Elliott Management, the activist U.S. hedge fund, famous for seizing an Argentinean ship after the country refused to make good on a bond payment, once again acquired a somewhat unusual asset, this time a chain of bookstores called Barnes & Noble.
While most would agree, the nostalgia and whimsy of walking the aisles of a well-stocked bookshop is a wonderful experience, however in the age of Amazon and other online alternatives, they haven’t necessarily been good businesses. In fact Barnes & Noble has struggled like most booksellers, with sharp declines in revenues and profitability, causing the value of Barnes & Nobel shares to fall ~75% over the last four years ahead of Elliott’s acquisition bid (which came at a ~42% premium).
The genesis of the Barnes & Noble bid can perhaps be traced to Elliot’s experience with British bookseller Waterstones. Elliott bought Waterstones last year and in doing so acquired a management team and strategy that has uniquely had significant success with book retailing. You see, Waterstones nearly went bankrupt in 2011, however some clever manoeuvres and operational changes worked wonders. Of particular note was giving local outlets more freedom and responsibility to pick what they sell (like an artisan farmers market versus a generic fruit & vegetable section at a grocer). The effects were dramatic, with Waterstones EBITDA margin surging to just over 9% which is more than twice that of Barnes & Noble’s currently. Another interesting efficiency metric that improved considerably, was publisher returns. Booksellers typically return 20% of what they buy back to publishers after becoming stale on shelves, at Waterstones however, that number is closer to 4%. The reason being, the bookstores are more aligned with what their customers read as each individual store chooses what they stock, which in turn reduces working capital, raises turnover and increases profitability.
The economics for an investor like Elliott in replicating Waterstones’ success at Barnes & Noble is enticing. To frame this, Barnes & Noble is expected to generate $3.5 billion in revenue this year (2019) according to Bloomberg. If Elliott can grow that by 2% p.a. for the next 3 years (roughly in line with inflation), boost EBITDA margins to 6% from 4% (well below the 9% at Waterstones) and maintain the ~5.00x EBITDA acquisition multiple it paid, Barnes & Noble would increase from ~$680 million to $1.1 billion, that’s over 60% more than what Elliott is paying today. Additionally, the use of debt to fund 50% of the purchase price would see these returns nearly double, assuming a successful execution.
While all this sounds great on paper, there is a long line of U.K. retailers whose good ideas and flawless execution at home, struck an iceberg on the journey across the Atlantic before ultimately failing in the U.S. Some notable examples include Marks & Spencer, Tesco, Dixons Carphone and HMV, which all made similar mistakes of mapping a homogeneous chain format and British preferences, onto Americans. Barnes & Noble may not repeat the mistakes of its predecessors, as its strategy sounds more like a federation of independent booksellers, which modern day millennials and avid book reader should appreciate. However, it remains a brave bet, particularly as it all hinges on James Daunt, the former investment banker and author of Waterstones’ turnaround becoming CEO of Barnes & Noble, a business that has seven times (7x) the revenue base of Waterstones and is fighting Amazon in its home market. As they say, bon voyage, and hopefully this one doesn’t end up at the bottom of the Atlantic like the long line of British retailer strategies that have come before it!
Amit Nath is a Senior Research Analyst with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.
