Apr 302012

Microsoft will invest $300 million in the Barnes & Noble Nook e-reader operation.Microsoft will gain a foothold in the fast-growing e-books market while Barnes & Noble gets more firepower to compete against the Amazon Kindle and Apple iPad. However the attraction for Microsoft is not the NOOK technology which is bought-in, nor the Android based operating system which is certain to be replaced by Microsoft’s own. More likely, Microsoft is looking to secure top quality and exclusive content for its tablet-friendly Windows 8 operating system, expected on the market around October. This news indicates that Microsoft’s strategy is to strengthen Windows 8 as a platform for ebook reading.

B&N also benefits as the deal will encourages B&N to consider the investment cases for the digital and non-digital parts more impartially. For example if Microsoft wants to invest more capital into Nook, B&N can choose either also throw cash at Nook, or decline if the investment case for B&N bricks and mortar business is more compelling, and possibly give Microsoft another chunk of Nook in instead of cash.

Shares of Barnes & Noble soared nearly 70 percent upon the news, while Microsoft shares were unchanged.

Included in the agreement is the B&N’s college bookstore division. Both will be placed in a subsidiary, which is valued at $1.7 billion based upon the deal between Microsoft and B&N. Microsoft will receive a 17.6 percent stake in the new company, yet to be named. Barnes & Noble will continue to have a large interest in the Nook business at over 80% and will maintain the current relationship with the U.S. bookstore chain’s nearly 700 stores and the Nook offerings.

A clear reason for the deal is that Barnes and Noble desperately needs to improve its cash reserves for investment, in both its digital and non-digital businesses. The eBook reader marketplace is highly competitive with players such as Amazon, Apple and Sony launching upgraded ereaders every 12 months or so. The Nook business has been dominating Barnes and Noble financial resources, so a $300 million inflow will no doubt be very welcome. In 2011, Barnes & Noble suspended its dividend to have more cash to develop Nook. The company’s e-readers, tablets and electronic book sales have helped it offset a broader decline in book sales. In January 2012, B&N lowered its sales and profit forecasts due to reducing sales of printed books. Meanwhile sales at Nook eBooks store continued to grow spectacularly, more than doubling on a comparable basis.

Since the launch of the Nook in 2009 (two years later than the Kindle), Barnes & Noble’s Nook has found a strong following, allowing it to garner some 27 percent of the U.S. e-books market. Initial success of the Nook was due to the unique feature that the dedicated book lovers could borrow eBooks free from local libraries. This was particularly important for many consumers as the cost eBooks has remained comparable with physical books despite the elimination of manufacture and distribution cost. However this key advantage disappeared at the end of 2011 when Amazon teamed with Overdrive to bring public library eBooks the Kindle. Recently the Nook ereaders and tablets which are based on the Google Android operating system, and start looked indistinctive alongside the dozens of other Android tablets. The partnership with Microsoft will no doubt mean an end to the Android based Nooks, but will a Windows 8 Nook be better?

However, the main reason for the deal could be to have preferential access Barnes and Noble digital content. Both Amazon and Apple have been gathering content, sometimes exclusive, for their ereader and tablet users. If Microsoft wants to launch a credibile tablet, it needs to show that it has a fully stocked digital content store, including the latest eBooks. The deal with Barnes and Noble may be one more significant step toward that goal.

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