Barnes and Noble (BKS) Soars 50% on a $300 Million Investment from Microsoft (MSFT)

Shares of long-suffering book retailer Barnes & Noble (BKS: Charts, News) rallied over 50% yesterday after Microsoft (MSFT: Charts, News) announced a $300 million investment in the company's digital media business.

The newly forged partnership will create a new subsidiary, of which Microsoft will claim a 17.6% minority stake, for the further development of Barnes & Noble's Nook tablet. The new business, which also includes Barnes & Noble's college textbook business, could be spun off as a new company altogether, although a final decision is still pending. Prior to the investment, Microsoft had been locked in a legal battle with Barnes & Noble over the Nook's operating system, Google (GOOG: Charts, News) Android, which Microsoft claims violates several of its key patents.

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Although the Nook has been a minor success for the company, it trails far behind Amazon's (AMZN: Charts, News) best-selling Kindle Fire tablet, which recently claimed over 50% of the Android tablet market within a single quarter. Meanwhile, Microsoft has struggled to make a dent in the tablet market, which is dominated by Apple's (AAPL: Charts, News) iPad and Android devices from multiple manufacturers - such as Amazon, Samsung and HTC.

Apple and Google are also the primary threats to Microsoft's fledgling Windows Phone business, which is now primarily offered through its partner, Nokia (NOK: Charts, News). The Barnes & Noble deal ironically puts the Nook, an Android tablet, under Microsoft's banner, which has raised speculation that the next generation Nook tablet could run Windows 8 or Windows Mobile 7. While Nook tablets have yet to gain mainstream recognition, its latest iteration, the $99 black-and-white Nook Simple Touch, has been well received.

More importantly, the Nook will help Microsoft evolve its e-book software, which was originally introduced in 2000, but failed to attract publishers, writers or customers. Its aging e-book software will be discontinued on August 30, in order to make way for its new partnership with Barnes & Noble. "The shift to digital is putting the world's libraries and newsstands in the palm of every person's hand," stated Microsoft president Andy Lees, "and is the beginning of a journey that will impact how people read, interact with, and enjoy new forms of content."

Microsoft has stated that a Nook e-reader application, which is available for Windows PCs, will be available for its first generation of Windows 8 tablets, due to arrive this fall. Barnes & Noble CEO William Lynch denied Microsoft exclusivity, stating that its Nook software will still be available on competing products, such as the iPhone, iPad and Android devices. This is similar to Amazon's approach of offering its Kindle software across multiple platforms to increase digital purchases.

Barnes & Noble controls roughly 27% of the e-book market, while Amazon leads with nearly 60%. Apple claims nearly 10%, while the remainder is split among other fragmented competitors. Since 2010, publishers have switched to an "agency" model that allowed publishers, not retailers, to set their own prices for e-books. Prior to this agreement, retailers such as Amazon would discount books so deeply that publishers and authors could barely make a profit. Apple, Amazon and several leading publishers were recently sued by the U.S. government over allegations of price fixing in order to sidestep these measures.

Barnes & Noble, which operates 691 stores in all 50 states, has been squeezed from both its e-commerce and brick and mortar fronts by primary rival Amazon. Prior to Microsoft's investment, many investors were concerned that Barnes & Noble would not have sufficient capital to fend off another full year of competition from Amazon.

Although shares of Barnes & Noble are off its lows, its long-term growth is still in peril, as Apple and Amazon will prove to be increasingly hard to overcome in the next few quarters. Similar to its deal with Nokia, Microsoft will likely be the true beneficiary in this deal, opening up a new avenue of growth as old ones - such as Windows operating systems and Microsoft Office - gradually wane.

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Published on May 1, 2012
By Leo Sun
Leo Sun
Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

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