In the late 1990s dot-com boom and bust, tales of successful short-sellers who profited by selling technology stocks high and buying them back later for pennies on the dollar were rare. Most amateurs and professionals who tried the strategy in 1999 got burned as stocks continued to climb.
But Barnes & Noble, the book-selling chain, has effectively pulled off just such a feat. Last week, it offered to buy out the remaining shareholders of its publicly held spinoff, barnesandnoble.com, for about 14 percent of the price shareholders paid in the company's 1999 public offering.
In the mid-1990s, when Amazon.com burst onto the scene as a pioneer in Internet book-selling, Barnes & Noble's days were supposed to be numbered. The rapidly expanding bookstore chain, controlled by brothers Stephen and Leonard Riggio, was saddled with a suddenly outdated retailing model—selling products in bricks-and-mortar stores—and with a suddenly outdated product. Who, after all, would buy expensive, bulky books bound up in paper and cloth at a time when eBooks would soon be available for download at a fraction of the cost?
But the Riggios weren't about to be daunted. First, Barnes & Noble wasted no time in creating an Internet bookstore of its own. In March 1997, barnesandnoble.com was capitalized with a chunk of the chain's own money. Then, like all good early-stage Internet investors, the brothers found successively greater fools: first a blinkered corporate partner and then the hapless investing public.
In the fall of 1998, Barnes & Noble struck a deal with Bertelsmann, the hidebound German publisher that had become smitten with all things digital. Bertelsmann contributed $200 million in cash to barnesandnoble.com and paid another $100 million to Barnes & Noble—for the privilege of investing in the online business and to compensate the parent company for its Internet investments. In exchange, Bertelsmann received a 50 percent stake in the online business.
On May 25, 1999, barnesandnoble.com held an initial public offering. Investors lined up for shares, priced at $18 apiece, the way readers queued up to buy Harry Potter and the Prisoner of Azkaban at Barnes & Noble stores all over. Ultimately, public investors coughed up $517 million for a 20 percent stake in the company. Barnes & Noble and Bertelsmann were left each holding about 40 percent of the company—worth about $1 billion each.
In the years since, enthusiasm for buying books over the Internet has grown: barnesandnoble.com's sales rose from $62 million in 1998 to $422 million in 2002. But with the bursting of the Internet bubble, enthusiasm for the stocks of companies that sell books over the Internet has cooled. As barnesandnoble.com rapidly lost money and burned through the huge pile of cash it raised—it was down to its last $35 million as of June 30—the stock fell like a ton of Robert Caro's Lyndon Johnson biographies. The stock hit a low of 43 cents in the third quarter of 2002.
Dumb money always comes in at the top and leaves at the bottom. After a string of poor investments, Bertelsmann in September 2002 decided to abandon das Internet and focus exclusively on books and music. And the Riggios were happy to oblige. In July, Barnes & Noble agreed to buy Bertelsmann's stake for $2.80 per share, or about $164 million. In the end Bertelsmann lost—and Barnes & Noble made—45 percent on the transaction. Leonard Riggio said, "We sincerely thank our partners at Bertelsmann for their many contributions to Barnes & Noble.com." A contribution—not an investment—is precisely what it turned out to be. The deal closed on Sept. 15.
But Bertelsmann's contributions were nothing compared to the highly generous (if not altogether involuntary) contributions barnesandnoble.com's public shareholders were asked to make a few months later. Left holding a 25 percent stake, the public shareholders were at the mercy of majority owner Barnes & Noble. Late last week Barnes & Noble offered to buy back the remaining shares of barnesandnoble.com that it didn't already own for $2.50 each. In others words, by spending $115 million in the open market, Barnes & Noble aims to acquire a group of assets that it had effectively sold to the public for $517 million back in 1999.
Barnes & Noble—and barnesandnoble.com—isn't out of the woods. The bookstores are now under assault from Wal-Mart and Costco, which sell a small selection of best sellers at a small markup. And the online bookstore is still losing money. But barnesandnoble.com has $35 million in cash, $48 million in inventory, and annual sales of more than $400 million. By merging the online unit back into the original parent company, Barnes & Noble can save significantly on overlapping administrative and marketing costs.
In the past three months, Barnes & Noble has offered to pay about $280 million for assets for which, in 1998 and 1999, it convinced investors to pay more than $830 million. The story would make excellent fodder for a book on great corporate asset sales and buybacks. But you wouldn't find that book prominently displayed in the window of the nation's largest book retailer.