ML sets BKS target at $31, raises 99 EPS $0.10 to $1.29,2K EPS $0.12, rates LT BUY
Excerpts follow: 10/13/99
Estimates (Jan) 1998A 1999E 2000E
EPS: $0.76 $1.29 $1.60
P/E: 30.4x 17.9x 14.4x
EPS Change (YoY): 69.7% 24.0x
Consensus EPS: $1.18 $1.46
Institutional Ownership-Spectrum: 30.9%
Investment Highlights:
ú Babbage?s acquisition first step in what we
believe should be a series of growth initiatives
contributing to the continuation of double-digit
EPS gains for many years to come
ú Although Babbage?s adds volatility and
additional seasonality to BKS, the acquisition
is immediately accretive and carries a higher
growth rate than the core business
ú Raising 1999 EPS $0.10 to $1.29 (up 70%) and
FY 2000 EPS $0.12 to (up 24%)
ú Positives:
1. Provides another growth business, but one
at an earlier stage in its development
2. Adds another internet vehicle?and one in
the rapidly growing video game market
(18%)
3. Adds an estimated $0.12 of EPS in 2000,
or when applying a 19x multiple, an
incremental value of $2.28 per share
ú Negatives:
1. Volatility of hit-driven industry
2. Adds seasonality in 4Q sales (40%) and
earnings (63%) to an already seasonal mix
ú Our 12-18 monthprice objective is $31, a 19x
2000 multiple vs. the current 18x multiple
Acquisition Of Babbage?s
Immediately Accretive
While Barnes & Noble?s comp store sales continue to be
healthy (up 6% in the first half of 1999), superstore square
footage growth is slowing (forecast to increase 6% in 1999
versus 10% in 2000) and growth in the book industry is a
sluggish 1% to 3%. Thus, Barnes & Noble is looking to
other areas related to books to bolster its already strong
growth prospects. Accordingly, Barnes & Noble
announced intentions to acquire Babbage?s, Etc., one of
the leaders in the video game and entertainment software
industry. We believe that this acquisition is likely to be
the first step in a series of growth initiatives that should
help the company in continuing to generate robust earnings
growth. In addition, it will also provide Barnes & Noble
with another internet vehicle to complement bn.com.
The video game industry is at a much earlier stage of
development than the book industry, and is growing at a
robust 18% rate.
The purchase price of $215 million 1 ($189 million cash
plus $26 million assumption of liabilities) represents a 6.0x
multiple of LTM EBITDA and a 5.1x multiple of 1999
projected EBITDA. We believe the deal is immediately
accretive, adding an estimated $0.10 to earnings in the
fourth quarter of 1999 and an estimated $0.12 in 2000.
Applying a 19 times multiple the incremental 2000
earnings implies an additional $2.28 of value for BKS
shares.
After the acquistion, Babbage?s will comprise
approximately 15% of sales and 12% of EBITDA for the
combined entity.
We continue to rate Barnes & Noble a near-term
Accumulate and a long-term Buy.
Babbage?s Overview
Babbage?s, Etc. operates 495 stores under three operating formats:
465 Babbage?s and Software, Etc. are mall-based stores of
roughly 1,500 square feet, 30 GameStop stores are based in
strip centers and on average are slightly larger than 1,500
square feet. The GameStop stores carry a higher percentage of
higher margin used merchandise than the mall stores.
Babbage?s recently launched a website to sell video games
and entertainment software over the internet. Initial results
have been extremely strong.
Babbage?s generated $465 in sales and $31 million in
EBITDA in 1998 and is forecasting $580 million in sales
in 1999 and $42 million in EBITDA in 1999.
Product Mix
Babbage?s sells video games (40%), entertainment
software (17%), other PC software (10%), hardware
(10%), video game supplies and accessories (10%), PC
supplies and accessories (9%), and action figures (2%).
Square Footage Growth
Babbage?s currently operates 495 stores encompassing
approximately 743,000 square feet. The chain currently
plans to open 40 new stores in 2000 (30 Babbage?s and
Software Etc. and 10 Gamestop stores). The new openings
amount to 8% square footage growth, which exceeds the
growth rate of Barnes & Noble?s square footage.
Additionally, we believe that Babbage?s could open as
many as 20 Gamestop stores next year, which would imply
a more aggressive growth rate of 10%.
Acquisition Accretion
We expect the transaction to add $0.10 per share to fourth
quarter earnings due to the reasonable multiple paid and
the timing of the acquisition (the majority of the profits
come in the fourth quarter). We are forecasting $0.12 of
accretion in 2000. We believe that both of these figures
may be conservative.
Accretion Analysis
4Q99E 2000E
Barnes & Noble Net Income 81 110
Shares Outstanding 73 74
Barnes & Noble EPS 1.11 1.48
+ Babbage?s Net Income 8 9
= BKS Net Income 88 119
/ Shares Outstanding 73 74
= BKS EPS 1.21 1.60
Estimated Accretion 0.10 0.12
Video Game And PC
Entertainment Software Industry
Unlike the book industry, which is growing at 1% to 3%,
the video game and PC entertainment industry is
experiencing robust growth, 18% CAGR between 1995
and 2000E. At $8.4 billion in 1998 sales, the video game
and PC entertainment software industry is less than half
the $21 billion book industry.
Growth Of Industry Critical
The importance of the rapid growth is two-fold. First, it
provides fertile territory for organic growth prospects.
Second, and possibly more important given the current
market perceptions of internet competition, it provides some
defense against deterioration in comparable store sales.
Barnes & Noble management estimates that the internet has
caused only a 1% to 2% decrease in comparable store sales?
a modest decline given the stagnant growth in the overall
book industry. With 18% growth in the video game industry,
we believe there will be opportunity for continued robustness
in comp store sales growth simultaneously with proliferation
of on-line sales. Furthermore, Babbage?s on-line site,
gamestop.com is also positioned to grab a considerable
portion of the on-line video game sales.
Len Riggio?s Involvement
A number of investors have expressed concern about about
a potential conflict of interest created by the acquisition
due to Len Riggio?s position as the Chairman & CEO of
Barnes & Noble and the principal owner of Babbage?s Etc.
LLC (ownership interest of 65%). A handsome profit by
Riggio alone, is not dispositive of a conflict of interest. In fact, if anything, it appears that Riggio?s involvement
helped Barnes & Noble acquire Babbage?s at an extremely
attractive valuation. Furthermore, we believe that the
acquisition was not a self-serving ploy by Len Riggio, but
rather a sound strategic move for Barnes & Noble.
We think that Barnes & Noble will continue to execute
transactions in related product categories with similar
demographics. There is solid cross-over between the
demographics of book buyers and video game purchasers.
They are both highly educated, computer literate and upper
income. And while video game purchasers tend to be
younger than book buyers, the average age of video game
buyers continues to increase.
As an example of the crossover, some of the strongest
performing Software, Etc. stores have been ?combo
stores,? ones directly abutting Barnes & Noble stores.
Valuation
Over the past twelve months, Barnes & Noble shares have
fallen 5%, well below a 43% rise in the S&P Retail
Composite and a 34% climb in the S&P 500. Since the
beginning of the year, Barnes & Noble shares have
declined 44%, below a 6% increase in the S&P Retail
Composite and a 9% rise in the S&P 500. On a forward
four-quarter basis, Barnes & Noble shares are trading at a
28% discount to the market compared with a five-year
historical average of a 45% premium. Our 12-18 month
price objective is $31, reflecting a 19 times multiple of
2000 EPS of $1.60 versus the current multiple of 18 times
1999 EPS of $1.29. The acquisition of Babbage?s is
immediately accretive and adds an estimated $0.10 to 1999
earnings and $0.12 to 2000 earnings. |
