Special Situation Alert (SAMPLE): Barnes & Noble Education
Massive dilution creates volatility-induced opportunity
(This idea is a sample for readers who are considering a subscription. If you want even more special situations/ bargains like this, be sure to subscribe.)
Note: This is a highly speculative special situation that employs a two-step trade that involves options, so please be mindful of your own risk tolerance and investment knowledge and experience.
Today, Barnes and Noble Education (BNED) released a bombshell announcement telling shareholders they had reached an agreement with a consortium of private investors for a cash infusion that would shore up their balance sheet, which had been teetering on the edge. The terms were onerous, and will lead to a roughly 5,000% dilution for the company.
As of their latest report (February 23, 2024), the company had roughly 53M shares outstanding. This latest development will balloon that figure to about 2.63B shares (that’s a B for billion). In return, they will receive $75M of net cash, and eliminate $34 of debt $34M via a debt to equity swap. This will leave them with a roughly net-neutral cash/debt position (after including inventory, receivables, and payables).
Specifically, the company will:
a) Issue 900M shares in a rights offering for $0.05 per share ($45M of gross proceeds)
b) Issue 1B shares in a private placement for $0.05 per share ($50M of gross proceeds)
c) Convert $34M of second-lien debt into 680M shares at $0.05 per share
d) Use $20M for transaction-related costs
The rights offering in (a) can be subscribed by existing shareholders at an estimated ratio of roughly 17:1 (assuming 53M total shares outstanding on the record date). So for every share you own, you could exercise the rights to receive an additional 17 shares at $0.05 per share.
The company, which traditionally sells/rents textbooks to university students on campuses, is currently undergoing a transition to their “First Day” program. This program allows students to enroll for a specific set price (discounted), and receive all their textbooks before the first day of school. This saves students both time (eliminate finding and shopping for individual textbooks) and money (institutions that enroll in the program are entitled wholesale discount pricing which can be passed onto students).
The program has been successful and is being adopted by institutions around the country quickly (should eventually supplant the existing business in a few years). However, the company burned through a lot of cash and basically reached the end of their runway, hence the need to shore up the balance sheet. This latest infusion should allow them to execute on their transition, as they had already almost reached GAAP profitability. With the lowered interest expense through debt paydown and restructuring, combined with continued uptake of the First Day program, management is expecting to reach sustained profitability in the coming quarters.
As of this writing, BNED trades at roughly $0.20 per share, giving it a pro-forma market cap of roughly $530M. For every share bought before the record day (to be determined), you also get the right to buy an additional 17 shares (estimated) at $0.05 per share. Management has guided for roughly $100M in EBITDA in 2025 when the new program should reach critical mass, putting currently valuations at roughly 5x. EBITDA in this business should roughly equal free cash flow, given the low capex requirements. At 10x EBITDA, BNED could be trading for $0.40 per share, or roughly 100% from today’s price (before subscribing to any shares in the rights offering).
However, there is a more attractive way to play this currently, which is made possible only because of the extreme volatility.
THE TRADE:
Purchase BNED shares at ~$0.20, and write (“sell”) October 18, 2024 covered calls with a strike price of $0.50 at a premium of $0.10 - $0.15 per contract. This will effectively give you a cost basis of $0.05 - $0.10 per BNED share (depending on your premium), and contractually oblige you to sell the shares at $0.50 if shares trade at or above that level at any time on or before expiration date. This works out to a valuation of roughly $1.3B, or 13x 2025 EBITDA for the entire business.
Warning: Should the above two-step trade successfully execute, the rights to subscribe for additional shares may belong to the counterparty to whom you sold the covered calls to, if the record date falls on or before the expiration date and the contract is exercised. Please plan appropriately. We also don’t recommend writing any contracts beyond the amount of underlying BNED shares you own (this is called writing naked calls), as this could subject you to indefinite losses should the stock price surge above the $0.50 strike price.
Finally, although the latest cash infusion has extended the company’s runway to execute on their transition, there is no guarantee they will be able to achieve their targets.
Recommended additional reading on company:
https://valueinvestorsclub.com/idea/barnes_andamp%3B_nobles/3937773282
https://valueinvestorsclub.com/idea/BARNES_andamp%3B_NOBLE_EDUCATION_INC/6612401556
(Disclosure: The author and funds under their management hold shares of BNED and various BNED options. We may hold, buy, and sell any securities mentioned on this blog at any time. The information contained herein should not be construed as investment advice or a recommendation to purchase or sell any specific security. Structured securities, derivatives and options are complex instruments that are not suitable for every investor, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved.)