite a big drop-off in Nook-related sales (which made money for the physical stores but lost money overall). Meanwhile, lower losses in the Nook division have helped Barnes & Noble earn a pretax profit for the first time in several years.

This goes to show that while selling books in stores is a declining business, it's not going to disappear in a year or two. Core sales at Barnes & Noble retail stores have actually moved back toward the flat line recently, suggesting that a large group of customers still prefer physical books over e-books.

Looking ahead
Barnes & Noble is not abandoning the e-book market entirely, as management believes that it's an integral part of being a bookseller in the 21st century. But the company has right-sized its Nook business by cutting its staff by 26% while working with other companies to develop new Nook-branded tablets without exposing Barnes & Noble to markdown risk.

These initiatives should hopefully help Barnes & Noble get the Nook business to breakeven in the next year or two. If that happens, Barnes & Noble stock could move significantly higher, as the core retail business (including college bookstores) remains quite profitable in spite of Amazon's best efforts to disrupt it.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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