BNED: The College Bookstore Business and the Threat of Non-Consumption
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In its early, bookselling, days, Amazon was a superior experience to traditional bookstores for a few different reasons. Bibliophiles no longer had to get in their cars and drive to Barnes and Noble, Borders, or Books-A-Million, but could instead order books from the comfort of their homes. On top of that, Amazon could use order history data to better understand what books I might wish to buy in the future. This meant the company could recommend those books when I returned to the site while also having a more accurate picture of overall demand for titles than its brick and mortar competitors. That said, there were also some similarities between traditional bookstores and Amazon. Most importantly, they both sold books that were reasonably priced, and that people actually wanted. The question was not whether people would want to read books in the future, but instead how people might order those books. There are other companies, however, where the risk to the business is not a competitor, but non-consumption. Barnes and Noble Education ($BNED), an operator of bookstores on college and university campuses, is an example of such a business. It was spun-out from the larger Barnes and Noble organization in 2015, and has experienced a rocky journey since then. Non-consumption threatens it in a few ways:
College enrollments have declined over the past decade or so. Some of this was just a result of many students deferring enrollment in 2021 to avoid remote classes. In the same way Covid was a temporary boon for software businesses, it was a temporary hindrance to college enrollment. That being said, enrollment numbers still sit below where they were in 2010.
Professors are assigning less course materials for classes.1
An estimated third of college students don’t buy their course materials anyway.
Moreover, college textbooks are so egregiously priced that students have few qualms about accessing a free copy online. It’s a rare experience to buy all your course books and not feel ripped off. BNED already struggled before Covid, but it’s hard to think of a worse pandemic business model than operating a bookstore on college campuses, particularly when higher-margin apparel sales are a significant part of the attempt to make the four-wall economics of college bookstores work (If you’ve ever been to Notre Dame on game day, it’s pretty clear that apparel sales are an essential part of a campus bookstore’s business). As if the above headwinds weren’t enough, the bulk of BNED’s profits come from only a portion of the year. In other words it’s like See’s Candy, but if See’s Candy didn’t have a beloved brand and its seasonal profits were far less substantial. BNED’s annual report ‘Business’ section is a bit of a headache to get through, which is perhaps a negative signal in and of itself, but broadly speaking BNED can be divided into three segments:
Course materials - self explanatory. Selling and renting textbooks to college students.
DSS - Digital Student Solutions. Software to help K-12 and college students with homework. The most interesting part of this segment is Bartleby, which is a direct competitor to Chegg.
General Merchandise - a mix of both school spirit apparel and standard student staples like laptops and tablets. In late 2020 BNED partnered with both Fanatics and Lids to improve their school apparel, a higher-margin segment that can potentially benefit from Fanatics’ e-commerce expertise and Lids’ store data. It’s worth noting that revenue for apparel sales is now recognized on a net basis given this partnership.
As one would expect given the above preamble, the numbers paint a pretty bleak picture of the business (numbers in thousands other than EPS):
The business hasn’t turned a profit since 2017 and S&A expenses, which primarily consist of store payroll and operating expenses, have increased significantly from 72% of gross profit in 2012, even without the effects of 2020/21. While the decrease in profit margins looks like a Covid phenomenon, there’s an additional factor that will weigh on them going forward: digital textbooks, which in 2019 accounted for only 11% of course material sales. Understandably, the pandemic significantly altered this mix shift, with the course materials balance sitting at 35% digital, 65% physical as of fiscal year 2022. This shift shows no signs of slowing down, and was mentioned as a key factor in the company missing gross profit guidance in its preliminary fiscal year 2023 results.
There is, however, a potential bright spot for BNED, particularly in its fight against non-consumption. Over the past few years it’s rolled out two different, but related, programs: First Day and First Day Complete; First Day is for individual courses, whereas First Day Complete is applied campus wide. Under these programs, BNED partners with colleges/universities to deliver discounted course materials to students before the first day of class. Universities pay BNED a set fee per student per credit hour, and then include that price in tuition or bundle it in as a course fee. In other words, the university, not the student, becomes the primary buyer, and the default for students becomes opt-in rather than opt-out. The results thus far have been impressive. On typical college campuses that Barnes and Noble serves 30% of students end up buying their books through BNED stores, 30% of students buy their books elsewhere, and the remaining group of students doesn’t buy books at all.2 First Day Complete changes these numbers drastically, with 80% of students now purchasing books supplied by BNED. Importantly, the discounted course materials don’t come at the expense of already low margins. Michael Husby, BNED’s CEO, has explained the program well in the past:
‘The [First Day] complete model is adopted by an entire institution which drives substantially greater adoption rates for the bookstore, enhances revenue for the schools and ensures students have access to all of their materials at a substantially reduced cost by the first day of class. In addition, publishers who supply the content have significantly higher sell-through rates. This is truly a winning solution for all who participate, which is why First Day Complete is gaining so much market traction.’3
Because both BNED’s and publishers’ business models are under pressure, publishers are willing to drop their prices in exchange for greater volume. Order fulfillment is simpler and less expensive when working directly with universities rather than with individual students, and so First Day Complete’s gross margins are higher, sitting at roughly 35%. Additionally, revenue share agreements with educational institutions mean BNED’s customers are incentivized to see the First Day programs succeed. Some of these universities also consider offering textbooks for free as a way to remain competitive as institutions and boost enrollment, and view First Day Complete as essentially a marketing expense. BNED’s executive team sees its First Day programs as the way forward, and has signaled a willingness to cancel contracts with schools that don’t wish to make the transition from its traditional course materials model.4
The growth of the First Day programs has been impressive thus far, with revenues compounding at 90% annually from 2019-2022, and, conservatively speaking, slowing to 50% at the end of this fiscal year. Management’s comments, for good reason, have predominantly focused on First Day Complete rather than First Day by course. The benefit of campus-wide implementation is not only the larger annual contract size, but also the lower risk of churn. Supplying textbooks before the first day of class for an obscure course on German economic policy in the 1930s becomes a very bad business if that course is discontinued, but that risk is less relevant if you’re also the supplier for the course that takes its place.
The bull case for BNED is this: As the First Day program continues to grow it will replace the traditional course materials business with a revenue stream that’s higher margin, more predictable, and greater in magnitude. The cost of running stores should remain about the same, resulting in not only greater gross margins but also non-negative operating margins. Put another way, investors will own a business that makes the flip from unprofitable to profitable, and commands a higher multiple on those profits given the greater predictability of revenue. Revenue from the course materials business was approximately 594mm and 236mm for 2022 for the traditional course materials and First Day programs, respectively. The path to becoming profitable might (very roughly!!) look something like this:
All existing (excluding non-rental) traditional course material revenues convert to First Day programs, with the vast majority converting to First Day Complete. Opt-in rates on this traditional business go from an average of 30% up to 80%, but book prices are discounted by 40%, resulting in First Day revenue of roughly 993mm. I’m assuming that BNED experiences zero campus store growth during this period, which seems unlikely.
First Day margins end up at 30%, given that First Day by course margins appear to be lower than 35%. First Day gross profits are thus 298mm.
Textbook rental profits stay about constant at 56mm, leading to combined gross profits of 354mm.
General merchandise sales stay flat at 558mm with 20% gross margins, leading to combined gross profits of 466mm, and EBITDA of 82mm assuming S&A expenses stay constant.
There’s also a bear case for BNED, which centers around the company’s current debt load. Net debt sits at 184mm, or well over half of enterprise value. The company was recently told by creditors it needed to increase its liquidity, and so in late May it sold off its DSS business segment for net proceeds of 20mm.5 The sale amount is surprising given DSS includes a high growth software segment, Bartleby, that did 13mm in revenue last year. The threat of ChatGPT may have been a factor, but it also suggests that management was so desperate for cash it was willing to accept almost any price. While the First Day programs have a favorable margin profile, they’re a significant drag on working capital. BNED delivers books to students before the first day of class, but universities only pay BNED once the add/drop period has ended. This isn’t inherently a problem, but it could become one for a company that has to convince lenders it won’t run out of cash. To add to the financial concerns, the company is currently trying to refinance its debt and the CFO resigned in April. BNED’s First Day programs are compelling, but the risk is that the company runs out of money before it’s able to make the full transition.
Disclaimer: The information in this post is not intended to be and does not constitute investment or financial advice. You should not make any decision based on the information presented without conducting independent due diligence.
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