Does the Nook Spinoff Make Barnes & Noble a Buy?

Shares of bookseller Barnes & Noble (BKS) are up about 50% since the beginning of the year. Back in December I wrote that the Nook business was masking the profitability of the retail business, and the recent announcement that Barnes & Noble is planning to spin off the Nook business will now allow the profitable retail stores to be more appropriately valued by the market.

Does Barnes & Noble still offer any value after a 50% gain? Or will competition from online competitors like Amazon.com (AMZN -1.65%) continue to eat away Barnes & Noble's core business?

The Nook spinoff
Nook Media contains both the Nook business as well as the college bookstore business, so Barnes & Noble will be left with only its normal retail stores after the spinoff. These retail stores are the most profitable part of Barnes & Noble, but sales and profits have been declining. In 2014, retail revenue fell by 6%, while retail earnings before interest, taxes, depreciation, and amortization fell by 5.9%.

The college business posted a slight decline in revenue and a slight increase in EBITDA during 2014, and it represents the only part of the company that has any real potential for growth. Once Nook Media is separated, though, the profits from the college business will be weighed down from continued losses from the Nook business. While the college business recorded EBITDA of $115 million in 2014, Nook had a negative EBITDA of $218 million.

Cutting costs is the focus going forward for the Nook business, and during the first quarter the operating loss associated with the Nook was only 36% as big as the loss during the first quarter of 2013.

With Barnes & Noble planning to split into two companies, one that's profitable but in decline and another that's unprofitable but has the potential for growth, is there any value in buying Barnes & Noble at the current price?

Rough estimates
If we simply take the results from 2013, we can come up with a rough estimate of what both companies will look like. Here is the operating profit by segment in 2013:

Source: Barnes & Noble.

The hope behind spinoffs like this is that the market will value two companies separately at a greater collective value than the company before the spinoff. Total operating profit in 2013 was just $34 million, and Barnes & Noble is currently valued at about $1.3 billion, so if we assume a 35% tax rate, the stock is trading at about 8.7 times the estimated net income of the retail business alone.

Nook Media is losing money, so it's difficult to tell how much it will be worth after being spun off. But it's clearly worth something, and if the Nook segment ever reaches breakeven, a value of $500 million to $600 million seems reasonable based on the earnings of the college segment.

If the retail segment weren't declining, Barnes & Noble would look like a steal. The retail business on its own would be worth more than the whole company is worth today, and Nook Media would just be icing on the cake. But the continuing decline of the retail business complicates this story. For a business that's declining by 6% per year without any sign of stopping, even a single-digit P/E ratio doesn't look very good.

It's impossible to tell when the retail business will begin to flatten. The rise of e-books and Amazon's Kindle e-readers are certainly a big reason for Barnes & Noble's troubles, and with Amazon an enormous force in the book business, Barnes & Noble certainly has a tough road ahead. E-books now make up 30% of book volume, and Amazon has a roughly 65% share.

Although books are now a small business for Amazon, representing just 7% of the company's revenue, they are part of the ecosystem that the company is trying to build around its devices and services. In that sense, e-books are extremely important, and Amazon's tough negotiating tactics in the recent dispute with a book publisher in an attempt to get lower prices shows that Amazon is pushing hard to be able to offer the lowest prices possible for its customers. That should worry Barnes & Noble.

The bottom line
The Nook Media spinoff is ultimately a good thing for shareholders since it allows the profitable retail business to not be weighed down by the money-losing Nook business. But it's still a declining business, and after a 50% rise in the stock price, it's not nearly as cheap as it once was. Barnes & Noble is risky at this price, as there has been no sign that revenue declines have been slowing down in the retail business. I'd wait for a significant pullback before considering buying shares.