Barnes & Noble Sees Bright Future

While Barnes & Noble chairman Len Riggio said at last week's investors conference that physical books will constitute the majority of its sales for at least the next five years, the company is investing heavily to make the transition from a bookseller to an electronic and technology retailer. CFO Joe Lombardi noted that B&N will invest $140 million in the current fiscal year to upgrade its digital capabilities, and B&N's long-range forecast calls for the retail share of total unit sales to fall from 90% in 2010 to 69% in fiscal 2014. The decline in retail will be offset by gains at Barnes & Noble.com driven by the sale of e-books and e-readers and accessories.

Lombardi explained that B&N was confident B&N.com could hit that target in part because of the record fourth quarter of the division; sales in the period ended May 1 rose 51%, leading to a 24% increase in fiscal 2010, to $572 million. Lombardi said the sale of the Nook as well as of e-books drove the gains, particularly in the last period, when the Nook became fully available after being out-of-stock before Christmas.

B&N executives, however, assured investors that it has no intention of abandoning the brick and mortar retail market. Executives stressed that they believe that the physical stores give B&N an advantage over online-only players by providing a destination where consumers can test new products. The sale of Nooks, which initially took place primarily online, is now mainly through the stores, with bookstores accounting for 80% of device sales in March, April, and May. Operating stores also gives B&N a better connection to publishers by providing them with a showroom to display their books, Riggio said. Publishers depend on bookstores "to be the starter kit for their authors," he said. Riggio added that he would like to see more books published and theorized that now that publishers have the benefit of having backlist available as e-books, they may be willing to up their title output.

B&N will close no more than six to 10 stores annually over the next three years as leases expire, said Mitch Klipper, CEO of the retail group, adding that with the weak commercial market B&N is renewing leases at rates that are reduced by 10% to 20%. The company, however, has no plans to develop small-format stores to replace the Dalton outlets it closed in malls. Klipper touted the efficiency of B&N's stores, with shrinkage down to 0.9% of sales and sales per hour rising to $103.90 in 2010 and expected to increase to $110 per hour in the current year, aided by sales of the Nook. Klipper said the children's department continues to be the fastest growing area at the stores, and that over the summer B&N will roll out its educational toys and games and school departments to 400 stores. He noted that sale of Nook accessories will add "tens of millions" to B&N's top line this year and is a category "that didn't even exist a year ago."

Klipper didn't deny there will be fewer bookstores in the country, but both he and Riggio said B&N will be the beneficiary of the consolidation. Riggio said that, at some point, stores that aren't fully committed to books will get out of the market, especially those that don't want to invest in digital delivery of e-books. And while Riggio agreed that the number of traditional bookstores will be consolidated, he said given B&N's strong numbers he expects B&N "to be the ones doing the consolidating."

Riggio and other executives, including CEO William Lynch, also stressed that B&N already has a larger share of the e-book market (20%) than it does of the bricks-and-mortar store market (17%). Lynch said given the investment necessary to sell a large number of e-books, he believes the e-book market will be dominated by only three or four players. B&N's advantage will be its stores and its commitment, despite the Nook, to remain "device agnostic" in selling e-books to all types of devices. Touting how popular B&N's apps have become, Lynch quipped that he doesn't think "Google will launch an app for Apple." E-book pricing, Lynch said, remains in a period of experimentation. While bestsellers are settling in at the range of $9.99–$12.99, other pricing runs the gamut from as low as $1.99 to a $75 medical book.

The optimism of B&N executives is tied in part to the belief that digital books will grow the entire market for consumer books. Riggio likened e-books to the debut of mass market paperbacks, which transformed the industry by making books more widely available than they had been and at cheaper prices. E-books will grow to a $6 billion business by 2013, B&N predicts, driving consumer book sales to $27 billion, and their growth will offset the projected $2 billion decline in the sale of print books.

Barnes & Noble Fiscal 2010 Sales and Fiscal 2011 forecast (in millions)