Every successful bookie will tell you the key to business is ensuring other people take most of the risks. Its line of work differs a bit, but America's largest bookseller, Barnes & Noble (BKS), knows this aspect of bookmaking cold. To see what I mean, look at barnesandnoble.com (BNBN), the click in B&N's clicks-n-bricks strategy.
B&N is offering to take private barnesandnoble.com, the public company that runs the Barnes & Noble.com Web site. On Nov. 7, B&N unveiled its plan, which calls for paying $2.50 a share, or $115 million, for the 25% of barnesandnoble.com that it doesn't already own. The stock, which had been idling near $2.25 a share, leaped and now trades above $2.80. In other words, the market expects B&N ultimately to raise its bid. Some shareholders are even suing, alleging that B&N's offer is unfairly low. B&N denies that and plans to defend itself against the suits. Yet whatever price B&N ends up paying, I'm betting it will show itself more than just lucky.
CONSIDER THE NEW YORK-based bookseller's moves so far. In March, 1997, with Amazon.com's (AMZN) initial public offering just weeks away, B&N opened its first online store. By October, 1998, the site was drawing plenty of traffic, but profits were nowhere in sight. That's when it took on a partner, Bertelsmann, the German media giant. It paid $225 million up front and an additional $75 million when barnesandnoble.com went public the next spring. After the IPO, Bertelsmann had 40% of barnesandnoble.com and B&N had 40%, at a cost of $116 million. The public? They got 20%, for $518 million, or $18 a share.
After zipping up initially to $26.50 a share, the stock took a long downhill ride. It has rallied in the past year as operations have grown more efficient. Although sales edged down 1%, to $291 million, during the first nine months of 2003, and the bottom line was $9.9 million in the red, barnesandnoble.com's operating margin keeps improving (chart). B&N sees barnesandnoble.com's earnings before interest, taxes, depreciation, and amortization at least breaking even this quarter and in 2004.
Bertelsmann, whose board has been in conflict over its global strategy, will not share in any future improvement at barnesandnoble.com. It sold its entire stake to B&N for $164 million in September. If B&N also buys out the public's 25%, B&N will have closed a five-year-long circle of laying off and taking on the risk of e-tailing. The prices it is now paying indicate a total value of $450 million for barnesandnoble.com.
How risky is that? Next to Amazon.com, hardly at all. Amazon's elephantiasis-plagued $21 billion market capitalization is five times its past four quarters' sales. A better comparison may be 1-800-Flowers.com (FLWS), with a $768 million market cap. It trades at 1.4 times the past four quarters' sales. At that, barnesandnoble.com would be worth $575 million.
Representing barnesandnoble.com's public investors is a committee of two of its three outside directors. It's led by Patricia Higgins, CEO of Switch and Data Facilities, an Internet communications company in Tampa. To her credit (and unlike most of the dozens of directors in similar situations whom I have contacted over the years), Higgins did not hide behind a secretary, publicist, or lawyer. She told me she has challenged Credit Suisse First Boston (CSFB), the committee's adviser, "to ensure that we are getting the best deal for the minority shareholders." She added: "That's my responsibility." Given B&N's savvy, her goal may prove easier said than done. By Robert Barker