Apple (Nasdaq: AAPL), Google (Nasdaq: GOOG) and Amazon.com (Nasdaq: AMZN) have emerged as the three most important players in the consumer technology landscape. These companies are so good at what they do (building deeply loyal customer bases and ever-rising revenue streams) that they may not even notice that they have competitors nipping at their heels.
Indeed, both Barnes & Noble (NYSE: BKS) and Nokia (NYSE: NOK) would like to finally take back some lost market share from these technology leaders, but they may not even be on their competitors' radar screens in a few quarters. Each is embarking on a last-ditch, Hail Mary pass, and if they fail to connect with consumers, it may be game, set and match. Looking at recent short-selling activity, a growing chorus of investors is wagering that both Barnes & Noble and Nokia are toast.
The Bezos Curse
Barnes & Noble's founder Len Riggio rues the day he first came across a little company called Amazon.com back in the 1990s. He quickly found out that Amazon's Jeff Bezos didn't play fair. He has been committed to market share -- at all costs -- even when it meant sacrificing near-term profits.
Fast forward to late 2011, and Barnes & Noble is again trying to stave off the Amazon juggernaut. Its just-released upgraded Nook e-reader, which retails for $249, is garnering a series of high-profile mentions in media outlets such as the Wall Street Journal and CNBC. Reviewers have taken note that the Nook is a well-developed product, leading Barnes & Noble's CEO William Lynch to boast last week at a Liberty Media conference that the company will control 30% of the e-book market by 2015, which will be worth $7 billion by then. That helped to get the stock going, and it really took off on November 10 when it was rumored that Liberty Global (Nasdaq: LBTYA) was looking at acquiring Barnes & Noble. ( Liberty looked at buying Barnes & Noble earlier this year and took a pass, instead making a $200 million investment in the book-seller.)
Short sellers, which had just finished building positions, quickly realized that it might be wise cover their positions and fight the battle another day. (The size of the collective short position had increased 8.4% to 10.1 million shares from the middle of October to the end of October, making this stock the 11th-most heavily shorted stock on the NYSE, in terms of percentage of the trading float.)
But the short sellers are right to smell blood in the water. Simply put, Barnes & Noble is playing a game it can't win. Amazon, Apple and other tablet makers are better prepared to fight for market share because they have much greater financial firepower. Barnes & Noble sports net debt of nearly $300 million, while key rivals sport embarrassingly high levels of net cash.
More to the point, Amazon's decision to build an ecosystem around its $199 Kindle Fire, including loads of free content included in the $79 annual Amazon Prime free shipping plan is a very compelling value -- one that Barnes & Noble can't match. Perhaps of greatest concern, it's hard to see how Barnes & Noble will avoid losing money on Nook hardware sales as major computer vendors such as Hewlett-Packard (NYSE: HP) found it impossible to make money selling tablets that retailed for $400 or $500. And as Goldman Sachs recently noted, "The upcoming advertising necessitated by head-to-head launches may drive further cost creep."
That's why investors need to give a close read to Barnes & Noble's fiscal third quarter report, slated for the week after Thanksgiving. Analysts expect the company to eke out a modest $0.02 a share profit after two straight money-losing quarters, but rising expenses may make that impossible. More broadly, analysts expect Barnes & Noble to finally return to profitability in the fiscal year that begins next May after two straight money-losing years. Don't let the recent share price rebound fool you, Barnes & Noble may be seeing sales move up on the heels of expanding Nook sales, but a hardware-centric business model with low margins may make projections of a future profit impossible to achieve.
Windows phones -- what's that?
In a world of Apple iPhones and Google-based Android phones, it's easy to forget that Microsoft (Nasdaq: MSFT) is still in this technology segment. Updated market shares that reflect the October launch of the latest iPhone are hard to pin down, but it looks as if the Android operating system is used on more than 50% of all smartphones, while Apple's share may be around 20% (it was in the mid-teens of September as iPhone sales temporarily slowed), Blackberry likely holds low-teens market share, and Nokia's Symbian platform accounts for the remainder.
Notably, Nokia is phasing out Symbian to piggyback on Microsoft's Windows 7 smartphone software. So its market share is starting from almost nothing. Few realize it, but Windows 7 has already been on the market since October 2010 without making any sort of impact in the marketplace. Early reviews of the new Nokia phones that run on Windows 7 have been favorable: Microsoft's "Metro" interface is lively and appealing. But it's unclear how the Microsoft/Nokia phones will ever boost market share levels with such a long lag time in hitting a quickly-maturing market, especially as both the Apple and Android platforms already have tens of thousands of applications built for them.
That, in a nutshell, is the bet being made by short-sellers. The short position rose from 85.5 million shares in mid-October to 103 million shares two weeks later, making Nokia the third most heavily-shorted stock on the NYSE (after Bank of America (NYSE: BAC) and Ford (NYSE: F)).
Short-sellers may not have long to wait. Within a few months, it will quickly become apparent whether the Nokia/Microsoft phones are making a dent in terms of market share. As CEO Stephen Elop said at an investment conference in Barcelona last week, "We want to see volumes begin to move. We need to get developers recognizing there is a growing opportunity here, so that we attract applications." He's right. Whether that happens is an open question.
Risks to Consider: If you short these stocks, you need to closely monitor sales trends. Any real market share gains for the Nook or the Nokia smartphone means you should think about covering your short position.
Action to Take --> These companies are up against fierce rivals and would have to expend a considerable amount of marketing and development resources to stay relevant. Their relatively weak balance sheets may make that impossible.
When Barnes & Noble's quarterly results are released near the end of the month, you'll need to move quickly as a good or bad set of numbers will likely move the stock sharply in one direction or the other. Still, a 40% jump since early November implies that expectations are quite high, and a downside move may be more likely than an upside move from here. As for Nokia, it simply may be too late in the game for the company to make any sort of dent in the smartphone space. Either way, I wouldn't want to own either of these stocks right now.