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It's Been A Hard Day's Night For Barnes & Noble (BKS); We're Buyers

 December 11, 2012 11:03 AM

(By Kevin Donovan) We recently picked up a book, Graham and Dodd's "Security Analysis", and were reminded of a scene from our favorite movie:

Paul's Grandfather (watching Ringo read a book): Have you no natural resources of your own? Have they even robbed you of that?

Ringo: You can learn from books….

…Grandfather: Do you think I haven't noticed? Do you think I wasn't aware of the drift? You poor, unfortunate screwup. They've driven you into books with their cruel, unnatural treatment. Exploitin' your good nature!

Cruel and unnatural indeed.  That's how the multitude of bears have treated bookseller Barnes & Noble (BKS), a "poor unfortunate screwup" in their eyes.  But before you throw down the book and go "paradin' " like Ringo did in The Beatles' "A Hard Day's Night," consider, as Ringo said, what you can learn from a book.  

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By most any measure, shares of Barnes & Noble are cheap.  Consider -- what else? -- book value per share.  The company is trading below 1.00, often a threshold that excites value investors like Messrs. Graham and Dodd.  Cash per share is $7.86, more than half the recent stock price, indicating the market is willing to pay just $7.00 or so for the ongoing business.  Bears say the stock is cheap for a reason, but the riposte to their Debbie Downer mantra lies in the company's powerful partner.

Enter Microsoft (MSFT) and its $300 million investment for a 17.6% stake in the Nook Media subsidiary.  That commitment values Nook at $1.7 billion, nearly double the $943 million market capitalization of BKS itself.  With Barnes & Noble's 59.9 million shares outstanding, some simple algebra tells us the Microsoft stake values the Nook unit alone at about $28 per share.  Indeed, the BKS share price briefly spiked at $26 in late April when the investment was first announced.

[Related -Microsoft Corporation (MSFT) Earnings Preview: What To Watch In Q2 Results?]

Since then Barnes & Noble has struggled, up 8% year to date versus a 13% gain for the S&P 500.  We think the share price has more upside as investors come to recognize Nook's value and give the company credit for more than holding its own against Amazon's (AMZN) Kindle e-reader.

To be sure, the bears have a case.  Barnes & Noble logged another loss in its latest quarter, as sales of real books continued to be lackluster and margins compressed.  But Nook sales bucked that trend, and some big investors are calling on Barnes & Noble to spin off Nook to unlock its value. 

One measure of bearish sentiment could give the stock a boost.  The ratio of short sales to share float is almost 33%.  A scramble to cover those short positions would provide more fuel for the stock price if it keeps appreciating as we expect.

By all accounts, the Nook is a nifty product that is more than holding its own with the Kindle.  Barnes and Noble recently cut the price of the basic Nook to $79 to stay competitive with Amazon's offering.  Consumers can find the product at mass market retailers Target and Wal Mart, as well as the company's stores and, of course, on line.

As of October 23, 2012, the company operated 689 bookstores in 50 states.  We're headed to one of them today.


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