Barnes & Noble Inc – 20 November 1998
2
Strong Retail Operations Offset By Internet Losses
Barnes & Noble posted its second consecutive earnings
decline after seven consecutive quarters of gains. Strong
earnings at retail were overwhelmed by losses from the
internet operations. The company reported a third quarter
loss per share of $0.07 versus flat results in the prior year.
Results were $0.07 below our estimates and $0.04 below
the Street Consensus. Internet operations posted larger
than expected losses of $0.18 per share, $0.07 worse than
our estimate. Retail EPS was $0.11, up 120%.
We expect future internet losses to be higher than
previously expected. We are reducing our fourth quarter
EPS estimate $0.13 to $0.97 (down 1%) with a slight
improvement in the retail operations overshadowing losses
from the internet operations. We are forecasting total
fourth quarter internet losses incurred by
barnesandnoble.com of $15.6 million, 50% of which will
go to Bertelsmann implying a loss per share of $0.11. We
are reducing our 1998 EPS estimate $0.20 to $0.79, down
15% from last year, composed of a profit of $1.36 from
retail and a loss of $0.57 from internet. Our estimate for
next year is also reduced $0.38 to $1.12, composed of a
profit of $1.68 from retail (up 37%) and a loss of $0.57
from internet. We tentatively guess total internet losses
incurred by barnesandnoble.com at 1999 should be $84
million (up 71% from 1998), of which Bertelsmann will
take 50%.
Internet Business To Be Spun-Off Through IPO
Management still intends to spin-off up to 20% of the
internet business through an IPO. Online sales were $17.2
million in the third quarter (up 38%) from the second
quarter, and a 300% increase from the $2.2 million in sales
last year. Online losses were $12.3 million or $0.18 per
share in the 3Q. Sales are expected to reach approximately
$67 million in 1998 and $150 million in 1999.
Comp Sales Sluggish, But Still Lead Industry
3Q superstore sales increased 10% as a result of an 8% rise
in store count and 4.5% comps. Mall sales decreased 2.4%
in 3Q98 from a 9% decline in stores and a 1% decline in
comp sales. Inventories rose 13%, slightly above sales
growth as a result of the increase in the DC inventory to
750K titles available for shipping within 24 hours for
internet and retail stores. In the fourth quarter, we are
forecasting an 11% rise in superstore sales on a 4.5%
comp, a 9% decline in mall sales on a negative 1% comp,
and an internet increase of 63% over third quarter sales.
Strong Gross Margin Improvement Continues
Gross margin increased for the seventh consecutive period
in the third quarter with a gain of 88 basis points and 13%
in dollars. This improvement reflects the shift in the
merchandise mix to superstores and higher margin titles,
freight cost efficiencies and more direct buying because of
the new distribution center. We expect 4Q gross margin
be flat.
Internet Investment Increases Expense Ratio
Expenses as a percent of sales increased for the sixth
consecutive quarter, after seven quarters of improvement,
exclusively as a result of an increased investment in the
internet business. SG&A ratio increased 240 basis points
and 22% in dollars in 3Q98. We expect the SG&A ratio to
rise 89 basis points in the fourth quarter.
EBITDA Margin Declines From Internet Operations
EBITDA margin declined for the third consecutive quarter
after eight consecutive periods of improvement. EBITDA
margin decreased 132 basis points and 20% in dollars. We
expect EBITDA margin to decrease 100 basis points in
4Q98 from continued internet investment.
Valuation Remains Extremely Attractive
From the beginning of the year through the market peak on
July 17 th , Barnes & Noble's shares were up 36% versus a
46% rise in the S&P Retail Composite and a 22% gain in
the S&P 500. Since July 17 th , Barnes & Noble is down
29% versus a 2% decline in the S&P Retail Composite and
a 3% decline in the S&P 500. The shares are trading at a
39% premium to the market on a forward four quarter
basis, below its five year average premium of 70%. Our
twelve month price objective is $50, a multiple of 45 times
next year's estimate of $1.12, compared to the current
multiple of 42 times this year's estimate of $0.79.
We believe the internet business is significantly
undervalued. As a stand alone company we believe
BarnesNoble.com is worth $8 per Barnes & Noble share if
valued at half of Amazon.com's price to 1998 sales
multiple of 17.1 times. An IPO of BarnesandNoble.com
should enable Barnes & Noble stock to more fully reflect
the inherent value of the internet business. We estimate
the core retail business if valued similar to other high
growth retailers on a P/E to growth rate basis is worth
about $47 per share.
Merrill Lynch is currently acting as financial advisor to
Barnes & Noble Inc., in its proposed acquisition of
Ingram Book Group, announced on November 6,
1998. |
