By Eric of The Fit and Value Investor
Books-a-million Inc. ($BAMM)
Price at time of writing and research: $3,54
Current price: $3,24
Write-up: Friday the 17th of June, 2011
Estimated intrinsic value: $6,42
Estimated Margin of Safety: 37,4%
As promised, I hereby post my investment thesis about Books-A-Million. I found this firm via screening. I noticed that it looked undervalued on the basis of both the balance sheet and discounted cashflows. That was an immediate trigger for me to dig deeper into the world of brick-and-mortar retail and especially the book business.
Books-a-Million is the third largest book retailer in the U.S. Books-A-Million sells for the most part books via a chain of bricks-and-mortar superstores, traditional stores and via the Internet. Next to this, they have successfully engaged in cross-selling other related merchandise like gifts, toys, cards, collectibles, magazines, music and movies. Customers can also enjoy a cup of coffee or tea in each instore Joe Muggs café to create a comfortable and ‘convenient reading experience’. Their main market coverage is within the Southeastern states of the U.S.A. and is through 210 Superstores which has an average size of 23.500 ft and 30 traditional smaller stores with an average size of 4.500 ft.
The books and magazine business is where they get 95% of their revenues from. The other 5% of the revenues come via internet sales. Underneath is a small breakdown given of their revenues. Clearly, books and magazines revenue is in a downward trend. However, in the case of Books-A-Million this seems to be filled up slowly by general merchandise and other products like DVD’s and E-books.
When breaking the revenue down in terms of distribution (i.e. via online sales versus store sales), we can see that Books-A-Million only gets around 5% of its revenue from Internet sales. 95% comes from retail sales in stores.
Their revenues are strikingly similar with those from Barnes & Noble. Just as Books-A-Million, Barnes and Noble also only has about 5% to 6% sales from their website. This virtually means they don’t have any penetration at all in this market. Borders Group states in their 2010 annual report (I use 2010 instead of FY2011 as the reported numbers are over 2010 and not 2011, kinda confusing ) that industrywide Internet-based selling is going to grow. Currently, about 10% of revenues come from Internet sales. My guess is that Internet sales and sales from other products fill up the gap that arises in the declining book revenues. While these other products revenues and online sales may rise, overall revenues could well stay about the same.
Looking at the key drivers of this business we can see that this business is driven by low margins and high volume. Therefore, economies of scale are important to have as it enables you to increase margins by buying large or put more cash into venturing into new business, new value propositions or fueling organic store growth.
The competitive landscape is can almost be called an oligopoly. Amazon is the largest book retailer with their Internet sales of books and E-books. Barnes and Noble is the second largest book retailer with their traditional stores followed by Books-a-Million which is the third largest and Borders group that is the fourth largest. Next to these four large retailers, there are several other relatively smaller book retail chains like Powell’s Books (Portland) or other book retailers. This setting puts pressure on margins but also gives enough room to earn a small but satisfactory margin. Companies are not competing to own the book reader, instead, every effort is toward creating a convenient shopping experience for customers. There is less risk of price wars in this sector. Recent developments in the E-reader business has put some pressure on the margins of the companies who engaged in the development of these innovations. Barnes and Noble in specific suffered from this development and the crisis that passed along as their management persisted on competing the Kindle.
Traditional stores concepts are all aimed at creating a comfortable atmosphere in which people are eager to read books and eventually buy these books. People want to learn, want to be entertained and want to be amazed. Books and magazines have always been a means of communication that provides these needs. The strong rise in Internet activity and the convenience that Internet offers makes it also suitable to read books and to receive this needed entertainment. Companies capitalize eagerly on this opportunity but it is to be questioned if this would lead to a complete replacement of traditional books. We have already seen such a (similar) disruptment in the movie rental and music business. Retail stores that sold music and/or rented out movies have suffered enormously from Internet developments and convenient buying behavior of consumers.
Companies like Apple with iTunes made it too easy and too convenient for consumers to buy music online. Illegal download sites were also amassing the interest of people as it made movies and music suddenly free. A final choice is easily made, if you are able to download music and films for free and you don’t even get caught. So why drive to the store in your spare time and buy a CD for $5 or $10? IF it even is in stock.. A dramatic shift has been made in consumer groups who choose to “buy” from the Internet and groups who still prefer to stroll through retail stores to search for music and DVD’s.
But will this be similar for books and magazines? I must honestly say that when it comes to books and magazines, I am emotionally biased. But who isn’t? I still like it to walk through book stores and buy hard copies instead of reading from a screen. It is easy to read from a screen, flip through databases and lists of books to choose from but what is not to like about going into a physical store, enjoy a cup of coffee and spend some quality time learning, flipping through books and being entertained by the written words of many writers. Thank God I didn’t buy Books-a-Million on sentiment but on its attractive margin-of-safety. I know that emotions are an investors Achilles’ heel, however, I have imprinted quite some diligent (I think) protection measures and one of it is to buy only with a margin-of-safety. One that offers enough room for mistakes and in this case maybe, emotional biases. Yet that I think that you have feelings with everything you get in touch with, therefore you are