Case 12 Barnes & Noble, Inc. The Yucaipa Proxy Challenge! 1 On September 4, 2010, Leonard Riggio, the founder and chief executive officer (CEO) of Barnes & Noble (BN), the U.S.-based bookseller, learned that Ronald Burkle had filed a "Definitive Proxy Statement" through his Yucaipa Fund for the upcoming Annual Stockholder Meeting on September 28. The Yucaipa proxy (see Exhibit 1) was a challenge to the set of nominees recommended by BN to be elected to the company's board, and the proxy made a case for the election of Yucaipa's own nominees instead.2 For Riggio, this was the second piece of disconcerting news concerning Yucaipa in the last two days. On September 2, Burkle had announced that he was appealing the Delaware Chancery Court's rejection of his challenge to a BN poison pill.3 2 As Riggio examined in detail the contents of the Yucaipa proxy, he realized that he and BN's board of directors would have to address this challenge prior to the Annual Stockholder Meeting. As the owner of 18 percent of BN stock and a vociferous critic of Riggio's strategy for BN,4 Burkle's intention to appeal the Delaware ruling and challenge the company's board nominees warranted a response from Riggio, lest he lose control of the company he had founded. BARNES & NOBLE 3 BN was a New York-based bookstore chainX 1209 - '3' [3' 524584085.pdf lg] IE] CNAICS 451211, SIC 5942) that engaged in the sale of trade books (hardcover and paperback mass- market ction and nonction), children's books, e-books and other digital content, e-readers and related accessories, bargain books, magazines, gifts, caf products and services, music, and movies to consumers through its bookstores or online. It operated through two business segments: B&N Retail and BSzN College. As of May 2010, B&l\\' Retail owned and operated 720 bookstores that ranged in size from 3,000 square feet to 60,000 square feet, with an average store size of 26,000 square feet. This segment also included Barnes & Noblecom and Sterling Publishing (the company's publishing operation that produced SparkNotes and other books). As of May 2010, BSLN College sold textbooks, school supplies and gifts, both online and through 637 stores that ranged in size from 500 square feet to 48,000 square feet. For scal 2010, EN reported revenues of $5.811 billion and net income of $36.68 million5 (see Exhibit 2 and Exhibit 3). Source: Professor Ram Subramanian \"Tote this case solely to provide material for class discussion. The author does not intend to illustrate either effective or ineffective handling of a managerial situation. The author may have disguised certain names and other identifying information to protect confidentiality. Richard Ivey School of Business Foundation prohibits any form of reproduction, storage or transmission without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivejv Publishing= Richard Ivey School of Business Foundation. The University of Western Ontario= London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; email cases@ivey.uwo.ca_ Copyright Q 2011, Richard Ivey School of Business Foundation Version: 2011-11-16 EXHIBIT 1 Selected Excerpts from the Yucaipa Proxy Form DFAN14A Filed on 09/02/2010 1:09 X 524584085.pdf "The Yucaipa Companies today announced that it filed its notice of appeal from the decision by the Dela- ware Court of Chancery dismissing Yucaipa's challenge to Bames & Noble, Inc's poison pill rights plan." "We believe that the important stockholders' rights at issue in our suit against the Riggio-dominated Barnes & Noble Board-equal treatment of stockholders and the rights of stockholders to freely and effectively vote to elect independent directors-should be decided by the Delaware Supreme Court*-statement made by a Yucaipa spokesperson. "Barnes & Noble stockholders will have the opportunity at the September 28, 2010, annual stockholder meeting to vote on Yucaipa's proposal to amend the Board-approved poison pill rights plan to eliminate the special treatment for Leonard Riggio and his family and to vote to elect Yucaipa's slate of three new independent director nominees." Source: Barnes & Noble. Inc. Investors Web site. hepoffberacsandnobleinc.com/for_investors/for investors.html, accessed March 10. 201 1. EXHIBIT 2 Summary of Barnes & Noble's Financial Performance ($ Millions, Except Store Count) 13 weeks till 13 weeks till Fiscal 2010 May 2. 2009 May 3, 2008 Fiscal 2008 Fiscal 2007 Revenues 5,810,564 1.105,152 1.155,882 5,121,804 5,286.674 Operating Profit 73,246 (3,244) (1,747) 143,331 202,151 Net Earnings 36.676 (2,693) (2,224) 75,920 135,799 Store Count 720 726 717 726 713 The company announced a change in fiscal year effective September 2009 to better align the business cycles of Barnes & Noble and Barnes & Noble College, The company had long-term debt of $260 million in fiscal 2010, $87 million in the fiscal period ending May 3, 2008, and zero in fiscal 2008 and 2007. Sources Barnes & Noble 2010 annual report. 4 In the late 1960s, Leonard Riggio was employed as a student clerk at the New York University (NYU) bookstore in New York. He made $1.10 an hour. Riggio dropped out of NYU and quit his job in 1971. He bought the Barnes & Noble store on New York's Fifth Avenue and immediately began to expand. He made a comment to Forbes magazine in 1976 that captured his strategy succinctly: "There are 30,000 mini-delicatessens in American bookselling, and we are the only supermarket."6 5 Using discounts (BN discounted bestsellers by 40 percent) and mass buying, and by increasing the retail space in each store, Riggio built BN into a national chain. Its sales per square foot stood at $244.33 (nearly 50 percent greater than that of the average independent bookstore) in 2003. That number had declined to $231.03 by 2010. BN went public through an initial public offering (IPO) in 1993, and in 1996, Riggio privately acquired the video-game retailer GameStop for1:09 X 524584085.pdf Q $59 million, later selling it to BN for $218 million in 1999. BN invested $400 million in GameStop and then spun it off in an IPO. In 2002, Leonard Riggio stepped down as BN's CEO and was replaced by his brother, Stephen. On March 18, 2010, BN announced that William Lynch, an executive with a background in e-commerce, would become BN's new CEO, with Leonard Riggio as its chairman and Stephen Riggio as its vice-chairman (see Exhibit 4). EXHIBIT 3 Barnes & Noble Stock Price History (Selected Dates) Date High Low 1/2/2008 34.89 26.24 6/2/2008 30.65 24.43 1/2/2009 20.00 14.81 6/1/2009 26.96 19.78 1/4/2010 20.74 17.18 6/1/2010 20.00 12.80 7/1/2010 13.94 11.89 8/2/2010 16.74 12.70 9/1/2010 17.92 15.11 9/2/2010 16.50 15.48 9/3/2010 16.87 16.28 9/7/2010 16.00 15.57 Source: Yahoo Finance. THE BOOKSELLING INDUSTRY$ 6 In 2010, retail bookselling was a $24 billion market that was fragmented in spite of national chains such as BN and Borders and the leading Internet retailer of books, Amazon. Bookstore chains operated in the "Specialty Retail" segment of the retailing industry. Standard & Poors forecasted that the bookselling industry was mature in 2010 and that due to declining adult readership of books, industry growth was expected to be either nonexistent or at best, in low single digits. Further, Standard & Poors indicated that e-books (which, in 2010, accounted for $500million in sales) would cannibalize the sales of hardcopy books. The announcement of the bankruptcy of Borders was seen as a favorable trend for BN since the two chains competed for customers who bought books from bricks-and-mortar stores. Standard & Poors believed that major players such as BN and Amazon would use their buying power with book publishers to increase their gross margins. 7 The two major competitors in the bookselling market were BN and Amazon. Amazon, an Internet-based retailer, was launched in 1995. BN launched its own Internet Web site in 1997. In 2010, analysts believed that Amazon was the leader in the bookselling industry, with an overall market share of 15 percent. Leveraging the trend toward e-books, Amazon had set itself the goal of obtaining a 50 percent market share by 2012. EXHIBIT 4 Barnes & Noble's Board of Directors Age Board Tenure Name Primary Company ( Years) (Years) Leonard Riggio Chairman, Barnes & Noble 69 25 Stephen Riggio Vice Chairman, Barnes & Noble 55 18 George Campbell Jc. President, The Cooper Union 64 3 William Dilard, Ill Chairman and CEO, Dillard, Inc. 65 18 David G. Golden Partner and Executive Vice President, Revolution LLC NA Patricia L. Higgins Former President and Chief Executive Officer, Switch and 59 5 Data Facilities Inc. Irene R. Miller Chief Executive Officer, Akim, Inc. 57 18 Margaret T. Monaco Principal, Probus Advisors 62 16 David A. Wilson President and Chief Executive Officer, Graduate Manage- 68 1 ment Admissions Council Audit Committee: Higgins (Chair), Monaco, and Wilson Compensation Committee: Campbell (Chair), Dillard, It, and Golden Corporate Governance and Nominating Committee: Dillard, Ill (Chair), Higgins, and Monaco Source: http:/barnesandnobleinc.com/for_investor/for_investors.html and www.mergestonlite, accessed March 10, 201 1. 8 Amazon launched the Kindle e-reader in November 2007. In response, BN launched the Nook in October 2009. In 2010, Kindle had a market share of 70 percent to 80 percent. In addition, Apple launched its iPad, which had an e-reader feature. The economics of e-books wasdifferent from that of hardcopy books. Retailers such as BN and Amazon typically paid $13 for a hardcopy book that retailed for $26. In contrast, in an electronic format, that same book would sell at a profit margin of around $3 or $4. BURKLE AND RIGGIO 9 In 1986, Burkle founded a Los Angeles, California-based holding company-The Yucaipa Companies (Yucaipa)-in order to invest in underperforming businesses and create value through mergers and acquisitions and strategic repositioning. In 2010, Yucaipa owned stakes in about 35 companies, using the more than $30 billion in contributions from investors (principally pension funds). Yucaipa made its name by focusing on the grocery retail industry, wherein it acquired and merged Fred Meyer, Ralphs, and Jurgensen's to create value for its investors. In 2010, Yucaipa's investments included significant stakes in A&P and Whole Foods.9 10 On November 24, 2008, Yucaipa made its first investment in BN by buying 75,200 shares. On November 10, 2009, Yucaipa bought an additional 1 million shares, and in the same week, made further purchases to increase its stake in BN to 16.8 percent. 10 11 Just prior to Yucaipa's initial investment in BN, Burkle called Leonard Riggio to indicate his interest in becoming a BN investor. The two men knew each other well, primarily because Riggio had made a multimillion-dollar investment in Source Interlink (which filed for bankruptcy protection in 2009 and went private shortly thereafter), a wholesale company that was controlled by Burkle" and was BN's main supplier of music, videos, magazines, and newspapers. Following his November 2008 investment, Burkle met Riggio for lunch in New York City, at whichtime he had two strategic suggestions for EN. The rst was to cede ground to Amazon and its Kindle e-book reader and instead partner with Microsoft and Hewlett-Packard, using BN's store oor space to showcase their devices. The second was to acquire Borders, a bookstore chain that was rumoured to be close to bankruptcy. Recounting his reaction to the conversation, Riggio later stated in court: Ron Burkle is a dealmaker. He likes to put things together. I told him that I didn't want him buying Barnes & Noble stock, and while there was nothing I could do about that, I certainly wasn't going to take his strategic advice about Borders. I didn't want to sink money into bricks-and-mortar retail, not when the book business was going through sweeping change.\" 12 On September 30, 2009, the BN board approved the company's $596 million purchase of the 624 Barnes & Noble college bookstores owned privately by Riggio and his \"fe. Justifying BN's purchase of the college bookstore chain, Riggio argued that: College bookstores operate in a separate niche that has proven resistant to recessionary cycles. While it made sense in the 19805 to keep the mass market and college bookstores as separate corporate entities: it makes sense to consolidate them now. The world is blurred now because book buyers may soon be carrying everything they readtextbooks, novels, magazineson a single e-reader. It is important to reunite the company for the purpose of having a single platform.13 13 BN stockholders expressed outrage at this move, which they felt enriched the Riggios at the expense of the company, and left the company indebted and \"deeply invested in the one sector of the market, textbooks, that appeared most likely to go digital in the short term.\"4 In the aftermath of this transaction, BN stock dropped 20 percent, and several institutional stockholders led suit. While Burlde expressed outrage, he did not join the lawsuit.15 14 In response to Yucaipa increasing its stake to 16.8 percent in November 2009, the BN board met \\ia conference call to insert a \"poison pill\" into the corporate bylaws. The poison pill called for a rights plan to take effect once an outsider acquired a 20 percent interest in the company. As per the rights plan, existing shareholders could buy stock at a 50 percent discount without board approval when that threshold was reached. On May 5, 2010, Yucaipa bought 100,000 additional shares in BN, thereby increasing its stake to nearly 20 percent. At the same time, it led a lawsuit in the Delaware Chancery Court in order to challenge BN's poison pill. In its ling, Yucaipa made various allegations against Riggio and the BN board: Barnes & Noble directors are engineering a self- dealing scheme designed to entrench the Riggio family and stymie Ron Burkle's efforts to gain seats on the board. The Riggios used Barnes & Noble as a personal piggy bank, authorizing a deal for the college chain at an above-market price. In addition, Barnes & Noble has an agreement to leases in which the Riggios have interests at an annual rent of more than $5 million, the company purchases $8.25 million in textbooks from a Riggio ailiate= and contracts freight services from Riggio interests for shipping to retail stores. The board's near obsession with activist stockholders as a threat shows its determination to frustrate the exercise of the stockholder franchise.\" 15 B&N defended the poison pill in court papers: The company's board, reasonably fearing a hostile attack, set up the poison pill on the advice of legal and nancial advisers after learning that Burlde had bought up almost 18 percent of the stock. The plan, designed to make a hostile takeover prohibitively expensive, is intended to protect our shareholders from actions that are inconsistent with their best interests. 1 7 BARNES & NOBLE'S DIGITAL STRATEGY 16 In response to changes in the bookselling industry, BN embarked on a multichannel retail strategy. From a store-based model, it repositioned its business to a multichannel model centered on Internet and digital commerce. In July 2009, EN launched an e-bookstore and digital newsstand that had more than a million e books, magazines, and newspapers atailable for sale. The company began selling Nook in BestBuy and BestBuy.com in addition to its own retail stores and Web site. It enabled its e~books to be read on a variety of digital platforms, such as Apple and BlackBerry. CEO William Lynch, who had worked at the Home Shopping Network prior to joining BN, captured the company's digital strategy: My appointment is a not-subtle signal about the company's future. We're morphing into a retail and technology company. We're purveyors of content, and I don't think anybody at this company would say we sell physical books. We do sell that= but that's not how we define ourselves,18 17 Riggio reiterated the signicance of the company's strategy shift and his own ambivalence about it: The thing that excites me most about the digital revolution is the possibility of timber democratization of the worlds of knowledge and literature. But I still can't imagine that the bookstoreor what I would like to call the \"cultural piazza"is replicated by a piece of plastic, We believe bookstores will exist all during and after this revolution. we're just absolutely convinced= both as citizens and as business people that bookstores are going to be important to the American culture.\" BURKLE'S RESPONSE TO BARNES & NOBLE'S DIGITAL STRATEGY 18 Burlde summed up Yucaipa's investment strategy: We always try to buy companies that are doing OK but that have some issues. We buy at a price that if they just muddle through we don't go broke. And if they do better, we make a lot:0 19 More specically, Burkle believed that BN t Yucaipa's metrics for an investment: Everybody was afraid the world was coming to an end. I wasnat. This is an opportunity. We can buy a phenomenal company and brand at a ridiculous price;1 20 In his testimony in the Delaware Chancery Court, Burkle indicated his strategy for BN: Vt'e invest in promising companies because we want to try to make them better companies. At the same time. we wouldn't want to keep them forever. Instead of chasing Amazon's technological lead: I think BN should forge alliances with Hewlett- Packard and Microsoft to offer electronics in retail stores and to print paperback books on-demand= uithout having to maintain large inventories. The keys for BN are its formidable brand name and its valuable real estate}: THE DECISION 21 In his letter to BN's shareholders for the company's 2010 Annual Report, Leonard Riggio reiterated Barnes 8: Noble's emphasis on the Nook and on the digital marketplace for books: In less than a year (of the launch of the Nook): the Company achieved a 20 percent share of the e-book marketplace: larger than even its current 17 percent share of the physical book marketplace. .. . A survey of our Members (our very best customers) shows they have increased their combined physical and digital spend with us by 17 percent since purchasing a Nook and by a phenomenal 70 percent in total units. In addition, we've already begun to see the halo effect of Nook, both online at BN.com and in our stores. For example, a quarter of Nook owners are new to BN.com, which means we've been able to attract a significant number of new online customers to the Company through our strategic marketing efforts.23 22 Yucaipa's filing of a Definitive Proxy to challenge the company's nominees to the board signaled the intention of Ronald Burkle to shape Barnes & Noble's long-term strategy through his own personal board appointees. Riggio, the founder, chairman, and largest stockholder of Barnes & Noble, not only had to respond to the immediate proxy threat at the September 28 stockholder meeting but also come up with an action plan to retain control of the company in the long run. Would taking the company private represent the ideal solution, or was there an alternative approach for retaining control? This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives presented in this case are not necessarily those of Barnes & Noble Inc. or any of its employees. 2 Barnes & Noble, SEC Filings, September 2, 2010. 3 Reuters, "Timeline-Ron Burkle's waw ww Scarf of tudou The Ughmly M Moslem Sticks IVEY Proxy Fight for Barnes & Noble," http://www.reuters.com/article/2010/09/28/us- barnesandnoble-factbox-idUSTRE68R4QQ20100928. A poison pill is an anti- takeover measure. In this case, the poison pill prevented any shareholder from acquiring more than 20 percent of