Barnes & Noble's Risky Buyout (Update 1)

Updated to include closing share prices and Barnes & Noble comments

NEW YORK ( TheStreet) - Barnes & Noble ( BKS) chairman Leonard Riggio said in a regulatory filing on Monday that he plans to buy the book seller's retail outlets and its Web site, in a deal that leaves investors praying for a long-expected spinoff of the company's burgeoning e-book and tablet business, NOOK Media.

Riggio's proposed take-private of Barnes & Noble bookstores -- still the lion's share of the company's revenue -- may give support to its stalled share price and help with an eventual spinoff of its Nook unit.

Still, the deal is the exact opposite of Barnes & Noble's proposal to spin-off its Nook business just over a year ago, which many expected could give its shareholders a payout after years of under performance.

Riggio's proposal may raise the prospect of a fire sale of the company's staple bookstore business, just when it is needed as ballast to support Nook or its prospective divestiture. Financial details of Riggio's bookstore proposal or how it would impact Nook remain unclear

Given the relatively stable performance of Barnes & Noble bookstores through 2012 and a deterioration in the outlook for the Nook business through this holiday season, investors might want to question the reversal of course, amid a weak track record by chairman Riggio in creating value for investors.

After rising nearly 30% in pre-market trading, Barnes & Noble shares have since faded to gains over 11% to $15.06 in Monday trading, erasing the company's year-to-date share losses.

In January of 2012, Barnes and Noble proposed that the company spin off its Nook tablet unit, in a move that could have unlocked the value of the e-book and tablet business for shareholders, while also helping the company to refocus on the retail bookstores at the heart of its earnings and cash flow.

"We see substantial value in what we've built with our Nook business in only two years, and we believe it's the right time to investigate our options to unlock that value," said CEO William Lynch in January 2012.

In April, Barnes & Noble sold a 17.6% stake in the company's Nook business, called Newco, to Microsoft ( MSFT), in a $300 million cash investment. The deal gave the unit a valuation of about $1.8 billion, or on par with the company's total market cap at the time.

Some investors and analysts took the valuation as a sign of the potential Nook value trapped in Barnes & Noble's shares. Meanwhile, with a monetization of Nook, many also felt Barnes & Noble's legacy bookstore businesses would be given more worth by investors.

After Microsoft's Nook stake, a spinoff remained on track. The move also indicated Nook had a strong partner in Microsoft, which itself is in the midst of rolling out its own app store and a new Windows 8 operating system to take advantage of the growing tablet market.

Just days after Christmas, media giant Pearson took a 5% stake in Nook for $89.5 million, in a move that continued to value the overall e-reader and tablet business at about $1.7 billion.

Microsoft's stake in Nook came just ahead of the well-received launch of its Nook HD 7 and 9-inch tablets, which helped to drive shares in the early part of 2012.

Pearson's stake, in contrast, came as a bookend to the holiday season, which showed weaker-than-expected tablet sales amid competition from the likes of Apple ( AAPL), Google ( GOOG)-powered Samsung devices and the emergence of the Amazon ( AMZN) Kindle.

Now, just as Barnes & Noble's guidance indicates a weakening of the prospects of the Nook tablet, the company appears positioned to sell off retail outlets to Leonard Riggio, the company's chairman and its largest single investor.

While Nook eventually may be monetized for shareholders, according to Riggio's plans, it may leave investors who could benefit from stable bookstore sales in a vulnerable position.

"We believe the issue for investors is not whether there is more value thanthe stock price in Barnes and Noble bookstores, as we believe that is aneasy yes. The issue is whether there is positive value in the money-losing,and increasingly poorly positioned, Nook Media division," Gary Balter, an analyst at Credit Suisse wrote in a note to clients on Monday.

"Left alone, even with cash, will that business make it on its own, or is taking out the positive cash flow stream of Retail, at ~4.5x, a death knell for Nook Media," the analyst notes, in what may be a key question for Barnes & Noble's Board of Directors.

Three independent directors, with the advice of Evercore Partners and Paul, Weiss, Rifkind, Wharton & Garrison, will review Riggio's proposal, Barnes & Noble said in a press release. Barnes & Noble "does not intend to comment further regarding the evaluation of Mr. Riggio's proposal, unless and until definitive agreements for a transaction are entered into," the company said.

In January, Barnes & Noble said that sales of Nook tablets and e-books fell short of expectations, with sales falling 12.6% from year-ago levels, a faster decline than its core bookstore business.

"While Retail sales of NOOK products fell short of the company's expectations, bookstore sales of core products exceeded the company's expectations, and therefore, the company continues to expect fiscal year 2013 Retail comparable bookstore sales to decline on a percentage basis in the low- to mid-single digits," said Barnes & Noble in a January press release.

Barnes & Noble said the Nook business had revenue of $311 million in the 9-week holiday season, a double-digit decrease, in contrast to a 3.1% decline in comparable store sales at its brick and mortar outlets. While e-book sales increased 13.1% within Nook, the unit's results indicated far fewer than expected tablet sales.

"We entered the holiday with two great new products, NOOK HD and NOOK HD+, both highly rated media tablets of phenomenal quality. NOOK device sales got off to a good start over the Black Friday period, but then fell short of expectations for the balance of holiday," said CEO Lynch, who is "examining" the cause of the shortfall.

Nook now is expected to earn $3 billion in 2013 revenue, while its operating losses remain in line with 2012 levels.

Had Barnes & Noble followed through on its Nook spinoff proposal prior to the holiday season, it might have been able to unlock the unit's value to investors when the company's tablets were en vogue.

"Although the company has done well to sell off slices of NOOK over the past six months, to Microsoft MSFT and Pearson, the sales pitch to additional outside parties (excluding other publishers) is becoming more difficult, in our view, given the recent lagging performance," Peter Wahlstrom, a Morningstar analyst wrote in a February note to clients.

"From a valuation perspective, NOOK Media remains a wildcard, as the market is not ascribing much (if any) value to this segment," the analyst added.

Wahlstrom's note foresaw the prospect of the Nook business and Riggio's involvement in the potential acquisition of bookstore businesses, however, what the analyst highlights as the way to unlock value to shareholders appears to conflict with Monday's proposal.

"If ultimately spun off, we believe that the remaining (core) retail business could be taken private (perhaps with the existing management team taking a prominent role) and/or return to its former dividend-paying ways, which could be an attractive alternative for income seeking investors," Wahlstrom concluded, earlier in February.

Instead, the exact opposite appears in the cards, given a filing by Riggio on Monday.

According to the filing, Riggio notified the Barnes & Noble board he plans to propose to purchase all of the assets of the retail business, including, among other things, Barnes & Noble Booksellers and; and would exclude NOOK Media LLC (comprising the digital and College businesses).

"Mr. Riggio plans to make the proposal in order to facilitate the Company's evaluation of its previously announced review of strategic options for the separation of its investment in NOOK Media LLC," the filing reads.

While a price isn't spelled out, Monday's filing states "the purchase price is currently contemplated to be comprised primarily of cash consideration and the assumption of certain liabilities of the Company. Mr. Riggio would provide the equity financing for the transaction and undertake to arrange any debt financing required for the transaction."

After spurning high-priced takeover bids by the likes of Liberty Media in 2011 and moving slowly in monetizing Nook, investors should be skeptical they are getting a bad deal in Riggio's proposed retail outlet acquisition.

If Barnes & Noble takes Riggio's proposal seriously, the company also needs to explain how it expects to operate Nook or spin it off to investors.

For more on Barnes & Noble, here's a look at four deals that rewrote the company's history and five short-sighted spinoffs. For more on how companies can invest in eBooks, see the reasons why Barnes & Noble can't act like Amazon.

-- Written by Antoine Gara in New York

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