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What Does Ron Burkle See in Barnes & Noble (BKS)?

August 15, 2010 | About:
Geoff Gannon

Geoff Gannon

410 followers
There’s been a lot of speculation about what Ron Burkle sees in Barnes & Noble (BKS). Why did he start buying the stock back in 2008? Does Burkle see real value in Barnes & Noble? And what changes would he make if and when he takes control?

Most of the articles written about Ron Burkle and Barnes & Noble are nothing but spitball speculation. The writer interviews some stock analysts who know nothing about Burkle and prints what they say. But a couple articles give us a glimpse into Burkle’s mind.

The first is an article called “Burkle’s Books” written by James Covert in the New York Post on August 6th. Covert writes: “While Barnes & Noble’s stock has taken a beating on fears the nation’s No. 1 book chain is losing the battle over e-books, sources close to Burkle say the savvy retail tycoon has dismissed such fears as overblown – and dwarfed by the opportunity to cut costs.”

The last part of that sentence is telling. Most of what is written about Burkle and Barnes & Noble has focused on the huge changes caused by e-books.

Reports that include talk of Amazon buying Barnes & Noble are unbelievable. Reports that include talk of cost cuts, like this one, are very believable. They don’t sound like something a source would fantasize about. They sound like something Burkle would think about.

Covert goes on to write: “People close to the situation said Burkle sees an opportunity to reverse recent losses by slashing spending at the retailer, in large part by halting store growth and slowing capital improvements.”

The first part of that sentence makes little sense. Barnes & Noble is no longer adding to its overall store count. In the last few years, it did open several stores. But it closed even more. Today, there are almost the same number of Barnes & Noble stores there were 3 years ago.

However, Burkle might want to stop opening new stores altogether. Closures could then bring the store count down faster. If Barnes & Noble stopped opening new stores and continued to close stores at the same rate it has over the last 5 years, it would cut its store count by 2% a year.

The part about slowing capital improvements makes more sense. However, the capital improvements Barnes & Noble announced this year are focused on the e-book business. I doubt Burkle wants to cut those. So, while there may be operating efficiencies to squeeze out, the promise of freeing up a lot of cash by spending less on building new stores and improving old ones is limited.

Finally, the Post quoted one source as saying: “For Burkle, it’s all about the proper use of capital. If you manage it properly and do the right thing, you could get back the price you paid for the company within three or four years.”

That makes it sound like Burkle thinks Barnes & Noble is cheap compared to its current cash generating ability. That’s true. Or it could be, if the company was willing to skimp. But how long will that last? Will the transition to e-books come so fast the stores dry up before Burkle can milk them for cash?

That’s the risk Burkle is taking.

Another article that gives us a glimpse into Burkle’s brain was published in BusinessWeek back in March. It’s called “The Other Ron Burkle.”

In it, Burkle is quoted as saying: “I don’t pay attention to how I feel about anything. What I like or use is irrelevant…I know I’m not in consumers’ heads. I don’t know what’s going on in America. I know what people in New York and Beverly Hills think…but I don’t know what people anywhere else think.”

That’s a common problem for all investors. Burkle tries to overcome it through research: “Before investing in Barnes & Noble, Burkle and his team asked publishers, book agents, consumers, and tech companies the same question: In the era of the e-book, what good is a bookstore? What Burkle learned was that Barnes & Noble has a deep and abiding relationship with its customers and could do a lot more to exploit it.”

According to Judge Strine’s poison pill trial opinion: “Burkle’s chief suggestion, which he referred to as ‘the thesis’ for Yucaipa’s investment, was that Barnes & Noble should somehow form a partnership with a technology company, such as HP. Burkle thought HP would be interested in a quality retail partner like Barnes & Noble as a way to rival Apple’s dominance in consumer electronics. And, such a partnership would give Barnes & Noble an edge in competing with the likes of Amazon.com, whose e-book reader, the Kindle, had beaten Barnes & Noble’s e-book reader, the Nook, to the market.”

There are a few interesting points there. One is that Burkle does not come off as just being interested in milking the existing stores for cash. He sounds like he’s interested in making changes at Barnes & Noble, and in fighting for the e-book market.

Personally, I think the idea of teaming up with a consumer electronics company makes a lot of sense. I don’t have much faith in the ability of a book retailer to develop multiple generations of an e-book reader without wasting tons of cash in expensive investments and missteps. Trying to get some other company, who happens to know a lot more about hardware than you do, to bear the burden makes sense. I don’t have high hopes for companies making profits on the hard side of the e-book business anyway. In the long-run, the soft side will be the more consistently profitable space. But tech companies seem interested in chasing the hard side of the business.

Burkle seemed to be proposing that a company like HP should be given the chance to use some of Barnes & Noble’s in-store retail space. That’s something the HP brand needs. And it’s something HP probably wouldn’t succeed in doing well on its own. A partnership like that might make sense. Would it work? Who knows? But it does tells us how Burkle thinks about Barnes & Noble.

Burkle took the idea far. In fact, Burkle told two members of Barnes & Noble’s board that he spoke with a top executive at HP about “things (HP) could do with Barnes & Noble”. And Burkle suggested the board might want to add that HP executive to the Barnes & Noble board.

Burkle’s focus on e-reader technology comes through repeatedly. For instance, Aletheia’s Peter Eichler said: “Burkle and he discussed some specifics, such as Burkle’s view that Barnes & Noble was a ‘cheap stock’, that Riggio had initially discouraged Burkle from purchasing Barnes & Noble stock, and Burkle’s belief that Barnes & Noble could be a leader of developing e-reader technology.”

Of course, the point about Barnes & Noble being a “cheap stock”, is probably what most attracted Burkle to Barnes & Noble in the first place. In his interview with BusinessWeek, Burkle described Yucaipa’s approach to investing: “We always try to buy companies that are doing O.K. but that have some issues. We buy at a price that if they just muddle through, we don't go broke. And if they do better, we make a lot.”

That’s a good description of what Burkle normally looks for. As for what specifically attracted him to Barnes & Noble, the way he described the weekend strategy session he held with Yucaipa employees during the 2008 stock market crash, sums up how he saw Barnes & Noble: “Everybody was afraid the world was coming to an end. I wasn’t. This is an opportunity. We can buy phenomenal companies and brands at ridiculous prices.”

And that’s what Burkle sees in Barnes & Noble: a phenomenal brand at a ridiculous price.

Disclosure: Author owns shares of Barnes & Noble (BKS)

This is the fourth article in Geoff Gannon's ongoing series covering the Barnes & Noble proxy fight. For additional background read Why Would Anyone Buy Barnes & Noble Stock at $15 a Share?, Who is Ron Burkle? Why Does He Want to Control Barnes & Noble? And How Does He Know Charlie Munger?, and Who Will Win the Barnes & Noble (BKS) Proxy Fight? Ron Burkle? Or Len Riggio?

Look for the fifth article in Geoff Gannon's ongoing Barnes & Noble series tomorrow.



About the author:

Geoff Gannon
Geoff Gannon


Rating: 2.8/5 (13 votes)

Comments

gulee00
Gulee00 - 4 years ago
Books are loss leaders that bring people in to the store. Walmart sells top nytimes books at below cost so it will bring people in to the store so they can buy tires, or something. Burkle is thinking the same: have books be loss leaders, and install a "technology/media" booth where they can sell higher margin technology products like HP's line of consumer tech goods

Going long BKS on these reasons alone however is PURE SPECULATION. It has nothing to do with the fundamentals of BKS, which is deteriorating. Burkle is taking the risk that he can turn around BKS, but remember as Buffett admonishes, turnarounds *seldom* turn around!

BKS stock will probably be mired in low prices, unless someone decides to take the co private. At this point it doesn't look like Burkle is willing to do that.
Lillycomm
Lillycomm - 4 years ago


As someone who is deeply involved in the publishing industry, I can say that your comments regarding this situation are very insightful and well researched. I have watched B&N rise from a small group of stores in NY to the bookselling powerhouse that they are now. There is no doubt, that their peak as a retailer has already happened and we are now witnessing the downward trend (or spiral) and quite frankly the last thing B&N needed right now was Ron Burkle.

I notice in your posts that you never mention Borders or Bill Ackman. I will grant you that Borders is a shell of a company that should have declared bankruptcy ages ago, but the Borders / Ackman situation is relevant for other reasons. The beginning of the end for Borders was when grocery store executives took control of the chain in the early 90's and they tried to run the chain like grocery stores. DOES NOT WORK! Burkle's retail background is also in groceries and the difference between the 2 businesses is night and day. Also, Ackman thought he was a retail genius and that he would be able to turn Borders around. How did that work out for him? At this point, he has basically washed his hands of the whole deal and written off the investment.

B&N is at a critical point and frankly I am not sure how they will survive. The model for retail sales in media is no longer a large brick and mortar store. Keep in mind as far as B&N's digital strategy goes, they lose money on many (most?) of the ebooks they sell and every Kindle sale is basically a customer who will now shop online = one less browser / impulse purchaser in the store.

I admire Len and B&N that they do not want to lose the race for ebooks like they lost the online bookselling race to Amazon, but at what cost are they competing? They are not a technology company and they are trying to compete with industry giants like Apple and Amazon (Amazon is also not quite a technology company, but certainly better suited than B&N to make this kind investment and continuosly update their product), they have no clear cut model for profit in ebooks (Amazon also loses $ on almost every ebook they sell) and they are burdened with these large retail leases which are no longer the destination for shoppers that they used to be.

I don't know what the answer is for B&N, but one thing I can tell you for sure - Ron Burkle brings nothing of value to the table and I would say that without a doubt, his inolvement will end up doing more harm than good. I think the Borders / grocery store mgt / Ackman history provides a frightening look at the possibilities of what might happen.

Full disclorure - I do not work for B&N or Borders and I never have. I am involved on the publishing side of the business.
buffetteer17
Buffetteer17 premium member - 4 years ago
Notes from a loyal customer but discouraged investor. I have a small stake in Barnes & Noble (3.5% of my portfolio). Recognizing that B&N book stores are no longer growing, I ran a no-growth DCF for BKS and came up with an intrinsic value of $26. But after considering Geoff's comments, I guess I should have run a negative growth model instead. However, I've visited a number of their stores in several cities, and I see a lot of customers roaming the stores and more importantly, long check-out lines. I'm an old fart who likes paper books and hanging out in bookstores. I don't own an e-reader and I'm not planning on buying one anytime soon. I do read WSJ on my PC instead of awaiting the print edition in my mailbox, since I want to get the latest news right away.

It now looks like I may have blundered by paying $17 a share. I can only hope that Geoff is correct in that the Burkle-Riggio contest will drive the price up and let me out for a profit. In my heart I'm hoping that BKS will survive because it is a very nice place to visit.
Sivaram
Sivaram - 4 years ago


Lillycomm,

What percentage of your sales (or your understanding of a typical publisher) is through bricks & mortar stores like Barnes & Noble and what percent is through online retailers like Amazon? And how about book-specific physical stores like Barnes & Noble compared to general retailers like Wal-mart?

I'm curious because the future prospects of companies like Barnes & Noble depends a lot on how quickly sales decline. When it comes to music, the decline was very rapid with digital music sales quickly replacing physical sales. But I wonder about books. I still purchase physical books (note that I'm mostly into non-fiction) and most people I run into still rely on physical books. The shift to digital music was straightforward but I am not sure e-books will be as quick. Fiction is pretty straightforward, and I suspect what is driving Kindle sales, but it still doesn't appear that e-books are any good when it comes to non-fiction. Even investing books with charts or diagrams aren't quite up to par IMO.
Geoff Gannon
Geoff Gannon - 4 years ago
Sivaram,

A recent study estimated 75% of e-book sales are fiction. I think a big reason for this is that half of all e-book readers are given as gifts. And those gifts tend to be given to heavy readers who read lots of fiction.

I think the only difference with decline in physical book sales and physical music sales has to do with the hardware you use to play the media. For me, digital music works fine on any platform. So far, digital books only work for me on a dedicated e-reader or in small sips. I can't read a 300 page book on my computer. I've tried. It's a breeze on an e-reader.

Since Kindle and Nook are both being sold as hardware with a one-time price, instead of given as part of monthly subscription, like your cablebox, I think what you are really seeing is that e-readers are being adopted by heavy readers first because they are being given as gifts by spouses, sons, daughters, and parents. And obviously they are only giving those gifts to loved one who read a ton and thus probably read a lot of fiction.

If the adoption of e-books depends a lot on the adoption of e-book readers, which I think it does, that decline of physical book sales will depend on price of Kindle, Nook, etc. and whether they move from a buying model to a bundling model.

Over time, we will see e-reader prices fall, perhaps to "free" in the sense that they are sold with a $10 - $20 a month subscription and contract lock-in with Amazon or B&N.com that includes both free shipping on all physical books and use of the e-reader as long as you pay monthly fee. Long-term, that would be my expectation. A lot of entertainment services with hardware a component eventually moves towards subscription service where hardware is bundled instead of bought. I know people are skeptical about this right now. But there was a time when subscription TV sounded odd too. Over time, I don't think e-readers will be sold as pricey hardware. They will be real cheap or bundled.

Lillycomm
Lillycomm - 4 years ago


Geoff - I thought your posts and research were spot on, but your comments above are a little off. First of all, the ebook / ereader does not work along the same lines as the razor / blade profitability model. As I mentioned above, both Amazon and B&N are losing money on many of the ebooks they sell. If you have thoroughly researched this industry, then I will assume you know about the agency model pricing for ebooks. That model is currently being used by some of the largest publishers, but the largest publishing house - Random House - has refused to adopt it. As much as Amazon kicked and screamed about the agency model approach, it is actually the only way that Amazon and B&N are making any money selling ebooks. All of the books sold at $9.99 and less, which are not priced by the publisher in the agency model, are profitable for the publisher and being sold below cost by the e-tailer.

Amazon's original approach was to get control of the ebook market and then bully the publishers (a frequent Amazon technique) into a significantly larger discount on ebooks off of the cover price of a physical book vs the current discount for ebooks which is very close to and sometimes the same as the physical book discount. Apple's entry into the market and the subsequent agency pricing model approach derailed Amazon's strategy. So, now both Amazon and B&N are in a price war over the hardware and they are losing money on a large % of the ebooks they sell. In fact, Amazon is probably losing money on many of their physical book sales. Amazon never breaks out books in their reports of "media" sales and they have all along used books as their loss leader to grow into the retailing giant they have become.

B&N's approach was always "we are a bookstore and we are not going to play the pricing game with Amazon". Well, good for them, but as it turns out they lost that "game" and are now desperately trying to stay relevant. in the last 6 months, B&N has cut physical book prices on bn.com to come closer to Amazon's pricing, but ultimate B&N IS a bookseller and they have to make money selling books - they cannot afford to see ebooks or physical books become their loss leader. I think your subsription theory has some possibilities, but there is no viable revenue model in that approach for a 700+ brick and mortar bookstore chain. If Amazon cares about making money in the ebook world, it won't work for them either with the current e-pricing structure. And just in case you are wondering, publishers cannot afford to cut their ebook prices - publishing is a 100% returnable buiness for most publishers. It is an antiquated model and one that let the chain bookstores flurish and at the same time created a vicious cycle where publishers kept publishing more and more new books to make up for revenue they were losing in unsold books. The costs of editing, designing, printing, marketing, shipping and taking returns on a book leaves VERY little margin for a publisher and when you factor in the fact that a large majority (#'s vary by publisher) of the books published never make any money for the publisher and actually lose money - this industry starts to look like a house of cards about to fall down.

As far as the research about 75% of ebooks being fiction - that is off. BISG is known in the industry to not have terribly accurate data about this subject. A bestselling non-fiction book may sell anywhere from 5 - 20% of sales in the first few months in the ebook format. Books which are bestsellers in physcial form are also e-bestsellers - Fiction and Non-Fiction. The difference with fiction is all of the genres - Mystery, Science Fiction, Romance - where there are many inexpensive (or free) ebooks and where avid readers will fly through a book very quickly and be on to the next one. That is where fiction has an advantage.

And finally, Sivaram - there is no set % of books sold in each location. A bestseller which will be carried at Wal*Mart, Target, Costco, B&N, Borders and Amazon will probably sell 30% in the chains, 30% in the mass merchants and 30% online (approx). A non-bestseller does not have any presence in the mass merchants and it used to be about 70% of the sales on those titles were in the brick and mortar bookstores, but as the brick and mortar inventory and traffic shrinks that is changing. Also, some books can sell 80% or more in the brick and mortar stores because they are impulse books, gift books, unique formats... which really need to be seen in person and really only sell in a brick and mortar stores. Bottom line, there is no easy or single answer to your question.

I am compelled to repeat this again - Burkle is Ackman and previous Borders management all rolled up into one. Any B&N stockholders who are considering a vote for Burkle's candidates (assuming non-Burkle, non-Althea and non- B&N shareholders will have any affect on the outcome of the election) MUST review the history of Borders and what happened when grocery store mgt and then the big money investor thought that they were smarter than people with years of publishing and bookselling background!
Geoff Gannon
Geoff Gannon - 4 years ago
Lillycomm,

Thanks for the terrific comments.

Separately, I am wondering about how the loss of stores and move to e-books will change the world for publishers. Aren't book stores a big part of how readers discover the books that are published? Wouldn't it be too expensive to market books - even e-books - any other way than through retailers? And doesn't that mean that companies that can offer an e-book reader, a wide selection of titles at their website, along with national name recognition - and I'm thinking only Amazon and Barnes & Noble fit these criteria - will gain share against other book retailers. If they do, doesn't that mean publishers will be in a weaker position bargaining with Amazon and Barnes & Noble than they were when books were more widely sold in chains like Borders as well.

Also, do you think agency pricing will stand up to anti-trust scrutiny? Publishers may not like Amazon's tactics. But aren't Apple's tactics closer to collusion?

I don't have a view on these subjects. And am not saying which is morally right or wrong. I just assumed that Apple's approach will face legal challenges. And I do have my doubts about how good Apple will be at selling books compared to Amazon and Barnes & Noble.

I'd love to hear your thoughts.
Lillycomm
Lillycomm - 4 years ago
You are right - the changes (past and future) in the bookstore world will affect publishers. Fifteen years ago publishers looked to independent bookstores to make a break a book and they catered to their every need and knew the most influential indie store owners very well. Then B&N and Borders began their nationwide, exponential growth and the indies became less and less important and are now an afterthought (if they are thought about at all). The chains promoted books by getting publishers to pay for placement on certain shelves in a section or on a table for a certain period of time. Publishers thought they had the best of everything - large stores which would carry all of their backlist (older titles) and relatively easy and affordable ways to make sure a book was face out and on display.

Then came Amazon and the Internet and that was a new and foreign world to publishers and it is one they are still feeling their way around. All publishers feel the pressure to get the "buzz" going online for a book with bloggers or influential websites or even consumer reviews on Amazon. Amazon offers marketing options, but Amazon's "marketing" does not really sell books - the key is getting your book in front of the consumer and the old days of the table at B&N + Today Show = probable bestseller are long gone and no publisher has figured out the magic formula in this new retail world.

How did The Girl with The Dragon Tattoo or The Help take off? Word of mouth which probably started at some indie bookstores (back to the orginal drawing board). Twilight started as an indie bookstore favorite. I worked with Stephanie Meyer when her first book came out and she was a darling at indie stores and a complete unkown at the chains. At the end of the day, it is still those individual bookstores that are in the business because they love books that can make or break a book. And for every Dragon Tattoo, Twilight & The Help, there are tens of thousands of books each year that aren't even a blip on the radar of the public (despite the best efforts of many publishers).

You are right - it is too expensive to market in this new world and it isn't the (somewhat) exact science it used to be. I honestly fear for this whole industry because Borders is clearly spiraling the drain, but most publishers have no back up plan and at some companies Borders may represent +30% of their business. Ch. 11 or Ch. 13 for Borders will be a benefit to B&N in the short term, but there are publishers that will not survive the loss of Borders - not because B&N and Amazon will become too powerful, but because Borders is a large % of their business and a good amount of that business will disappear.

Right now, B&N is not throwing their weight around and quite frankly compared to Amazon, B&N never dealt with publishers in that confrontational, bully in the playground approach that Amazon uses. B&N knows that taking that approach will not help anyone right now. Your comments that the company that offers an ebook reader and a wide variety of titles on their website will have an advantage is correct - but, as I said earlier, B&N is losing money on all of this - ebooks, selling physical books at a discount on bn.com, and trying to develop hardware and keep it current and technologically advanced. Sadly, I don't see where this scenario plays out in a positive way for them given that they have the expensive albatross around their neck of the store leases. My fear is that Burkle's lack of understanding of the book business and publishing industry will result in a variety of unrealistic ideas and expectations which will quicken rather than slow down the path B&N is on right now.

I can't speak to Apple's pricing and the legal ramifications, but I can say that publishers are not retailers and books are an odd commodity as it is since publishers print a price on them. But ultimately it was up to the retailer what he or she sold the book for. To put all of that control in the hands of the publisher is probably not the best idea and leads to many unforseen complications for the publishers.

Sivaram
Sivaram - 4 years ago


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