Barnes & Noble Inc – 7 October 1998
2
Positive Joint Venture for Internet
Business Announced
Barnes & Noble and Bertelsmann announced a joint
venture regarding barnesandnoble.com. Bertelsmann, a
leading international media company and one of the largest
book publishers in the world, will buy a 50% stake in
barnesandnoble.com for $200 million. Both Barnes &
Noble and Bertelsmann will also invest $100 million each
in the capital of barnesandnoble.com. The initial public
offering of barnesandnoble.com will be postponed as a
result of this joint venture. We expect the offering to occur
some time next year. Bertelsmann will disband the U.S.
operation of its BooksOnline internet site but will proceed
separately with its European BooksOnline operation.
Joint Venture Should Boost
Growth of E-Commerce Venture
We believe this joint venture is very beneficial to
barnesandnoble.com. Bertelsmann has extensive expertise
in direct marketing, is a leading multi-media company and
has vast reach in global markets. We believe the strength
of Bertelsmann and the enhanced capital structure of the
joint venture should help to accelerate the growth of
barnesandnoble.com. Barnesandnoble.com is the sixth
largest e-commerce site according to Media Metrix with
sales of $34 million over the past twelve months.
However, it still pales in comparison with Amazon.com
with latest twelve month sales of $307 million. We
believe that this joint venture should help
barnesandnoble.com to pose a more formidable challenge
to Amazon.com. It also eliminates a major competitor to
barnesandnoble.com, which Bertelsmann had become
through its BooksOnline site. Bertelsmann's expertise in
the music business should also help barnesandnoble.com
to eventually expand into that category online.
Raising Estimates for Barnes & Noble
As a result of this joint venture, barnesandnoble.com will
be accounted for as minority interest for Barnes &Noble as
the company will only own 50% of the operation.
Therefore, barnesandnoble.com's operating performance
will no longer run through each line item of the income
statement and only 50% of the loss from the operation will
impact total company results. Obviously, when
barnesandnoble.com earns a profit, this will decrease the
benefit Barnes & Noble will receive, but that is still years
away and if successful, this joint venture should increase
the likelihood and scale of eventual profitability online.
While it is difficult to forecast losses for the online
business with certainty, we have adjusted our earnings
estimates to include only half of our previously forecasted
losses beginning in the fourth quarter of this year. Since
we expect significant online losses both this year and next,
reducing these estimates by half has a significantly
positive impact on Barnes & Noble reported earnings.
We are raising our 1998 EPS estimate $0.06 to $0.99, up
6% over the prior year. We estimate that total internet
losses should be about $38 in 1998, about $30 million of
which should occur in the first three quarters. Assuming
this joint venture deal closes by the end of the third
quarter, we expect internet losses applied to Barnes &
Noble of about $34 million for the year or $0.47 per share,
with the remainder absorbed by Bertelsmann. The retail
business is forecast to gain 38% to $1.46 per share in 1998.
We are also raising our 1999 EPS estimate $0.30 to $1.50,
up 51% over the prior year. This reflects growth in the
retail operation of 24% to $1.81 per share and a total
internet loss of $46 million, only half of which or about
$0.30 per share would impact total company results.
Reiterate Buy Rating
From the beginning of the year through the market peak on
July 17 th , Barnes & Noble's shares were up 36% versus a
22% gain in the S&P 500 and a 46% rise in the S&P Retail
Composite. Since July 17 th , Barnes & Noble is down 48%
as a result of lower than expected reported earnings
because the company sharply increased marketing
expenditures for barnesandnoble.com. During that same
period of time, the S&P 500 is down 17% and the S&P
Retail Composite declined 20%. The shares are currently
trading at 24 times our 1998 EPS estimate. We believe the
internet business is significantly undervalued. As a stand
alone company we believe barnesandnoble.com is worth
between $8 and $14 if valued at half of Amazon.com's
price to 1999 sales multiple of 7.9 times. The eventual
IPO of barnesandnoble.com should enable Barnes & Noble
stock to more fully reflect the inherent value of the internet
business. In addition, this joint venture which values the
online business at about $5.50 per share should enhance
the growth and ultimate value of that business. We
estimate the core retail business if valued similar to other
growth retailers at a 15% premium to growth is worth
about $40 per share. Therefore, our price objective on the
shares of Barnes & Noble is $50, 33 times our 1999 EPS
estimate of $1.50.
[BKS] An officer, director or employee of MLPF&S or one of its affiliates is an officer or director 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 1998 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
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