Barnes & Noble Is More Profitable Than It Looks on the Surface

By Markets Fool.com

This article is part of the Real-Money Stock Picks portfolio series.

Continue Reading Below

I've been running the Messed-Up Expectations portfolio since November 2010, a bit shy of 4.5 years now. Over that time, I've both trailed and beaten the S&P 500. While I'm currently trailing again, I'm not terribly worried because the company I work for, The Motley Fool, decidedly takes the long view.

A good part of the portfolio's volatility -- accounting for much of that swing back and forth against the S&P 500 -- is due to its relatively large position (15% currently) in Netflix . When the video streamer's shares go up, the portfolio does well, but it also follows the stock when it drops. Shares of Netflix are down over the past month and I've slipped against the S&P 500.

Note, however, that 15 of the portfolio's 20 positions are in the green, with four being doubles or better, as of last night.

One way to balance the effects of that Netflix exposure is to put more money to work in existing, smaller positions, letting them grow to larger proportions of the portfolio. This is what I'm doing now by increasing my positions inBarnes & Noble and GameStop . I'll cover B&N in this article and GameStop in a separate piece. (They'll both be linked here.)

"He's dead, Jim."
You can be forgiven for thinking physical bookstores have gone the way of the dinosaur given the dominance of online book maven Amazon.com and the dramatic fall of Borders. Personally, I buy almost all my books in Kindle form (and I read a lot, currently running through Perry Mason mysteries), supporting Amazon at the expense of Barnes & Noble and its e-reader, the Nook. Many of you do the same, which helps lead to the popular perception that B&N is doomed. Yet the company refuses to die.

Continue Reading Below

Here's why I believe that is the case: it's actually profitable.

The company's retail business (those bookstores) has generated between $196 million and $240 million in operating profit for rolling 12-month periods for the past two-and-a-half (going back to the TTM period ending July 28, 2012), $233 million most recently. The college business (college bookstores operated by B&N) has ranged between $40 million and $68 million over the same time period, $40 million most recently. Add back in depreciation and amortization and these two divisions generated roughly $340 million and $90 million in EBITDA over the last 12-month period.

Capital expenditures for either segment are not very large -- about $70 million per year for retail and $30 million for college -- so the two segments are definitely throwing off positive cash flow.

This has been masked by the Nook business's large operating losses (ranging from $169 million most recently to $516 million over the same time period). These losses make the whole company look bad, but the situation is being resolved, and I don't think the "everyone knows" perception has changed quite yet.

Corporate moves
The college division is being spun off to operate as a separate company under the auspices of Max Roberts, who is already running the business. Once on its own, it should be able to focus on growing the business, thereby creating value.

That leaves the retail and Nook segments tied together. Yet B&N has been moving here, too. Last June, Samsung became the manufacturer and partner for the Nook Galaxy tablet; B&N stopped making its own tablet, though it still makes the stand-alone e-reader. This, along with other "rationalization" moves made by the company, is why TTM operating losses improved from $512 million in fiscal 2013 to $169 million 21 months later, according to data from S&P Capital IQ.

I would not be surprised at all to see the company continue to make improvements and, at some point in the not too distant future, announce a sale or spinoff of the Nook business. That would leave the retail business standing on its own, and investors could (finally) see it for what it is: a decently profitable, cash-generating business. Of course, B&N founder and Chairman Leonard Riggio might carry out his goal oftaking the retail business private, too. We'll just have to wait and see.

With the spinoff of what should be a profitable business, the improvement in Nook and a possible further corporate move related to it,and the underlying strength of the retail business, I've decided to add a bit more of Barnes & Noble to the MUE portfolio's holding.

Come discuss the decision on the dedicated discussion board.

The article Barnes & Noble Is More Profitable Than It Looks on the Surface originally appeared on Fool.com.

Jim Mueller owns shares of Amazon.com and Netflix. Jim Mueller has the following options: short April 2015 $31 puts on GameStop, short April 2015 $22 puts on Barnes & Noble, and short June 2015 $405 calls on Netflix. The Motley Fool recommends Amazon.com and Netflix. The Motley Fool owns shares of Amazon.com, Barnes & Noble, GameStop, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.