At the end of May, Indigo Books & Music Inc. announced a loss of almost $37-million for the year ended March of 2019, and the stock promptly tanked 20 per cent on heavy volume. Chief executive officer Heather Reisman said the company had incurred significant expenses associated with store renovations and relocations, compounded by the Canada Post strike. Same-store sales were down 1.1 per cent, and the sole U.S. location is “going to do okay, but it is not knocking it out of the park.”
The company’s strategy will not be a renewed emphasis on the book business but rather a refocus on general merchandise. In conjunction with that, Indigo made several new management hires.
It is no secret that print-book sales took a hit with the arrival of inexpensive e-readers, but the past couple of years have seen a stabilization of market shares. Sales of print books, in fact, increased 1.3 per cent in 2018, according to the research firm NPD Group. So, maybe there is a future for bookstores after all.
The New York-based hedge fund Elliott Management Corp. certainly thinks so: Last week they agreed to buy struggling Barnes & Noble Inc. for a 40-per-cent premium over the previous closing price. This isn’t new territory for Elliott Management; in 2018, they acquired the Waterstones bookstore chain in Britain and have sustained a turnaround based on allowing local stores greater autonomy. They obviously think that this will work in the United States, as the Waterstones CEO will be running Barnes & Noble.
Although the takeover offer from Elliott Management represents a healthy premium over the recent depressed price, it is still only 1 times book value per share and less than five times EBITDA, a broad measure of cash flow. They clearly feel that they left a margin of safety in their offer to cover the uncertainties of the book business.
If a hard-nosed New York hedge fund finds these ratios attractive, what would they think of Indigo?
At $7.16, the stock trades at 52 per cent of book value and only a 22-per-cent premium to Ben Graham’s net-net working capital per share of $5.87. With 27.1 million shares outstanding, the market capitalization is almost $200-million, while revenue has exceeded $1-billion. No debt and a cash balance of $128-million as of March 31, 2019, means the enterprise value of the company is only $72-million. Last year the company lost money, so the EBITDA was negative, but the average EBITDA for the past five years has been $30-million. In other words, Elliott Management paid five times cash flow for a bookstore chain with a checkered past, and you can buy a Canadian bookstore chain with a strategy already in place for 2.5 times cash flow. What is wrong with this picture?
What is wrong with the picture, of course, is that Ms. Reisman and partner Gerald Schwartz own 15.6 million of the 27.1 million shares outstanding, or about 58 per cent of the total according to last year’s shareholder proxy. So, no one is making a move on Indigo without their approval.
In that case, wouldn’t it make sense for the controlling shareholders to take the company private and execute the long-term strategy without the need for quarterly earnings calls? The 42 per cent of the shares that they do not control have a market value of only $84-million, and the company has $128-million in cash on the balance sheet.
Minority shareholders will be reluctant to tender at the current depressed price, but by chance we have tangible evidence of what a smart insider thought the stock was worth a year ago. During several weeks in January and February of 2018, Mr. Schwartz reported significant insider purchases of Indigo shares in the $19-to-$20 range.
The business model has deteriorated since then, of course, but as a minority shareholder myself I am inclined to think that the Barnes & Noble transaction at book value sets a lower limit of $13.64 for Indigo Books & Music. Franklin Templeton Investments owns just more than 11.8 per cent of the shares, which is enough to prevent the company from going private, so hopefully they have a higher price in mind.
This type of deep-value investing is only appropriate for investors with a diversified portfolio and a patient outlook because you have no control over the timing or probability of an event and trading volumes are small. On the plus side, in the case of Indigo, there is no complicated technology to understand and you can shop in the stores while you wait.
Robert Tattersall, CFA, is co-founder of the Saxon family of mutual funds and the retired chief investment officer of Mackenzie Investments.