Price: $11 1/8
Estimates (Dec) 1998A 1999E 2000E
EPS: d$0.72 d$0.77 d$0.72
P/E: NM NM NM
EPS Change (YoY): NM NM
Q1 EPS (Mar): d$0.08 d$0.18 d$0.20
Cash Flow/Share: NA NA NA
Price/Cash F low: NM NM NM
Dividend Rate: Nil Nil Nil
Dividend Yield: Nil Nil Nil
Opinion & Financial Data
Investment Opinion: D-2-1-9
Mkt. Value / Shares Outstanding (mn): $1,602 / 144.0
Book Value/Share (Dec-1999): $0.84
Price/Book Ratio: 13.24
ROE 1999E Average: NM
LT Liability % of Capital: 0.0%
Est. 5 Year EPS Growth: NA
Stock Data
52-Week Range: $26 1/2-11 1/8
Symbol / Exchange: BNBN / OTC
Options: None
Institutional Ownership-Spectrum: NA
ML Industry Weightings & Ratings**
Strategy; Weighting Rel. to Mkt.:
Income: Underweight (07-Mar-1995)
Growth: Overweight (07-Mar-1995)
Income & Growth: Overweight (07-Mar-1995)
Capital Appreciation: In Line (28-Jan-1999)
Market Analysis; Technical Rating: Below Average (21-May-1999)
**The views expressed are those of the macro department and do not
necessarily coincide with those of the Fundamental analyst.
For full investment opinion definitions, see footnotes.
Investment Highlights:
ú barnesandnoble.com reported results on Tuesday.
The company had a strong Q4, exceeding our
expectations in revenue, operating income and
customer count and in-line with EPS estimates.
ú We are raising our revenue and EPS estimates for
2000 and 2001 and maintaining our 2-1 rating.
ú Revenue increased an impressive 67% sequentially
(217% Y/Y) to $82.1 million, exceeding our estimate
of $70 million and ahead of the pre-announced
number of $81.5 released on January 6 th .
ú Operating EPS of a loss of ($0.27) was directly in-line
with our estimate. We did not view this as
typically impressive as the company usually
exceeds estimates.
ú New customer accounts increased 1.1 million (39%
sequential growth) to an aggregate of almost 4
million, exceeding our estimates of 649,000 and
3.5M gross.
ú Revenue per account actually accelerated Y/Y
from $20 in Q4 1998 to $21 and exceeded our
estimate of $20.
ú We are raising our 2000 and 2001 revenue and
EPS estimates. For 2000, we are taking revenue
from $325M to $360M and EPS from ($0.81) to
($0.72).
ú Grade for the Quarter: B+
Comment
United States
Internet Software & Services
9 February 2000
Henry Blodget
Daniel Good
barnesandnoble.com
Q4 Results ? Solid Quarter ACCUMULATE
Long Term
BUY Reason for Report: Quarterly Results
Merrill Lynch & Co.
Global Securities Research & Economics Group
Global Fundamental Equity Research Department
RC#20104027
barnesandnoble.com ? 9 February 2000
(Continued)
2
Summary. We believe that bn.com is in the early stages of
building a strong platform to compete in the large and
growing online market for books, music, videos, software,
and related intellectual-property products. Along with
other e-commerce stocks, we expect BNBN to be driven
by: 1) continued strong operating performance 2) meeting
(and ideally) beating analyst estimates, 3) demonstrating a
continued ability to take market share away from
Amazon.com, 4) continued introduction of new intellectual
based products, and 5) normal seasonal catalysts.
barnesandnoble.com had a strong Q4 but there were very
few surprises on the call. The company had pre-announced
some of its Q4 results on January 6 th , so we had an idea
about what to expect. For the quarter, the company
exceeded our expectations in revenue, operating income
and customer count. EPS were directly in-line with
estimates which actually surprised us a bit because bn.com
typically exceeds our EPS estimates. We received very
detailed guidance with regard to margins and revenue
expectations for 2000 and 2001. We were also told to
expect profitability in the business by Q4 2001, on a
quarterly basis, and for the full year 2002.
Revenue increased an impressive 67% sequentially and
217% year-over-year to $82.1 million, handily exceeding
our estimate of $70 million and ahead of the pre-announced
number of $81.5M released January 6th.
The company added more customers than we expected and
average quarterly revenue per account actually accelerated
slightly Y/Y from $20 to $21, slightly ahead of our
estimate of $20. bn.com sold product in 216 countries
around the world. International product sales remained flat
as a percentage of revenue at 8% in Q4. We are raising
our Q1 revenue estimate just slightly from $59 million to
$62 million but we are increasing 2000 and 2001 revenue
estimates pretty significantly based on higher expectations.
Our $62 million estimate for Q1 will actually represent a
24% sequential decrease from Q4 reflecting a seasonal
slowdown in book buying. For Q1, we expect average
quarterly revenue per customer to decrease to $14. This
represents the first sequential decrease in revenue for
bn.com but is in-line with the seasonal effects impacting
estimates of other leading and somewhat mature online
retailers.
Gross customer accounts increased 1.1 million to almost
4 million. The incremental 1.1 million accounts added in
Q4 was almost double our estimate of 649,000.
Gross margin fell to 20.3% from 20.6% in Q3, and was
slightly below our estimate of 20.5%. We are expecting
gross margin to improve to 20.8% in Q1 2000 and to show
sequential improvement during the year. For the full year
2000 we are looking for approx. 22.3% gross margins.
The company attributed the decrease in gross margin to
product mix?namely, increased sales of lower margin
music products. Long term, the company expects gross
margins to improve as bn.com gains economies of scale by
building its own distribution facilities and ?going direct?
for a larger percentage of total product sold. bn.com
currently has most of its distribution handled at cost by
parent company Barnes & Noble and outsources the rest to
Ingram. The company said that plans to open two new
facilities, in Memphis, TN and Reno, NV, are on schedule.
The company plans to open the Memphis facility in May
and Reno is expected to open in October/ November 2000.
The two facilities will provide approximately 300,000 sq.
ft. and 600,000 sq. ft., respectively.
Operating loss margin pre-goodwill of 56.4% was better
than our estimate of 67.6%. Absolute operating losses in
the quarter were also better than our estimates but did
increase sequentially from ($30) million in Q3 to
approximately ($46) million in Q4. We expect absolute
operating losses to remain significant for the next 12 ?15
months, however, based on detailed guidance we expect
both absolute operating losses and operating loss margins
to improve during 2000. We will be very focused on
operating margins for the next four quarters to see how the
model begins to scale. Fulfillment expenses were
approximately 11.4% of revenue in 1999 (12.5% in Q4).
The company expects these expenses to increase slightly
for 2000 to about 13% of revenue due to increased costs
associated with its two new facilities. After 2000, bn.com
expects fulfillment to drop back to historic levels of 10%
of revenue.
Customer acquisition cost decreased from $36 in Q3 to
$30 in Q4?well below our estimate of $54. A key metric
for all online retailers is customer acquisition cost--the
average number of marketing dollars spent to induce a new
customer to buy something at the site. bn.com is focused
on bringing this cost down and plans to increase its sales
and marketing efficiency by leveraging the strong brand
name and physical presence of the parent company. By
leveraging Barnes and Noble?s brand name and using in-store
promotions to drive traffic to its web site,
management hopes to be able to consolidate the two
purchasing channels and capture as many new online users
as possible.
We believe bn.com will be able to reduce this customer
acquisition cost through effective marketing, however, it is
important to point out that reducing these costs may
become more difficult as time goes on. Customer
acquisition costs have been trending higher for most e-commerce
companies for the last few quarters. We believe
that online retailing is in the midst of a very serious
shakeout that will likely be followed by heavy
consolidation. This actually bodes well for the leading
companies, of which we think bn.com is one. The demise
(or at least decline) of the smaller online retailers should
make the advertising environment less competitive and
less confusing to the consumer, effectively making it easier
for the leading companies to reach new customers.
We are not suggesting that acquiring new customers is all
of a sudden going to be cheap, we are just suggesting that
the environment might get a little less noisy. We believe
that bn.com (and leading companies like it) should
barnesandnoble.com ? 9 February 2000
3
continue to spend as much as possible on customer
acquisition now as they try to take market share and
establish a large and loyal customer base. This continues
to be the time for companies to establish a meaningful
customer base and capture as much of the growth in new
Internet users. We expect customer acquisition cost to
increase in Q1 but to sequentially improve for the
remainder of 2000.
Operating EPS were a loss of ($0.27), directly in-line with
our estimate. For the same period, Q4 1998, bn.com had a
loss of ($0.27) as well. We were actually surprised by this
given the performance of bn.com over the last few quarters.
The company has easily exceeded EPS estimates each
quarter since its IPO. We will watch this line item closely,
however, guidance provided on the call suggests that
management feels very confident that it can improve the
bottom line. In our revised model, we estimate profitability
for bn.com in Q4 2001 and for the full year 2002.
Revenue from existing customers increased to 66%, up
from 63% in Q3. We generally consider this a positive as
it demonstrates that existing customers are returning to the
site to make a purchase.
We are raising our 2000 and 2001 revenue and EPS
estimates. 2000 revenue estimates increase from $325
million to $360 million and 2001 increases from $564 to
$700 million. Our EPS estimates for 2000 and 2001
increase from ($0.81) to ($0.72) and from ($0.45) to
($0.44), respectively.
Balance sheet. The company has approximately $550
million in cash and no debt. We expect bn.com to use this
cash to grow the business internally and make strategic
investments or possible acquisitions of products or services
that complement the company?s focused strategy. On the
call, the company said it preferred to build rather than buy
new businesses but did not rule out making opportunistic
acquisitions if it made sense. Cash burn in the quarter was
approximately $45 million.
Outlook and Recommendation
We continue to believe that the markets bn.com addresses and
intends to address are more than large enough to support the
growth of two large companies (ie, barnesandnoble.com and
Amazon) and that bn.com is in a good position to continue to
take market share from Amazon.
We learned during Q4 that book revenue at Amazon was
approximately $317 million (47 % of the total business)
and that the US book business was profitable in the
quarter. We believe that Amazon.com has proven to
investors that it can run its books business profitably. We
believe Amazon will now be very focused on growing the
ten new business it introduced in 1999 and proving that
those businesses can be run profitably as well. This slight
shift in focus, away from books, may provide bn.com with
a real opportunity to gain some additional market share.
We also continue to believe that online commerce is a
massive opportunity and that success is more difficult than
it looks. bn.com has all of the ingredients for success: a
clear strategy, focus, and an early mover advantage, as
well as a strong management team, strong financial
partners, and a strong brand name.
Trading at a 52-week low of $11 1/8, approximately 4.5x
2000 revenue and 2.3x 2001, we believe this represents an
excellent entry point for long term investors. We would
point out, however, that we do not see any near-term
catalysts for the stock. We believe there could continue to
be some negative sentiment surrounding the B2C online
retailing stocks in the near-term. We consider bn.com to
be one of the leading online retailers and believe there is
upside for BNBN for the balance of 2000.
(Continued)
[BNBN] MLPF&S was a manager of the most recent public offering of securities of this company within the last three years.
[BNBN] The securities of the company are not listed but trade over-the-counter in the United States. In the US, retail sales and/or distribution of this report may be made only in states where these securities are exempt from
registration or have been qualified for sale. MLPF&S or its affiliates usually make a market in the securities of this company.
Opinion Key [X-a-b-c]: Investment Risk Rating(X): A - Low, B - Average, C - Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12 mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 -Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9 - No Cash Dividend.
Copyright 2000 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). This report has been issued and approved for publication in the United Kingdom by Merrill Lynch, Pierce, Fenner & Smith Limited, which is
regulated by SFA, and has been considered and issued in Australia by Merrill Lynch Equities (Australia) Limited (ACN 006 276 795), a licensed securities dealer under the Australian Corporations Law. The information herein was
obtained from various sources; we do not guarantee its accuracy or completeness. Additional information available.
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