2023-12-13 04:16:32 ET
Summary
- Barnes & Noble Education is a mispriced opportunity with the potential for a breakout and a near-term price target of $2 per share.
- BNED's Q2 FY 2024 results were strong, with impressive free cash flow, increased retail sales, and improved Adj. EBITDA.
- The company's First Day and First Day Complete business transformation is promising, and the adoption of this model is expected to drive major growth in Adj. EBITDA.
As a small-cap value and special situations investor (as well as a tactical trader, mostly during quarterly earnings season), so much of my time is spent synthesizing quarterly earnings reports and conference calls within my fairly large coverage universe. As I track a few hundred different companies, if bandwidth allows, the idea is to quickly spot the inflection points. Having been doing this full-time, since May 2020, I've witnessed far too often the market can be very inefficient when it comes to small caps, notably companies with market capitalizations under $500 million. Moreover, within the micro-caps universe, perhaps even more so, at least in my experience, companies with market capitalizations sub $150 million tend to be even more inefficient.
Today, I write to share a very compelling and mispriced opportunity in Barnes & Noble Education, Inc. ( BNED ). Quite interestingly, and before we dive in, despite posting fantastic Q2 FY 2024, last week, BNED shares have had trouble definitely holding above its 200 DMA. Because BNED's Q2 FY 2024 was so strong and its outlook has improved so markedly, I would argue it is only a matter of time before the algos can no longer defend and protect the current 200 DMA, at $1.35 per share. Once this happens, the algos should flip from sellers, at or near the 200 DMA, to strong buyers, on a clean breakout through the 200 DMA. Either way, I would argue it is only a matter of time and that BNED shares are setting up for a leg up, with a good shot at reaching my near-term price target of $2 per share.
Why This Opportunity Exists
Last week, before Barnes & Noble Education reported its Q2 FY 2024 results, the company had only a $56 million market capitalization and $270 million of net debt, or a $326 million enterprise value. In early September 2023, the company posted a poor Q1 FY 2024 but maintained its FY 2024 Adj. EBITDA guidance, of $40 million. Given the disappointing Q1 FY 2024 as well as a slow transition, BNED shares have languished. Moreover, let's face it, this management has been really bad at setting its annual guidance and then really good at missing that guidance. In fact, they lost $10 million of Adj. EBITDA in FY 2022 and a shocking $8 million, in FY 2023 (BNED's fiscal year ends on or within days of calendar April 30th). These were both much worse than originally forecasted and a big reason why BNED shares have been stuck in the penalty box.
Taking a step back, though, the business has robust revenue, in absolute dollars, to the tune of $1.5 billion-plus, but has struggled with profitability as margins have been eroding and college enrollments have been slowly declining. The company's First Day and First Day Complete business transformation is highly promising, but it has taken longer than hoped, given all of the red tape at Universities (to get all the necessary buy-in, sign-offs, and then finally, the scheduling and adoption pieces). As First Day and First Day Complete (FDC) are charged as part of tuition, there are time constraints and deadlines that need to be met, in order for school to offer FDC, starting in the fall of a calendar year.
To make a long story short, BNED's equity was priced so low, ahead of its Q2 FY 2024 earnings, because the market has low current confidence that management can deliver and that its debt can be properly handled (they got an amendment and covenant relief that moves the revolver's maturity date to December 28, 2024). As part of the amendment, they had to embark on a Strategic Review, bringing on two independent directors and an overseer of that review, to protect the bank's/creditor's interest.
Simply stated, despite posting a fantastic Q2 FY 2024, last week, Mr. Market is asleep at the wheel here. Yes, the stock is up about 20%, as of yesterday's close, since reporting its Q2 FY 2024 results, but that is merely a $11 million increase in market capitalization, as Mr. Market seems to have already written off BNED and its equity.
As I try not to let the tail (stock prices) wag the dog (the fundamentals), I'm arguing Mr. Market has completely under-reacted to a very real turnaround.
Let's Read On......
Last Wednesday, December 6, 2023, after the bell, BNED posted fantastic Q2 FY 2024 earnings results. Enclosed below, and I grant you this is a busy slide, which contains all of the important details. BTW, I highly encourage people to review BNED's Q2 FY 2024 investor deck .
The three key takeaways are as follows:
- Q2 FY 2024 free cash flow was a blistering $61.1 million (going into last the Q2 FY 2024 earning print, BNED's market capitalization was only $56 million)
- Comparable retail sales were up 3.6%
- Adj. EBITDA was $50.3 million (8.2% margin), which was up $11.1 million, compared to Q2 FY 2023.
Crossing The Rubicon
Relatedly and very importantly, the company crossed the Rubicon. For the first time ever, First Day and First Day Complete revenues have a line of sight and are approaching 50% of course material revenue and the combined First Day revenue exceeded the decrease in the la carte model!
In the second quarter, FDC revenue increased 52% year-over-year to $136 million, and the combined First Day programs revenue reached $199 million. Our strategic transition to First Day Courseware business model has reached an inflection point. First Day and First Day Complete revenues are approaching 50% of course material revenue. And revenue increases from First Day offerings exceeded the decrease in revenue from the traditional à la carte model by $30 million on a year-to-date basis. This evolution to a subscription like B2B model significantly improves revenue and revenue visibility, which enables us to better align costs with revenue, improve inventory management and operating efficiency and ultimately achieve much higher four wall EBITDA per store.
The $30 million to $35 million of cost savings are complete.
Next, we've improved operational efficiency and maintained top line growth despite operating in 128 fewer stores. We've achieved our planned $30 million to $35 million of annualized cost savings and as a result, consolidated adjusted EBITDA increased 28% to $50.3 million in the second quarter. Looking ahead, we've identified additional opportunities to improve efficiencies further and reduce operating expenses to continue improving our profitability and cash flow. Importantly, the actions we have taken and continue to take position us to deliver more consistent, sustainable and profitable growth in the years ahead.
Major Growth of Adj. EBITDA Ahead
YoY, the company dropped 128 low-margin/money-losing stores and ended the quarter with 717 physical campus bookstores and 554 virtual bookstores. Going forward, once you get past the inventory liquidation and one-time hit to gross margins from these closures, this is very positive for Adj. EBITDA margins, working capital, and management's bandwidth, going forward.
The Retail Segment operates 1,271 college, university, and K-12 school bookstores, comprised of 717 physical bookstores and 554 virtual bookstores.
Now, here is where it gets really, really exciting/interesting. As of Fall 2023 (calendar year not fiscal year), there are 157 campus stores that adopted the FDC model. We know that the FDC model has higher Adj. EBITDA margin.
Based on management's prepared remarks as well as commentary during its analyst Q&A portion, we learned the following:
Exhibit A:
We've transitioned 157 campus stores to our innovative B2B course material model, which this past fall term, encompassed enrollment of nearly 800,000 students. While this is impressive growth, we believe we are just scratching the surface. Our active dialog with institutions and the FDC contracts already signed for spring term '24 and fiscal 2025 suggests that inclusive and equitable access is rapidly becoming the primary course material distribution model. Given the strength of our pipeline, we remain confident in our ability to successfully accelerate the scaling of FDC and the long term growth and sustainable financial benefits of the equitable access model.
Exhibit B:
( Source: BNED Q2 FY 2024 Conference Call )
Exhibit C:
( Source: BNED Q2 FY 2024 Conference Call )
If we take a step back, we have 157 campuses, out of 717 physical bookstores, on FDC model.
If the pipeline for fall 2024 is half as robust as management indicates then it is I would argue it is realistic to model that an additional 150 campuses would adopt the FDC model, by fall 2024.
Let's take another step back, BNED hasn't had a revenue problem per se, although that has been moving in the wrong direction, it has had an Adj. EBITDA margin problem.
Enclosed below are BNED's revenues and operating losses, from FY 2019 - FY 2023 (fiscal year ended April 30th)
As you can see below, let's look at Adj. EBITDA
Adjusted EBITDA
- FY 2019: $98.8 million
- FY 2020: $38.8 million
- FY 2021: -$70.1 million
- FY 2022: -$10.3 million
- FY 2023: -$8.1 million
- FY 2024 (guidance): $40 million
Based on consensus revenue estimates, for FY 2024, and as of December 6, 2023, and only Needham & Co. and Craig-Hallum Capital cover it, we're talking about $1.6 billion. So $40 million/$1.6 billion is 2.5% Adj. EBITDA margins.
Therefore, if you think about it, we know First Day and First Day Complete are more profitable.
Let's reverse-engineer some numbers:
Here is what we know. Despite 128 fewer stores, Retail revenue was $599.3 million (or down $9.7 million), but comps were up 3.6%.
We also know First Day and FDC sales were $199 million out of $476.1 million of total course material sales (or now 41.8% of the mix).
However, and here is where the magic happens, there are only 157 campus stores out of 717 physical stores, using First Day Complete. So $136 million/$476.1 million is 28.6% of material revenue mix. And yet, only 157 out of 717 campuses (21.9%) are using FDC.
Enclosed below is my simple back-of-the-envelope model.
This should give you a directional idea of the revenue uplift, just using basic averages, and what happens to incremental Adj. EBITDA, if we assume FDC's Adj. EBITDA margins are 500 bps, 800 bps, and 1,000 bps higher than the a la carte model. For example, in FY 2025, assuming an incremental 150 schools sign on, FDC revenue should be nearly double, and the incremental Adj. EBITDA margin dollars, from only FDC, should increase by $10.4 million.
The Debt
The reason BNED's equity trades so ridiculously low is twofold: the debt and three consecutive negative Adj. EBITDA years.
As of October 28, 2023, BNED's long-term debt was $233.8 million and its cash was $15 million, so net debt of $218.6 million. This is significantly better than $277.7 million of debt and only $7.7 million of cash, or net debt of $270 million, as of July 29, 2023. That said, the debt is still very elevated, at 5.5X ($219 million of debt/$40 million FY 2024 Adj. EBITDA guidance).
As we already covered above, but in a prettier chart, enclosed below is BNED's Adj. EBITDA, over the past three years, as well as this year's guidance.
In late July 2023, the company got amendments from its creditors that extended the maturity date of its revolver to December 28, 2024. Prior to these amendments, the debt was SOFR +375 Bps. Also, and I haven't confirmed this yet, but I'm guessing this quarter's $10 million interest expense might be higher due to fees and one-time payments associated with the covenants relief/amendments.
I need to double-check this, but let's assume for now, that we're talking about 10% debt.
Risks
- Despite the remarkable Q2 FY 2024 process, with Q2 FY 2024 free cash flow of $61.1 million, BNED still has a lot of net debt, at $219 million. Therefore, the business needs to continue to perform to get that debt refinanced.
- The company must continue to successfully onboard hundreds of more schools onto its First Day Complete model for the calendar years 2024 and 2025 (academic years).
- Given all of the moving parts from closing unprofitable stores, courting new schools to adopt and join FDC as well as efficiently running the existing store bases, there are operational/business execution risks.
Putting It All Together
Although not entirely out of the woods, for the first time, arguably in ages, BNED posted an impressive quarterly earnings report. The $61.1 million of free cash flow made a material dent in BNED's net debt (moving from $270 million to $219 million, from July 29, 2023, to October 28, 2023). Moreover, the company confirmed that its $30 million to $35 million of cost savings are realized and now in the numbers, and we saw it first hand, this quarter. In addition, and most exciting, at least for the equity holders, is management's commentary on its FDC pipeline for the fall of 2024. Given the higher revenue and Adj. EBITDA margin profile of FDC, you can much more effectively plan your costs, buy your inventory correctly, and have much better visibility into the business. Based on this, I would argue there is a realistic pathway to BNED growing it Adj. EBITDA from $40 million (FY 2024 guidance) to $60 to $65 million (FY 2026 base case). Arguably, at $60 million, the debt should easily get refinanced, and the company would spit off real free cash flow that can be used to pay down more debt. In that base case scenario, BNED shares should completely re-rate. Moreover, in more of a Blue Sky scenario, one could make a case for $80 million of FY 2026 Adj. EBITDA. If that scenario were to materialize, this is a $5+ stock, assuming there is no equity dilution associated with refinancing (in the form of some type of a kicker, like warrants, or if had to resort to some form of a revolver and convert, etc.).
To make a long story short, I would argue Mr. Market is missing the forest for the trees. Surprisingly, BNED and short-term trades are much too focused on whether it will or won't definitely pierce through its 200 DMA (now at $1.35). Because of this short-term resistance, and frankly a bit of a struggle to make a clean breakthrough that 200 DMA, market participants haven't even seemed to have noticed a real turnaround, in the actual business, is afoot here. Setting aside short-term technicals and silly stock prices, based on the fundamentals, my new price target is $2 per share.
Lastly, keep in mind that there are only 53 million shares of BNED, so a $1 move in the stock price isn't that big of a deal in the context of its overall enterprise value. We shall find out soon enough as to if/when Mr. Market awakens from his slumber when it comes to BNED shares.
For further details see:
Barnes & Noble Education: After A Great Q2 2024, Look For $2 Per Share