Selling Books and Booking sales

Selling Books and Booking sales

What would you think if I suggested you open a chain of bookstores? Would you be enthusiastic about the prospects or would you be wary?

There’s a chain of 1372 US based bookstores whose revenues are declining at a rate of 10 per cent annually. They carry between 22,000 and 164,000 titles, which is a lot of inventory. Their competitors aren’t minnows either, and include Amazon, Apple and WalMart.

Happily the company launched an eBook Reader. Only problem was that the competing products are iPad and Kindle. No surprise then that the business of selling eReaders is declining at 48 per cent per annum.

If you were running this business, would you be content or would you put your hope in other business lines? What about CD’s and DVD’s?

And how about you carry video 12,000 titles focusing on current and classic movies, documentaries, fitness and instructional titles, British TV series and movies, and foreign films? The music selection centers on classical music, jazz, pop rock, and show tunes.

And if that isn’t enough to get customers knocking your doors down, how about trying a strong selection of titles in vinyl record format, available in all stores, along with turntables?

The company is called Barnes & Noble and store closures and declining same store sales growth seems to be the norm.

Store closures and declining same store sales growth should be expected and that is precisely what is occurring.

But it seems that analysts haven’t cottoned on. Despite negative same store sales growth and the rate of store closures, consensus analyst revenue growth is too high. And despite declining revenue growth, consensus still has EBIT margins increasing!

Oh and there’s one more thing. There was a ray of hope for this company – it’s marginally more attractive 724 college campus stores called Barnes & Noble Education. Only problem for any new Barnes & Noble shareholders is that this was spun out of the company. And the CEO Mike Husby has left B&N and joined the education spinoff.

The business generates a return on equity of just three per cent, which is only slightly more than can be achieved in a bank account term deposit. The business however is a lot riskier than the term deposit. Sales are down about seven percent and cost of goods sold were down 10 per cent, which meant the company maintained its gross profit margin but the company has also been cutting costs and closing stores. These latter tactics have seen Selling General and Administrative expenses down by about seven percent. While it might sound good, one wonders how long the cuts can continue before the business must completely restructure or be restructured. Free cashflows is negative for B&N Retail after cash flow from operations are eroded by capital expenditure.

With a market capitalisation of about a billion dollars, we believe that the market is valuing this company too optimistically. Do you?

If you believed the business would deteriorate further and or the analyst community would eventually cotton on and downgrade their expectations – in turn causing the share price to fall – how could you profit?

A ‘sold’ portfolio of stocks is the answer and it works a little like this…

Imagine you knew the local car dealership would launch a “50 per cent off” sale in the next few weeks on the very same car as your next-door neighbour’s new vehicle.

To make a profit from this opportunity you could “borrow” your next-door neighbour’s Toyota, for example, (promising to replace it) and sell it online at the current price (receiving cash). When the local dealership conducts their sale, you buy a replacement Toyota for a much lower price, return the Toyota to your next-door neighbour and pocket the difference as a profit.

You can apply the same principle to the shares of companies that you believe are going to decline in value.

We do this in our Montaka Global Access Fund. We borrow the shares today, sell them for cash – knowing full well that we will be buying them back later, and if successful, at a lower price, keeping the difference as profit.

When we borrow shares and sell them in the market, we receive cash for the sale of the shares. We hold onto this cash and can use it to buy additional shares of high quality businesses that we believe are undervalued too.

If we only bought high quality businesses you would tend to make a profit in a rising market and you are 100 per cent exposed to it, if it falls.

Selling shares of business that are deteriorating however gives you the opportunity to make a profit in a falling market. Barnes and Noble is one example of the sorts of opportunities available to investors when the markets aren’t rising.

If you are interested in this investment strategy, please click here, or contact David Buckland on 02 8046 5000, or at dbuckland@montinvest.com.


Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Just another sequel.. I see that B&N fell 17% last week even on the day that the rest of the market bounced back. Nice play!

  2. A young university student at the university of new south wales was a bit of a larrikin. He went to a hamburger joint on Anzac Parade. He ordered a hamburger and asked that the meat was rancid. He wanted the tomato to be green and unripe and the bun had to be 2 days old. We couldn’t possibly serve you a hamburger like that was the reply. But that is what you gave me last week he quipped and laughed and walked out.

    But seriously these deteriorating businesses with the “montaka magic” can prove value adding. Let’s face it, you prolly come across (a lot) more of these type of businesses than the “good” ones. This broadens the opportunity base. Sensible, Strong Strategy…

  3. This story would make a great sequel to the 1990s feel-good movie “You’ve got Mail” where Tom Hank’s big book emporium (part of a huge chain) forces Meg Ryan’s little corner bookshop out of business. Meg Ryan’s mother says as she’s closing up her little shop “don’t worry about me I’m rich. I bought Intel at six”.

    In my sequel, it could play out that Tom Hanks business goes broke due to the scenario you outlined above. As Meg Ryan walks out on him she say’s “don’t worry I’m rich. I shorted you at eighty-five”.
    Just trying to brighten your afternoon :)

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