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Hard to see the upside of a Barnes & Noble sale

Barnes & Noble plans to put itself up for sale offered the most excitement the U.S. book-selling industry has seen in some time, with both it and beleaguered Borders showing gains in Wednesday's trading. But investors hoping for merger-induced profits likely face more downside than potential return.

Barnes & Noble, the biggest U.S. bricks-and-mortar bookselling chain, said late Tuesday its board intends to "evaluate strategic alternatives, including a possible sale of the company" since it believes its shares "are now significantly undervalued." The announcement had a predictable effect, lifting Barnes & Noble shares more than 19 per cent on Wednesday, to $15.31 (U.S.), from a level just above the company's 52-week low.

That elevated price, however, matches what some analysts think is a fair price for the company. And Barnes & Noble's situation is more complex than that of the typical company that announces it wants to make a deal.

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"If I knew this company would be sold, I'd make [my target price]higher," said Standard & Poor's equity analyst Michael Souers, who maintained his $16 level even after the announcement. "But with the significant risks, I prefer to continue to value it as before."

The announcement came as the company continues to squabble with one of its largest shareholders, billionaire retail investor Ronald Burkle. Mr. Burkle, who has been buying shares at recent low levels and now holds 19 per cent of the company, has sued Barnes & Noble because it adopted a poison pill that would block him from reaching 20 per cent.

Meanwhile, the largest shareholder, at 30 per cent, is Leonard Riggio, the company's founder and chairman. In Tuesday's announcement, Barnes & Noble said Mr. Riggio "intends to consider the possibility of participating in an investor group to acquire the company."

That type of financial buyout may be the only kind, as there's no strategic buyer on tap: At $900-million in market capitalization, it dwarfs the two other public booksellers, Borders Group, at $82-million, and Books-A-Million Inc., at about $100-million. (Border's stock was up 3 per cent Wednesday as part of the speculative frenzy - to $1.36. Its penny-stock status reflects its leverage and perceived also-ran status in e-books).

Yet any financial buyer would likely have to use Barnes & Noble's free cash flow to effect a major restructuring, given its challenges. Fewer adults are reading books, and many who are have switched to e-books, where Barnes & Noble is believed to trail online retailer Inc. Barnes & Noble, with about 800 stores across the United States, has an awful lot of real estate to wrangle as it makes the transition to digital.

To some, that means there's one scenario that's the overwhelming favourite: Mr. Riggio lines up backing and takes the company private in order to complete his restructuring without any pesky public shareholders. (Would Canadian giant Indigo Books & Music Inc. take a shot? "Won't happen" says analyst Bob Gibson of Octagon Capital Corp. "If Indigo wanted to do something like that, they'd look to Borders, where there's an existing relationship.")

The good news about the Riggio option is that the Barnes & Noble board will have to take a tough stance on whatever an insider-affiliated group might offer, and would likely need to extract a few extra dollars beyond an initial offer.

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Yet investors who assume the traditional merger premium of 30 per cent must wonder how much of that was eaten up by Wednesday's gain of nearly 20 per cent - how much higher could an offer be? By contrast, if the company ultimately announces it hasn't received a satisfactory offer, how close to its 52-week low of $11.89 will it go?

To Mr. Souers of S&P, and other analysts, the announcement seemed to be mainly about holding off Mr. Burkle and other dissatisfied shareholders, as it certainly didn't make any sense for Mr. Riggio. "If he's the most likely buyer, he's only bidding up the shares he might be buying."

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About the Author
Business and investing reporter and columnist

A business journalist since 1994, David Milstead began writing for The Globe and Mail in 2009. During eight years at the Rocky Mountain News in Denver, Colo., he individually or jointly won nine national awards from SABEW, the Society of American Business Editors and Writers. He has also worked at the Wall Street Journal. More

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