Identifying a great turnaround opportunity can be hugely
When investors become universally negative about a company's
prospects, you've got the chance to spot early signs of
improvement, and latch on before the crowd does.
Of course, it's impossible to perfectly time a turnaround,
even if your analysis is roughly on the mark. Roughly 18 months
ago, I saw signs that struggling consumer electronics retailer
Best Buy (
could get its act together, but it took several quarters for
that scenario to play out.
Though shares slumped further in subsequent months, Best Buy
is on track to deliver one of the best gains in the S&P 500
I was fortunate enough to identify two other stocks in this
group of big gainers, having profiled
Micron Technology (
Delta Airlines (
The sharp gains for Delta and Micron were due to a new
perception among investors about airline stocks, and a profound
change in the computer memory market, respectively. Yet Best
Buy's upturn was the closest to what we could call a true
turnaround. And you'll often find turnaround plays in the retail
sector, simply because of a subtle shift in strategy.
In the case of Best Buy, the retailer is "taking out costs
faster than expected, while tightly managing the spending needed
to deliver the turnaround," noted analysts at Merrill Lynch.
Despite recent struggles, Barnes & Noble is
still the nation's largest bookseller.
Of course, Best Buy was left for dead by investors as many
concluded that huge price pressures from
Amazon.com (Nasdaq: AMZN)
left the company at a terminal disadvantage. The reality: Many
consumers still like to shop for consumer electronics at
brick-and-mortar stores -- as long as the prices are good
That logic explains why I am looking very closely at
Barnes & Noble (
these days. This is yet another category where a consumer
browsing experience is going unappreciated by investors.
It's certainly been a brutal stretch for the nation's largest
bookseller. Here's a quick recap of major 2013 events:
- In early March, Barnes & Noble delivered surprisingly
strong fiscal third-quarter results, leading analysts to raise
their sales and profit forecasts. At the time, the retailer
also announced the formation of a committee to look at a
possible buyout offer from company Chairman Len Riggio. The
company also said to would look at ways to reduce losses in the
disappointing Nook e-reader division.
- In late June, Barnes & Noble delivered a lousy fiscal
fourth quarter at its retail stores and even steeper losses in
its Nook division.
- In early July, Barnes & Noble fired CEO William Lynch,
replacing him on an interim basis with Michael Huseby, a
turnaround-focused financial executive, signaling that the era
of branching out beyond the core of book-selling might soon
- In late August, Riggio suspended his plans to acquire the
company. "While I reserve the right to pursue an offer in the
future, I believe it is in the company's best interests to
focus on the business at hand," he said.
Riggio's decision against buying the company was surely a
disappointment for investors. But Huseby's comments in late
August that Barnes & Noble had no plans to abandon the Nook
has led to further waves of selling. Investors now fear that Nook
will keep generating losses that drag the whole company down.
Barnes & Noble said it would look at ways to
reduce losses in the disappointing Nook e-reader
But the company emphasizes that it will stop making the
devices, and instead merely support other firms' e-readers in
order to remain relevant in the area of digital downloads.
Huseby (or his successor) is likely to focus in coming months
on shoring up the retail store base, which likely means closing
the weakest 5% or 10% of the company's stores, most of which are
likely generating negative cash flow.
Even before that happens, Barnes & Noble is not as sick as
it may appear. Sure, the company is expected to generate a
roughly $50 million net loss in fiscal (April) 2014 and again in
fiscal 2015, according to consensus forecasts. But the retailer
is still expected to post solid earnings before interest, taxes,
depreciation, and amortization (EBITDA) of around $200 million in
each of those years. That means that shares trade for less 4
times EBITDA on an enterprise value basis.
Yet here is where the Best Buy analogy comes into play. Barnes
& Noble sells products (books and magazines) that will always
be in demand. Yes, digital downloads have taken some wind out of
those categories. But for many, perusing a hard copy in a
comfortable retail environment is still the preferred method of
The challenge, as was the case for Best Buy, is to show that
its prices are competitive with online retailers, and if you're
going to pay the same price, you may as well enjoy the retail
experience. Frankly, having a financial executive in charge of a
retail turnaround has drawbacks. Barnes & Noble needs a fresh
focus on its retail efforts, deploying creative ways to generate
fresh buzz for its stores. But as Best Buy proved, you can't
simply write off a well-known retail chain that has made
strategic missteps but still has a strong resonance with a core
of repeat customers.
Risks to Consider:
Though there is considerable buzz around the upcoming holiday
season for book launches, that may only help same stores sales
trends in the January quarter, implying that sales in the October
quarter could again disappoint.
Action to Take -->
Though shares hold intrinsic value simply based on current EBITDA
trends and the coming stabilization in same store sales, the
company is still likely keen to unload the Nook division for the
right offer. Last spring, TechCrunch noted that
Microsoft (Nasdaq: MSFT)
would be a strategic fit (Microsoft currently owns 17% of Barnes
& Noble). The Nook business has deteriorated since then, but
is still likely worth hundreds of millions of dollars.
Separating out the Nook from the core retail business would
allow investors to more squarely focus on the still-impressive
EBITDA metrics of the core business. That would also likely set
the stage for Len Riggio to finally take the rest of the business
private, which he has contemplated several times in the past.
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