Earlier this week, the board of directors of BKS announced it was considering putting the book retailer up for sale. The stock, which has been a severe laggard recently, jumped by about 20% in the following day’s trading. The straightforward interpretation of this market movement is that Wall Street feels the company would be better off economically in someone else’s hands. Zin this case, however, it may equally well reflect strong confidence that there is a wealthy buyer foolish enough to make the purchase at a substantial premium. There are, of course, already two significant holders of stock, Leonard Riggio with a 20% holding and Ron Buckle with 19%. Mr. Riggio has already expressed interest.
What’s going on?
Securities analysts are often forced to make mountainous theories out of molehills worth of information. It goes with the territory. But like any scientist would, we outline our assumptions and conclusions based on the data we have, and then look for information that could prove our resulting theories false. BKS is a case in point.
Here’s my theory:
Three or six months ago, the board of BKS may have been debating selling the company. But it didn’t do anything before now. So it seems reasonable to me that some recent development has either focused their minds or tipped them over the edge toward sale. What could that be?
I don’t think it’s just the recent weak bookselling environment, since this unfavorable development can’t have come as a complete surprise. Nor is it likely the bad blood between the two significant holders of the company’s stock, since this too has been around for a while. Instead, I think the factor involved is an unintended consequence of the move by publishing houses, in concert with AAPL, to force AMZN to raise the price it charges for e-books.
As I’ve written in another post, I think the publishers saw AMZN’s aggressive e-book pricing—it was paying the publishers around $12.50 for a hardcover bestseller and retailing it for $10, thus losing $2.50 a copy—as a threat to mom-and-pop bookstores. The publishing houses’ fear was that the low price would spur rapid adoption of e-books by consumers, shifting business away from mom and pop and destroying a valuable distribution network. That, in turn, would leave AMZN in the very powerful position of controlling a major part of the book distribution network.
For its part, AMZN could afford to use e-books as a loss leader because, although it began as an online bookseller, it has long ago established a thriving online business selling all sorts of other stuff, both for itself and as an agent for others. The contrast between it and BKS is stark. BKS, a purely bookseller, will have cash flow around $250 million this year. AMZN, books + other stuff, will have cash flow of around $1.7 billion, or 7x BKS’s.
What the publishers did was compel AMZN to charge $12.50 a copy for e-books and keep 30% of the revenue and return 70% to the publisher. This is the same deal they offered to AAPL, and is modeled on the standard arrangement with independent bookstores. Note, also, that in using the new system, the publishers were receiving less than AMN was willing to pay them for e-books. So boosting the near-term bottom line was clearly not the reason the publishers were doing this.
Raising the AMZN e-book price by 25%, they apparently reasoned, would slow e-book adoption, preserve small booksellers’ profits and give the publishers some breathing room to figure out what to do next. Things haven’t worked out that way, however.
Maybe higher prices did slow the rate of adoption, but if so the consensus wildly underestimated what that the adoption rate would prove to be.
But I think they also stopped AMZN from making a strategic blunder with e-books and redirected it onto a much more effective long-term path.
To me it’s not surprising that AMZN would be willing to lose money while it established its e-book market position. After all, it spilled red ink for years in its online original book business, propped up only by the billions it cleverly raised from internet-crazed investors in the late Nineties, before the bubble burst. And that turned out ok.
AMZN’s mistake, I think, was to focus on using the book price and not on the readers as a way of gaining market share. Given that the publishers forced AMZN to make a profit on bookselling, they eliminated that option. More than that, they gave AMZN all that “found” cash flow that it could direct into its other strategic e-book weapon–developing better and cheaper e-readers. The first in what I expect will be a series of innovations have just come out. You can now buy an e-reader with better screen resolution (wi-fi only) for $139—or at least be put on the waiting list for one—which is about half the price of the older models a couple of months ago.
BKS is a bookseller. AMZN is a technology behemoth, running mammoth server networks for itself and renting space to other “cloud computing” users. BKS might be able to compete in a battle about who can sell the most books. I think it has decided it can’t compete in a war over who has the best e-reader technology. So it’s sending up a white flag.
It’s maybe too early to tell for sure, but a good guess that the book publishers have accidentally precipitated the demise of BKS. Given the weak condition of Borders and the likely fading away of mom and pop bookstores, this action may also have given AMZN a decisive edge in the battle for book-reading customers.