Barnes & Noble Loss Seen Accelerating Selling of Stores

Barnes & Noble Inc.’s surprise loss during what’s usually its most profitable quarter was triggered by a 26 percent sales drop at Nook, the only segment that had been growing and is essential to aiding a shift to e-books.

The net loss of $6.06 million, which included $74 million in charges from plummeting demand for its newest Nook tablets, comes three days after founder and Chairman Leonard Riggio said he planned to offer to buy the bookstore chain’s retail assets. These results may speed up a sale as they offer more evidence that the largest U.S. bookstore chain should be broken up, said James McQuivey, an analyst at Forrester Research.

“It’s time to move on,” McQuivey, based in Cambridge, Massachusetts, said in an interview. The value of keeping a technology startup like Nook within a retailer was to transfer its customers to digital reading and acquire new ones, he said. “It’s turning out they aren’t capturing all the Barnes & Noble customers, and they aren’t expanding beyond them.”

Barnes & Noble gained 3.3 percent to $15.74 at the close in New York. The shares have advanced 4.3 percent this year, compared with a 6.2 percent gain for the Standard & Poor’s 500 Index.

After the deterioration in its digital business, the company said it will revamp the unit by cutting costs, expanding e-book sales on other devices and redesigning hardware.

The shares are up because “people are getting more comfortable with management’s ability to change the Nook model to make it more viable, and that could lead to the unlocking of value through separation,” said Peter Wahlstrom, an analyst at Morningstar Inc.

Changed Market

The retailer released the its first Nook in late 2009 as a way into the e-reading market that Inc. was already dominating with its Kindle. Within two years, Barnes & Noble had claimed the second-biggest portion of the U.S. e-book market after Amazon.

In the company’s 2012 fiscal third quarter, sales at the Nook unit, which includes devices, accessories, tablets and e-readers, rose 38 percent and digital content surged 85 percent. The success of the Nook tablets helped increase sales at its stores for the second holiday season in a row.

By the most-recent holiday season much had changed. Apple Inc. and Google Inc. unveiled 7-inch tablets, the same size as Barnes & Noble’s most popular Nook, joining Amazon in an increasingly crowded and fast-growing market, McQuivey said.

Apple, Google

While the Nook tablets are well designed, they struggled against how much the other companies could spend on advertising, McQuivey said. The new devices also had more versatility. That gave them an edge over the Nook, which was being pitched as a tablet for readers.

The 7-inch tablet “in its early days was a media-optimized device” for reading and watching movies, McQuivey said. Apple and Google have “turned it into a Swiss Army knife” that can replace a laptop as the consumer’s core device. “That leaves the Nook not well-positioned.”

Barnes & Noble Chief Executive Officer William Lynch said as much during a conference call with analysts.

“We are not going to continue what we are doing,” Lynch said. “We had been the innovation leader in e-readers and reading tablets” and “the market has shifted to multi-function tablets. That’s where growth is.”

Inventory Glut

The Nook division’s revenue sank 26 percent to $316 million in its third quarter, which includes the core holiday shopping months of November and December, according to a statement. The shortfall in demand forced the company to record charges from excess inventory, returns from retail partners and discounting. That doesn’t bode well for the unit’s future content revenue because devices drive those sales. Sales of digital content did rise 6.8 percent.

The rest of the company didn’t fare much better last quarter as retail revenue dropped 10 percent to $1.5 billion while its college chain posted a decline of 1.6 percent to $517 million. For the fiscal year ending in April, same-store sales at retail will decline by as much as “mid-single digits,” according to the statement. At college, they will fall by “low-single digits.”

Companywide revenue dropped 8.8 percent to $2.22 billion. Analysts estimated $2.4 billion, the average of five estimates.

‘Three Legs’

“You are looking at a company that has three legs under it and all three legs are in trouble,” McQuivey said.

Even with the company projecting sales at its stores to continue to decline, it won’t be speeding up closures. The retailer has been shuttering an average 15 stores a year and that will continue going forward, the company said. That’s because more than 95 percent of stores are profitable.

The net loss in the quarter ended Jan. 26 was 18 cents a share, compared with profit of $52 million, or 71 cents, a year earlier. Analysts projected profit of 54 cents.

The company said in January 2012 that it would review ways to separate the Nook unit from the rest of the company as a way to get the market to recognize its value. Since then Microsoft Corp. and Pearson Plc became investors in a new subsidiary, dubbed Nook Media, that includes the digital unit and college bookstore division.

If successful in buying the stores and website, Riggio would leave a public company composed of a college unit that runs bookstores for universities and the Nook division. Even with the college division’s profit, that combination had an operating loss of about $191 million in the three quarters through Jan. 26.

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