From Individual Investor
What?s Barnes & Noble?s
Spin-Off Really Worth?
individualinvestor.com
By Steve Smith 11/4/99
Thanks to the sky-high valuations the equities
market is awarding Internet companies, it?s no
surprise that everyone from Barnes & Noble
(NYSE: BKS - Quotes, News, Boards) to the
local pickle merchant is trying to monetize their
Web potential.
Can you blame them?
The stock spin-off has become a favored tactic for
a parent company that wants to retain a sizable,
but minority, stake in the subsidiary.
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You can almost picture management at the parent
company thinking to themselves, ?Hey if Wall
Street loves small revenue coupled with huge
losses, well, we can deliver that profile.?
This has resulted in some intriguing stock
valuations in which an Internet spin-off?s market
cap swells disproportionately to the original core
operation. We?ve looked at several of these
scenarios, such as Ziff-Davis? (NYSE: ZD -
Quotes, News, Boards) spin-off of ZDNet
(NYSE: ZDZ - Quotes, News, Boards) and IDT
Corp?s (NASDAQ: IDTC - Quotes, News,
Boards) stake in the then surging Net2Phone
(NASDAQ: NTOP - Quotes, News, Boards), in
which we flirted with the notion that the core
business is undervalued relative to the new issue
and thus a ?buy.?
Such an investment thesis was arrived at by
subtracting or backing out the core company?s
ownership stake in the new issue from the
parent?s current stock price. The result has left the
core business looking very cheap by nearly all
conventional ratios, such as price to earnings,
price to sales or price to book.
Unfortunately, there are few examples where this
strategy has played out, and we think we?ve come
up with at least a partial explanation by looking at
Barnes & Noble and its 41% stake in
barnesandnoble.com (NASDAQ: BNBN -
Quotes, News, Boards).
The market currently values the holding at $1.1
billion or $15.90 per share. If you subtract that
from Barnes & Noble?s $1.5 billion market
capitalization and share price of $21.58, it values
the core business at just $431 million or $6.12 per
share.
At Wednesday?s close, Barnes & Noble was
down $0.50 to $21.44, and barnesandnoble.com
was up $0.19 to $18.44.
But Barnes & Noble is expected to earn $1.18 per
share in 2000 and $1.47 per share in 2001. That
would mean the parent company is trading at just
5.3 times next year?s earnings once
barnesandnoble.com is factored out. Yet Barnes
& Noble has a projected growth rate of more than
20% for the next three years.
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Several analysts who have ?buy?
recommendations on Barnes & Noble are baffled.
Amy Ryan of Prudential Securities sees no flaw in
the valuation procedure. She says ?The core
business is strong, and the market is telling me
that its 144 million share stake is worth x amount
of dollars. I translate that into a per share
contribution. Barnes and Noble is cheap at these
levels.?
Jason Klein, an analyst with Blackford Securities
Corp., says that before the barnesandnoble.com
initial public offering, ?We were reluctantly
segregating the two businesses to get a better
handle on the core business?s value. Now, with the
online business operating as a separate
company, we feel this method is not only
appropriate, but the best method for valuing
shares based on current business projections.?
But Klein also issues this caveat,
barnesandnoble.com?s ?shares may be
overvalued. We are taking a conservative
valuation approach by saying that
barnesandnoble.com should trade about 10 times
sales.?
Klein bases his valuation of barnesandnoble.com
by comparing it to Amazon.com (NASDAQ:
AMZN - Quotes, News, Boards), which is
currently trading at 13 times sales.
Barnesandnoble.com is trading a 14 times sales.
In addition, Klein is assuming that losses don?t
accelerate beyond the $0.05 per share loss from
last quarter.
Klein?s approach sounds good. But there?s
another problem with valuing
barnesandnoble.com, and here it is ? liquidity.
Jim Jordan, an analyst with Southwest Financial
Analytics, explains that if Barnes & Noble, the
parent, went to sell its 40% stake, it would cause
?massive downward pressure on the stock.? This
has led Jordan to place a ?blockage discount? on
barnesandnoble.com?s shares. He figures that the
current price, shares would fall some 20% for
every 15% of stock released to the float.
For many companies, common stock has become
a form of currency, but its value is fleeting. As
soon as more supply hits the market, or if a holder
of the asset tries to translate it into cash, the
individual share value plummets.
Another factor working against
barnesandnoble.com is that it is in the unfortunate
position of competing against its parent company
in a relatively slow growth market. The book
industry is expected to grow at a 7% clip for the
next five years. That means that if Barnes & Noble
and barnesandnoble.com are to maintain their
current growth rates, they?ll be cannibalizing one
other?s business.
It?s also worth noting that Barnes & Noble
announced on Tuesday that it had bought a 49%
stake in iUniverse.com, a privately held company
that publishes paperback versions of new and
out-of-print books. The company?s publications
are sold both through traditional retailers and Web
sites. Barnes & Noble will use its marketing clout
to support iUniverse.com.
Bottom Line:
On the surface, Barnes & Noble may still look
cheap, but the difficulty in measuring
barnesandnoble.com?s fair market value
knocks out one possible reason for liking
this stock. Still, if you think Barnes & Noble is
a good company, go ahead and buy its
shares based on the core business alone.
Don?t expect the Internet spin-off to
contribute to the upside. |
