Value and Later-Stage Principal Investing Blog: Analysis and Recommendation for Barnes & Noble Education Inc.

Recommendation: Long

(Relatively) Recent Spin-Off Unloved / Underfollowed with Room for Price Growth

Barnes and Noble.png

Thesis

Investment Thesis:

  • Barnes & Noble Education, Inc. (‘BNED’), is a (relatively) recent spinoff from the Barnes & Noble, Inc. (‘Parent Co.’). Currently, BNED represents only ~ 19.0% of all college bookstores (i.e. market share). 52.0% of existing college bookstores are still operated by affiliated university, which allows for further market share penetration potential for BNED. BNED has a very seasoned senior management team, and their business represents the faster growing college bookstore division. BNED will be able to focus on new areas of growth and industry verticals, such as K thru 12 education (primary education) as well as vocational training programs. BNED may eventually prove to be a prospective acquisition target as well (Follett Corporation or Amazon). Seeing that it is a recent spinoff, and that most spinoffs generate their outsized returns between 2 to 5 years (with the majority of returns being generated in the 36-to-48+ month post-spin period), it is still too soon to judge negatively against BNED. The Company has an excellent Balance Sheet with NO debt (prior to the MBS Exchange, LLC acquisition), and trades at a LTM Price / Book Value of < 0.67x, hence in BNED you are ‘buying a $1.00 for 67¢’. The largest control shareholder is Abrams Capital Management, and thus David Abrams (of Boston) may act as an ‘activist investor’ in this situation to ensure that management instills proper ‘capital allocation’ to return excess free cash flows back to investors in the form of opportunistic share repurchases / debt pay-down / possible future dividend initiation. BNED current share price is at $9.53 and the Base Case implied intrinsic value is ~ $13.00 per share. The stock has fallen ~ 37%+ since it began trading in ‘regular way’ trading on August 5, 2015. BNED has a ‘economic moat’ (durable competitive advantage) in that it has a very flexible cost structure (i.e. ‘profit sharing agreement’ and NOT fixed leases) / exclusive relationship with campus administrators and faculty / and IT Financial Aid systems which exclusively allow recipients of scholarship and student loans to directly access funds at campus bookstore locations.

Top Reason to Buy BNED:

  • Revenues based on Long-Term contracts (w/ average duration of 5 to 15 yrs.)
  • High renewal rate of existing contracts (> 94% renewal rate)

  • Large distribution network of college education materials for students (relationships w/ > 9,000 different textbook publishers)

  • Potential to penetrate large yet untapped market (52% of college bookstores operated internally; BNED has ~ 19% market share)

  • Since being spun off from BKS, BNED shares are down ~ 30% (as of Dec. 2016)

  • Proper alignment of incentives between senior management and shareholders (i.e. equity ownership in form of RSUs)

  • Practically a ‘duopoly’ between BNED and Follett Corp. exclusively control market for college campus textbooks

  • BNED trades at a discount to LTM Price / Book Value = 0.67x (‘buying $1.00 for 67¢’)

Top Risk Factors for BNED:

  • No real ‘moat factor’ (i.e. lacking ‘durable’ competitive advantage as per VERY low ROIC / ROCTE levels)
  • Not VERY attractive Operating Profit Margins

  • Secular decline in total student college enrollments over next few years

  • ~ 34.8% (out of total store count of 751) of retail campus store leases will expire within the next 60 months

  • Spending on unprofitable Yuzu eBook platform has been replaced w/ LoudCloud platform instead (w/ effects on ROIC unknown as of yet)

  • Decline in traditional textbook sales due to secular shift towards online book retailers (i.e. AMZN & CHGG)

Key Summary Metrics:

  • Current Share Price (03/01/2017): $10.15
  • 3 Yr. Price Target: ~ $13.00

  • % Upside (‘Margin of Safety’): ~ 28.1%+

  • Fully Diluted Shares Outstanding (‘FDSO’): 47.596mm

  • Market Cap.: $484.5mm

  • Total Debt2: $305.0mm

  • Cash & Equivalents2: $99.4mm

  • Total Enterprise Value (‘TEV’) 2: $690.2mm

  • FY 2016 EV/EBITDA: 8.6x

Valuation (Summary) Metrics:

  • FY 2017 Enterprise Value / Revenues: 0.28x
  • FY 2017 Enterprise Value / Adj. EBITDA: 4.83x

  • FY 2017 Enterprise Value / EBIT: 32.72x

  • TTM Price / Book Value: 0.66x

  • TTM Price / Tangible BV: 1.96x

  • FY 2017 P/E : 51.1x

  • Return on Equity (3 yr. avg.): 2.3%

  • Return on Invested Capital (ROIC) (3 yr. avg.): 2.3%

  • Return on Tangible Capital Employed (ROTCE) (3 yr. avg.): 3.0%

  • “Moat” Factor (FCF % of Rev.) (3 yr. avg.) : 0.3%

Company Background:

  • On 09/30/2009, Barnes & Noble, Inc. acquired Barnes & Noble College Booksellers LLC
  • –Barnes & Noble College Booksellers LLC a wholly-owned subsidiary of BN until 10/04/2012

  • –Barnes & Noble College Booksellers LLC initially incorporated as NOOK Media LLC in July 2012

  • –Microsoft Corp. acquired 17.6% interest in NOOK Media LLC in 10/04/2012 (and BN retained 82.4% interest in NOOK Media LLC)

  • –Pearson Education Inc. acquired 5.0% non-controlling interest in NOOK Media LLC on 01/22/2013

  • –B&N Inc. re-acquired MSFT 17.6% interest in NOOK Media LLC on 12/04/2014 and Pearson 5.0% noncontrolling interest on 12/22/2014

  • Hence as of 12/31/2014, @ time of Spin-Off, B&N Inc. owned 100% full interest in Barnes & Noble Education, Inc.

  • –On Feb 2015, NOOK Media LLC corporate name changed to Barnes & Noble Education, Inc.

  • – 02/26/2015, B&N Inc. announced 100% spinoff of B&N Education, Inc.

  • –08/02/2015, legal separation completed (aka spinoff ‘distribution date’)

  • –Distribution Ratio: 0.632x BNED Shares : 1.00 BKS shares

Business / Product Overview:

  • The following line up represents the ‘Product & Service Offerings’ of BNED:

–(1) [Traditional] Textbook and Course Materials: traditional textbook business; BNED works directly w/ campus faculty; in FY 2016, c. 220,000 unique textbook titles

–(2) Textbook and Course Material Rentals: physical and eBook textbooks for rent; new business line growing at > 40.0%+ CAGR

–(3) General Merchandise: allows for higher Gross Profit Margins from change is product sales mix; focus on school-branded merchandise / café / stand-alone convenience stores to offset secular decline in Product Category #1 above

–(4) Digital Education: primarily LoudCloud Platform (i.e. relatively recent prior acquisition) / phasing out prior (money loosing) Yuzu eBook Platform

  • (i) FacultyEnlight
  • (ii) Campus Connect Technologies

  • (iii) LoudCloud Platform

Variant View:

  • BNED share price has dropped ~ 37% since it began ‘regular way’ trading back on August 2015
  • There was a large drop recently in BNED share price due to fear over a secular decline in college enrollment rates (as this was mentioned on a quarterly earnings conference call)

  • However, the general fear over a secular decline in college enrollment rates is actually overblown for the following reasons:

–(1) the largest decline in college enrollments is actually in 2-year junior colleges….. while college enrollments are declining due to Millennials entering the workforce, an unanticipated factor is the eventual ‘bursting’ of the ‘web 3.0 Tech bubble’, which will result in LARGE increase in college enrollments as Tech sector enters a recession

  • Furthermore, the market is pricing into the stock the fact that ‘comparable same store sales’ have been on a declining trend since FY2012. However…

–(1) BNED has a very flexible cost structure since it has a ‘profit sharing model per store’ as opposed to fixed lease payments and has lower overhead per store

–(2) if and when (in what exact fiscal quarter or year) BNED management can reverse the cause of ‘same store sales’ declining trend, then each one of the ~ 35+ new stores that it plans to open each year will become accretive to Operating Income (EBIT) / EBITDA / FCF per share / and (hopefully) diluted EPS

  • Additional market concerns include decline in traditional college textbook sales and transition towards online book retailers:

–(1) Traditional textbook sales have NOT fallen off a cliff….and even if they did….

–(2) BNED has already transitioned towards new revenue channel of online digital textbook rentals (growing at a 5 year CAGR = 46.3%)…

–(3) a transition towards more school-branded merchandise / product mix will help offset lost sales to online textbooks

Catalysts:

  • Main catalyst categories include the following:

–(1) Proper ‘harvest period’ for a recent spinoff (‘time arbitrage’ of 2 to 5 years holding period post-spin)

–(2) Reversal is secular decline of student college enrollments (‘reversion to the mean’ re 30 year historical statistical trend in annual increase in college enrollments)

–(3) Stabilization of ‘same store comparable sales’ to positive growth Y-o-Y

–(4) ~ $17mm in annual savings from termination of Yuzu eBook (unprofitable) division

–(5) Further market share gains in untapped (‘university affiliated’) college book stores

–(6) Potential activist investor campaigns by Abrams Capital Management / Daniel Tisch

–(7) Possible synergies to Adjusted EBITDA from integration of recent MBS Exchange, LLC acquisition

Valuation:

  • In general, the valuation came out on the very low side of things in terms of ‘Margin of Safety’
  • However, the main reason this happened is due to a 15.0% discount rate used

  • –This discount rate is NOT based on WACC / actual Cost of Equity / Capital Asset Pricing Model

  • –Instead, discount rate is based on my personal ‘required return’ threshold of ~ 15.0% to 20.0%+ per equity investment

  • Hence even though on a LTM Price / Book Value basis BNED is trading at a ~ 33% ‘Margin of Safety’, the actual Discounted Cash Flow implied value per share is ULTRA conservative (since presumably the actual WACC-derived discount rate would be MUCH lower)

  • Much more due diligence would be needed on the Terminal Period Enterprise Value / EBITDA multiple figure being used….

  • –In fact, possible reason that my implied value per share is SO CLOSE to actual current existing market price is MOST LIKELY due to Terminal EV/EBITDA multiple based on ACTUAL trading data RATHER than (i) Comparable Company Analysis or (2) Precedent Transaction multiples

  • –Hence again actual valuation MAY BE too conservative since (1) discount rate used for calculating Constant Growth Terminal Value based on personal ‘return requirement’ and (2) Exit Multiple  terminal value does NOT factor in ANY ‘multiple expansion’ (which is probable given spinoff from BKS ‘Parent Co.’)

Investment Risk Factors:

  • Several potential investment risk to consider for BNED:

–(1) Actual decline in 2 year junior college student enrollments is an actual ‘paradigm shift’ rather than a short-term ‘transitory’ trend

–(2) Potential integration problems w/ recent MBS Exchange, LLC acquisition

–(3) Bulletproof Balance Sheet will debt drawn down from Credit Facilities

–(4) LoudCloud Platform turns out to be shareholder ‘value destroying’ ‘pet project’ (similar to what Yuzu was) and thus Yuzu restructuring charges and SG&A Expense savings will NOT be realized to shareholders

–(5) Same Store Comparable Sales trend does NOT reverse to show Y-o-Y annual positive growth

–(6) Razor-thin Operating Income (EBIT) margins do NOT improve due to product mix shift away from traditional textbooks and towards higher margin textbook rentals / café / non-course re: school merchandise

 


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