Barnes & Noble Education’s Dilutive Rights Offering: An Opportunistic Investment
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Summary:
- During the second quarter, we initiated an opportunistic investment in Barnes & Noble Education.
- In its most recent fiscal year, BNED generated nearly $300 million in FDC revenue, up from just $100 million two years ago.
- I expect the position to benefit when the company executes its growth plan in the coming years, and likely gets added back to the Russell 2000 mid-next year.
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The following segment was excerpted from this fund letter.
During the second quarter, the Fund initiated an opportunistic investment in Barnes & Noble Education (NYSE:BNED) after the company announced a highly dilutive rights offering to recapitalize itself.
BNED, which was spun out of Barnes & Noble in 2015, is the largest operator of college bookstores across the US with 1,245 bookstores (55% physical / 45% virtual), serving nearly 6 million students. Since the spin, the company has faced increasing competitive pressures from eTextbooks, rentals and piracy.
In response to these pressures, BNED launched First Day Complete (‘FDC’), which provides students with required course materials prior to the first day of class at below market rates. When schools sign up for FDC, students are automatically enrolled, with an opt-out rate of less than 20%. As a result of significantly higher sell-through rates, BNED typically enjoys a course material revenue and gross profit uplift of nearly 80% and 100%, respectively, upon adoption.
Students enjoy a 30-50% discount, but also benefit from enhanced educational outcomes when they have their materials before the first day of school. Publishers gladly provide these discounts since they are more than offset by the greater sell-through rates. Schools benefit when student outcomes improve and because the rent they receive from BNED is primarily tied to its revenues.
Due to the win/win nature of the FDC program, the pace of adoption is accelerating. In its most recent fiscal year, BNED generated nearly $300 million in FDC revenue, up from just $100 million two years ago. As this growth continues, EBITDA should increase substantially, potentially into the hundreds of millions of dollars, up from $40 million currently.
To fully realize this growth potential, BNED needed to recapitalize itself from an overleveraged position that worsened during the pandemic, when college enrollment took a hit. After engaging advisors to explore strategic alternatives in the middle of last year, the company announced a highly dilutive rights offering in April of this year at 5c per share. Given the low price of the offering and the amount of capital coming in, the transaction handed over 98% of the company to new equity.
Unsurprisingly, the stock traded down significantly upon the announcement, given how unfavorable the deal was to old money. However, new equity was coming in at just 8x EBITDA, an attractive multiple relative to the significant FDC-related growth opportunity in front of the company. Furthermore, the much-improved balance sheet allows BNED to aggressively invest behind FDC, potentially further accelerating penetration from just a low teens percentage of the company’s school base today.
As such, in mid-April I invested 50 basis points of the Fund’s capital into the company’s shares at 23c each, which came with the right to invest up to an additional 3.5% of the Fund’s capital into the company at 5c each, which would bring our average cost to 5.5c per share.
Then in mid-May the stock went ex-rights, meaning that although the offering hadn’t closed yet, the rights would be ours even if we sold our original shares. Less than a week later, the company filed a proxy statement for the deal, outlining that while it received a competing proposal, the board did not deem it to be a superior transaction and thus rejected it. However, that day BNED was lumped in with a handful of meme stocks, causing its shares to rally almost 8x over the next four days, allowing us to exit our initial 50bp investment at 3x the Fund’s entry price.
What’s more, the shares stayed elevated until the transaction closed, allowing the Fund to dispose of most of its newly purchased shares also for around 3x its initial 5c cost. The shares then sold back down much closer to the rights price, allowing us to buy back some of the shares that we sold. Currently BNED represents approximately 3% of the Fund’s capital.
I expect the position to benefit when the company executes its growth plan in the coming years, and likely gets added back to the Russell 2000 mid-next year. It is worth noting that after the deal, BNED instituted a 100:1 reverse stock split so today’s $10 share price is equivalent to 2x the price of the rights offering.
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