I have the soul of a contrarian so I have a powerful bias against suggesting a company, any company, is on a beeline to oblivion. I have to confess, though, that Barnes & Noble (BKS) is making things especially difficult for me. The company appeared on the contrarian-oriented “Crazy Retail” screen about which I wrote on 5/20/16, which, in and of itself, is no great honor. But let’s roll up our sleeves here. The stock, priced in the mid teens, isn’t acting like a play on failure. Does Mr. Market know something I don’t?

The Investment Idea

The Portfolio123 screen, named by me “Crazy Retail,” looked for retailers that are below average in terms of inventory turnover and return on assets but which might be showing some glimmer of very recent improvement in something relating to fundamentals. Rather than looking for success, I’m looking for troubled situations more likely to have managers that are hungry and desperate, as opposed to self-satisfied. I cautioned, though, that this is not the sort of buy-them-all model in which I usually invest: I described this as being of the idea-generator variety (where I view a company’s appearance on the list not as a Buy signal but as a prompt for a closer look).

A pedestrian walks past a Barnes & Noble Inc. store at Union Square in the Manhattan borough of New York, U.S., on Wednesday, Nov. 4, 2015. Photographer: Yana Paskova/Bloomberg

The BKS Numbers

Sales have been declining since 2012, no great surprise to the many who have likely driven up to their local store to find it shuttered, or if open, to find that cashier lines that used to have a 15-30 minute (or more) wit times now have one or two people or more often, nobody, waiting. At one time, BKS had high hopes for its Nook e-reader, which actually beat Amazon.com’s Kindle to the punch in certain respects (a color tablet, a self-lighting e-ink variety) but now seems on life support (currently, Nook is really a co-marketed set of Samsung Droid tablets) as Nook sales desks have often been moved away from the front of the store and left unattended unless a customer hunts down an employee to go there – as if! So this is a case of what is seen by casual observers matching up with what is seen in the 10-Ks.

But here’s something positive. Expenses are also down. To me, the easiest way to spot a serous bankruptcy candidate is to find a company with negative gross margins. That metric, however, remains very much positive here and in fact, not far off from the company’s glory days. It’s harder to maintain the operating margin (where a larger component of cost is fixed) but even in this regard, BKS is positive and it has climbed out of the hole into which it slipped in 2011-13.

Here are some more good things: The company is debt free. There is no longer any preferred stock. Operating cash flows remain positive. And the company is still paying a common dividend – so far at least.

Bottom line to this point: While declining sales is not good, we aren’t even close to being in a position to schedule a corporate funeral based on the numbers. If we want to bury the company, we’ll have to turn to qualitative considerations.

The Stories

Anyone who hasn’t been hibernating for a few decades knows the big issue: technology. It’s hitting BKS two ways. First, it’s cutting into demand for much of what is sold in the company’s brick-and-mortar stores (books, CDs and DVDs) and even to the extent there’s demand for such merchandise, more and more of it is being satisfied through on-line purveyors. That part of the story cannot be expected to ever change.

There’s been some note recently that e-book sales aren’t what they once were. That may be a surprise to analysts and journalists but to me, as a heavy-duty reader, it’s no shock at all. A lot of what I bought in recent years was to build my e-library from scratch. I did that. So now, my purchases, fewer in number, are confined to new items. If anything e-reading likely still has a very long growth curve ahead as younger people migrate over time (oddly, it’s been my experience that Gen-Xers and Millennials I know are much more inclined to cherish the book they can hold, and I expect be more inclined toward e-reading later on as they age and their ability to see small print fonts declines and/or as they find themselves not wanting others around them to know they’re reading things like “Fifty Shades of Gray”) and as new generations grow up e-reading from day one.

Those are external challenges. There are also internal issues.

BKS never seemed to have had its head on straight when it came to Nook as it plagued its customers with a blandly-at-best designed web site, a horrifyingly inept book search engine, reputedly terrible customer service and questionable quality control. I used to pay every year for a B&N membership card that got me discounts on books. I called to ask if I could use this on my Nook app. The company said “no.” Seriously? Nook had its chances. BKS blew it. And now, that business is likely past the point of no return.

One thing a forward-thinking retailer will likely have to do to survive going forward is really reinvent the business model. Here’s an idea for a bookstore: How about borrowing from the now-accepted SAAS (Software As a Service) approach and aim for recurring subscription revenue instead of transactional revenue. Set up an e-library which, for a modest fee, gives you books when you want them for as long as you want them, and thus makes it worthwhile to step up from free public libraries that have wait lists and lending-time limits. Oh wait . . . Amazon.com already introduced this with Kindle Unlimited.

The B&N coffee shops remain great and there’s been talk of adding alcoholic beverages. That’s fine. But if that’s the business, $BKS would be at a dreadful disadvantage to brick-and-mortar cafes, which do the same thing with a lot less square footage (i.e. expense).

BKS could migrate to books, board games, toys, etc. This is not a new thing for the company and it’s been OK lately. But then again, it’s not as if brick-and-mortar retailing on those categories is hot and BKS isn’t exactly a leader in them.

Eureka! I’ve got it. The educational business! BKS is great at that.

Oops. That was already spun off. Good deal for those who held xBKS back in August 2015 and wound up getting shares of Barnes & Noble Education (BNED) handed to them – sort of (I haven’t looked into why, but I see that stock hasn’t done so well of late). But it’s a dead issue for today’s BKS holders.

Quo Vadis

I’ve painted a pretty bleak picture of BKS’ prospects for long-term viability. Now, here’s the good news: I’m a stock strategist, not a retailer. So just because I can’t think of a solution doesn’t mean there isn’t one. With that in mind, here are three things upon which a BKS shareholder can hand his or her hat:

• Amazon (AMZN), which seems to have done just about everything right, has entered the brick-and-mortar bookstore market. Those folks know way more about this business than I do so if they see something there, who am I to argue!
• I said BKS’ caused a lot of its own misfortune. In that light, it’s worth noting that the current CEO has been there for less than a year (in other words, the screw-ups weren’t on his watch) and founder and Board Chairman Leonard Riggio (who did great things in building the company up back in the day) announced he’ll retire in September. There’s no assurance change at the top can right a sinking ship and I’ve seen many instances in which it did not help. But it doesn’t hurt. I said in my May 20^th post I wanted retailers run by folks who are likely to be hungry and separate and that is probably the case here.
• Back to the numbers: The company has breathing room, something the typical failing firm lacks.

If you are or will be long BKS, mark June 23 on your calendar. That’s the date the company’s senior management will hold and investor-day webcast “to discuss the company’s financial results, business strategy and long-term outlook.” You’ll be able to access it online live at 9 AM E.T. or later in archive.

Obviously, I can’t prejudge what the company will say. But the stock’s non-deathbed pricing suggests many in the investment community see the company as a survivor and may, at least in the short term, feel a strong emotional-at-least compulsion to interpret anything that’s not downright ridiculous in a positive way. So at the very least there should be a trading opportunity here. Beyond that, let’s see what is said on June 23.

By the Way . . .

I didn’t mention the stock’s valuation metrics. You can look those up, but if you care enough to do so, don’t bother: Avoid!

Valuation ratios can only be as valid as the fundamental items against which the price is compared and even at that, we’re most concerned with where those metrics are likely to go in the future. Given the extent of serious structural change needed here, there’s no way anyone can use any such numbers to support an investment case. There’s no virtue in trying to do value where value can’t be done.