Digital Books' Popularity Not Enough for Barnes and Noble

Barnes and Noble BKS spiked nearly 4.5 percent in early morning trading Tuesday after reporting quarterly net income of $52 million, giving investors an EPS of 71 cents per share. While much better than last year's $60.6 million loss, it is below analyst expectations of 94 cents per share. Still, the stock is up on hopes that a continued push in the e-reader market will keep the bookseller competitive as consumers move toward digital books. The company reported a 42 percent increase in sales at BN.com, in line with widespread expectations that consumers will shop more and more online. This transition will be tricky for the company, as it is still a small player in Internet booksales when compared to Amazon AMZN, whose strong Kindle sales are locking a number of customers into the Kindle marketplace and away from BN.com. Barnes and Noble has been retaliating with a push of its own site, which offers 2.5 million ebooks. Although Amazon offers only half as much, shoppers remain unimpressed by the various Nooks on offer. In an effort to stay competitve, Barnes and Noble is introducing an 8GB Nook Tablet for less than $200, and it will be selling its Nook Color for $169. A price move was necessary. Greater pressure from Amazon's Kindle Fire has forced the company to trim its margin on the popular digital reader, and may hurt the company's earnings in the future. Disappointing sales of the Nook have been hurting the company for a while. Since Nook sales peaked at 1.4 million in Q3 2011, the units have been selling slower and slower. In Q4 2011, 950,000 were sold (a decrease of 31 percent). Since then, Nooks have become increasingly unpopular, with 875,000 units sold in Q1 2012 and just 550,000 sold in Q2. Despite the device's failure to sell, Barnes & Noble is still investing heavily in what it myopically calls its "rapidly growing NOOK business", which caused the company an EBITDA loss to $94 million, up almost 100 percent from last quarter's $50 million loss. Analysts have acknowledged that declining physical book sales and the growth of Amazon's popularity will continue to challenge Barnes and Noble. The company's lost market share to the online retailer prompted analysts at Goldman Sachs to lower their price target on the company to $15 last week. The stock spiked that day, and is still up 2.5 percent since then, thanks mostly to a steep rise in share price this morning as the market responded to the company's results. Investor optimism relies on Barnes & Noble's performance on the digital front. The company's retail stores saw a modest jump, with sales rising 2 percent to $1.49 billion. This small increase in sales was likely due to the closure of now-bankrupt rival Borders, which left Barnes & Noble the sole remaining chain bookseller in many malls and shopping centers around the country. Barnes & Noble College, which sells textbooks to university students nationwide, saw a 3 percent drop in sales thanks to the growth in the nascent textbook rentals market. Contrasting with dull storefront performance, BN.com saw a 32 percent jump in sales. Much of the excitement inspired by the company's results have to do with hope that this segment of the company will continue to see strong growth. Even if that does happen, it will take a long time for the company to rely on its web storefront for revenue. With just $420 million in sales, BN.com represents just 17.5 percent of the company's total sales of $2.4 billion. Its $1.49 billion retail sales, on the other hand, represent over 62 percent of the company's sales. While Barnes and Noble continues to push itself as the maker of the Nook and a leading online retailer, don't let the spin fool you. B&N is still first and foremost a seller of real paper books in real brick and mortar stores, and it will suffer from consumer disinterest in this sector unless it makes the transition to online retailer. On the internet, however, B&N is a David to Amazon's Goliath, and it will need to be cunning and swift if it wants to win.