barnesandnoble.com went public Tuesday and, by the standards of Internet investing, was greeted with a big yawn. Which is to say that its stock price rose just 27 percent on that first day, instead of the seemingly typical 250 percent. Of course, the barnesandnoble.com offering was bigger than most Internet IPOs, raising $450 million, and the company went public in the midst of a general selloff of Net stocks. (That selloff reversed itself Wednesday.) Given those factors, and given that the company has just $61 million in sales, 27 percent doesn’t look too bad.
That’s especially true when you consider that barnesandnoble.com now has a market cap of $3.6 billion, which is almost twice that of Barnes & Noble, its erstwhile parent. On the surface, this seems preposterous. Barnes & Noble does billions of dollars in sales. It has thousands of real stores, an established brand name, and a business strategy that revolutionized the bookselling business. The only way it could be worth less than its puny online offspring, then, is if all the traditional ways of valuing companies have been thrown out the window. In other words, despite its relatively weak IPO, barnesandnoble.com is yet more evidence of the insanity of Internet investors.
Well, maybe. But here are a couple of things to keep in mind. In the first place, although some in the press have suggested that it makes no sense (mathematically) that a subsidiary should be worth more than a parent, Barnes & Noble does not have a majority stake in barnesandnoble.com. After the IPO, it owns about 41 percent of the company, so its stake is valued at $1.5 billion, or $400 million less than its own market cap.
Still, that does mean that the market is valuing Barnes & Noble’s entire “real” business at just $400 million, which works out to about one-seventh of its annual sales. Amazon.com, by contrast, is valued at around 20 times sales. And this seems like prima facie evidence of foolishness.
Remember, though, that markets are only prospective, not retrospective. In other words, what Barnes & Noble has done in the past is irrelevant to its current stock price (except insofar as it might tell the market something important about the future). Its current stock price represents, or should represent, the value of all its future cash flows, discounted by an appropriate interest rate. What the market is saying, in other words, is that Barnes & Noble’s future cash flow is worth significantly less than Amazon’s future cash flow and barnesandnoble.com’s future cash flow.
On the whole, that conclusion seems about right (though the magnitude of the difference may be off). As I’ve argued here before, Barnes & Noble’s business model requires it to invest massive amounts of capital to get the same amount of sales as Amazon. That means that, all other things being equal, a dollar of Amazon (or barnesandnoble.com) sales is much better than a dollar of Barnes & Noble sales. It also means that all those things that look like assets, and that define Barnes & Noble as a “real” company, could easily become albatrosses if the migration of consumers to the Web continues.
If we knew, after all, that Barnes & Noble was going to liquidate itself tomorrow, selling off all it owned–with the exception of barnesandnoble.com–and returning the proceeds to shareholders, then we’d probably say that the company’s current stock price was too low (since if shareholders took those proceeds and invested them, they could probably make more than $400 million). But Barnes & Noble isn’t going to do that. Instead, it’s going to keep expanding, keep spending money on superstores and traditional bookselling. I’m glad, as a consumer, that it’s going to do this, since I like going into bookstores (though I buy almost all my books on the Web). But I also think–as the market apparently thinks–that what this strategy means is that from an investment perspective Barnes & Noble is going to be destroying value over the next 15 years rather than creating it, because its new stores aren’t going to earn as much capital as it cost to build them. And if that’s true, then Barnes & Noble’s shares aren’t undervalued at all.