Barnes & Noble Takes on Technology

First appeared in the Wall Street Journal

Barnes & Noble Inc. is the latest old-school company to discover how costly it can be to try to reinvent itself for a digital future.

The nation's largest bookstore chain warned Thursday it would lose twice as much money this fiscal year as it previously expected, and said it is weighing splitting off its growing Nook digital-book business from its aging bookstores.

Over the past 15 years, rapid technological change has transformed the company from a dominant retailing force that left smaller booksellers quaking in fear to a struggling giant grasping for a plan to ensure its long-term relevance to the publishing industry.

Barnes & Noble realized early on that e-books could appeal to consumers, but allowed Amazon.com Inc. to get an early leg up. Now it is locked in a battle with Amazon and another deep-pocketed rival, Apple Inc., to sell both electronic books and the high-tech devices consumers use to read them.

Digital technology continues to roil all manner of once-dominant companies. Former giants such as Blockbuster Inc., Circuit City and Barnes & Noble's main book-chain rival, Borders Group Inc., have struggled mightily—and in some cases, disappeared altogether—in the face of digital competitors including Netflix Inc. and Amazon. Wednesday's news that Eastman Kodak Co. was contemplating seeking Chapter 11 bankruptcy protection underscored the severity of the technology threat.

Barnes & Noble's stock fell 17% on Thursday. The company now may be at its most critical juncture since its chairman and largest shareholder, opened his first store in New York's Greenwich Village in 1965.

As recently as the 1990s, Barnes & Noble was known as a carnivorous competitor with the power to wipe out independent bookstores with its steeply discounted books and sprawling stores where customers could sip coffee and read in plush chairs. In New York City, the emergence of a Barnes & Noble on the Upper West Side was partly responsible for the mid-1990s closing of the beloved neighborhood bookseller Shakespeare & Company—the kind of narrative arc that cropped up in the movie "You've Got Mail."

Ironically, Barnes & Noble had been one of the first to recognize the potential of digital books. In 1998, it invested in NuvoMedia Inc., maker of the Rocket eBook reader, and the bookseller actively supported digital-book sales. But in 2003, it exited the still-nascent business, saying there wasn't any profit in it.

It wasn't until 2009 that Barnes & Noble re-entered the business, introducing its Nook e-reader. By then, Amazon had been selling its Kindle device for about two years, and was offering best sellers for $9.99, a fraction of what hardcover best sellers are priced at.

Apple introduced its iPad tablet in January 2010. Amazon responded with its competing Kindle Fire tablet this past September, and in November, Barnes & Noble introduced its Nook Tablet.

E-book sales have skyrocketed, jumping to $863 million in 2010, from $62 million in 2008, according to BookStats, a joint-research venture between the Book Industry Study Group and the Association of American Publishers. One publisher predicted Thursday that e-books could account for as much as 40% of total revenue by the end of the year.

Although Barnes & Noble was late to the game, its devices have won critical praise, and publishers estimate today that it controls as much as 27% of the digital-books market. "We saw more growth with e-books with Barnes & Noble this Christmas than anybody else," said the publisher.

But those sales have come at an enormous cost. Developing, manufacturing and promoting e-readers and tablets requires heavy upfront spending. Barnes & Noble's spending on advertising has more than tripled since 2009, according to Kantar Media, an ad-tracking unit of WPP PLC. To promote the Nook, the retailer returned to national TV advertising in 2010, after a 14-year hiatus, buying spots on popular programs such as "American Idol."

The heavy Nook investment has squeezed Barnes & Noble's bottom line. Largely as a result, its earnings before interest, taxes, depreciation and amortization—a critical measure of earnings—fell to $163 million in the fiscal year ending April 30, 2011, from $281 million in fiscal 2010.

When Barnes & Noble's stock weakened, the company came under pressure from an activist investor. In response, the chairman, who maintains control with a stake of about 30%, put the company up for sale in August 2010. Last May, Liberty Media Corp. made a bid to buy the business. The chairman appeared to support the bid, but Liberty Media eventually opted to invest $204 million for a 16.6% stake, receiving two board seats.

This holiday season has offered a ray of hope. Barnes & Noble said device sales had risen 70% for the nine-week period ending Dec. 31, compared with the year-ago period. It said the Nook business is likely to notch $1.5 billion in sales in the current fiscal year, compared with $880 million a year earlier. That business includes the Nook devices, digital-book sales, accessories, magazine and newspaper sales, app sales and sales of warranties.

On Thursday, Barnes & Noble increased its projected loss per share for the current fiscal year to between $1.10 and $1.40, from the 30 cents to 70 cents it reaffirmed one month ago.

Barnes & Noble blamed an unexpected shortfall of sales of the Nook Simple Touch e-reader on a Christmas where consumers embraced color digital devices, including the Nook Tablet and Amazon's Kindle Fire. The e-reader sales shortfall is significant because of its ripple effect on projected sales of related products, including e-books and accessories.

"We over-anticipated the demand for the holiday season," said the company's chief executive officer.

He said Barnes & Noble has plenty of capital to continue financing the Nook expansion, including a $1 billion credit line.

But in a comment at an investor conference on Wednesday,the Liberty Media Chief Executive hinted that Barnes & Noble might need help to continue building the business. Competing with Apple and Amazon, he said, was a "big-boy game." He said Barnes & Noble may find "partners to help fund that game, meaning the public or strategic partners."

Barnes & Noble said in a statement on Thursday it was "in discussions with strategic partners including publishers, retailers and technology companies in international markets." It said that could lead to expanding the Nook business overseas.

One possibility is that Barnes & Noble could sell a minority stake in the Nook business in a public offering. The two businesses would likely have different managements and different boards. Under such a scenario, Barnes & Noble would continue to have close ties to its Nook devices. Another possibility is selling the Nook business outright.

A portfolio manager for Aria Partner, a Boston-based investment firm that owns a stake in Barnes & Noble, suggested one logical buyer could be Google Inc., whose e-book store has had only a minimal impact so far. "The Nook business alone could be worth $1.5 billion," said the manager. The Nook runs on Google's Android software. Google declined to comment.

Another potential partner is Microsoft Corp., people familiar with the situation said. Microsoft declined to comment.

The idea for splitting off the Nook business may partly reflect the influence of Liberty Media, whose chairman, John Malone, and chief executive, Mr. Maffei, are experienced at devising complex financial structures to highlight the value of businesses. Mr. Maffei and another Liberty executive are on Barnes & Noble's board.

"This is classic Malone," noted a Maxim Group analyst.

The idea came up during the company's long-running strategic-review process, which began in the summer of 2010, according to people familiar with the situation. Barnes & Noble executives and the board discussed how the company could increase shareholder value and improve its stock price, these people said, and separating the Nook business was one suggestion.

The idea was also embraced by Liberty, said another person familiar with the situation.

Barnes & Noble said the decision to explore the potential sale of the Nook business was a board-level decision that had the full support of the company.

Investors have shown they are in favor of companies overhauling their structures to focus their business divisions, applauding moves by McGraw-Hill Cos., Kraft Foods and other companies that separated businesses last year.

Barnes & Noble investors may not have the patience to fund Nook growth here and abroad, said a Forrester Research analyst. "It's going to require sustained investment."

Barnes & Noble Updates E-Reader to Fix Frozen Screen

Bloormberg

 

Barnes & Noble Inc. plans to release a software update to its Nook e-reader this week to stop the screen from freezing, increase its speed and offer a Web browser and games for the first time, a company executive said.

“We’re fixing the problem,” Anthony Astarita, vice president of digital products, said in an interview in his New York office on April 16. “Like any consumer product, you have issues that do come up. No product is 100 percent perfect.”

Barnes & Noble released the Nook in November, entering a growing market led by Amazon.com Inc.’s Kindle and Sony Corp.’s Reader. Apple Inc.’s new iPad tablet computer, out this month, increased competition. The Nook is fundamental to the retailer’s push into the digital market, since users will turn to Barnes & Noble first to purchase e-books, said Michael Souers, a New York-based analyst for Standard & Poor’s.

Sales of reading devices will grow to 5 million this year from 2.2 million in 2009, the Consumer Electronics Association estimates. E-books and the Nook represent about 3 percent to 5 percent of Barnes & Noble’s sales, said Souers, who advises clients to sell the company’s shares. That should double to about 10 percent within five years, he said.

Revenue in the four quarters ended Jan. 30 totaled $6.07 billion. The company doesn’t disclose sales figures for the Nook or digital books.

Barnes & Noble, based in New York, fell 52 cents, or 2.3 percent, to $22.14 at 4:02 p.m. in New York Stock Exchange composite trading. The shares have gained 16 percent this year.

‘Almost Daily’

Hundreds of Nook owners have posted complaints online, including on Barnes & Noble’s Web site.

“It freezes almost daily,” Stacey Hendricks, a student at University of Louisiana at Lafayette, said in an e-mail to Bloomberg. “Assuming Barnes & Noble doesn’t whip this situation into shape pronto, I’ll likely be switching over to the iPad.”

Barnes & Noble has updated Nook software twice before now. The latest update speeds page-turns, lengthens battery life, and adds Web browsing and free chess and Sudoku games, Astarita said.

Best Buy Co. began selling the Nook in its U.S. stores yesterday. Barnes & Noble also provides the digital bookstore for e-readers such as Plastic Logic’s Que and free software that allow users of devices such as Apple’s iPhone to buy and read its electronic books.

The bookseller decided to make an e-reader in August 2008 and began work on the Nook in February 2009 at its offices in Palo Alto, California, Astarita said. Given the speed of development, the company assumed the software would need updating, he said.

‘Nail-Biting’

“It was one of those nail-biting scenarios that came down to the wire,” Astarita said. “It was that very reason that we made sure when we developed this product that we had the ability to do software updates and continually improve the product.”

Gloria Spink’s first Nook displayed garbled text. Barnes & Noble sent her a replacement last month. That one repeatedly froze, forcing her to open the device and remove the battery to unlock it, she said in a telephone interview.

“I said, ‘Enough and I want my money back,’” said Spink, a 63-year-old assistant buyer for Boyd Gaming Corp. in Las Vegas. “I returned the Nook and bought a Kindle online that same day.”

The Nook’s return rate, which also includes replacements, is below what the company expected, Astarita said, declining to provide specific numbers.

The retailer’s response to the freezing will determine the Nook’s success, Mike McGuire, a San Jose, California-based analyst for Gartner Inc., a technology research firm, said in a telephone interview.

“With hardware it’s not that there was a problem, it’s how you recover,” McGuire said.