Barnes & Noble Shaky Even After Microsoft Deal

The highly competitive digital book market has to contend with a new tag team, but hard questions remain about the venture’s long-term prospects.

Barnes & Noble Inc. (NYSE: BKS), which is already armed with its Nook e-reading tablet, gained Microsoft Corp. (Nasdaq: MSFT) as a partner in a strategic move announced Monday. Barnes & Noble said it had formed a subsidiary with a multi-million dollar investment from Microsoft to advance the adoption of e-reading technology.

Microsoft is investing investing $605 million over five years -- an initial investment of $300 million and another $305 million down the line. Word of the partnership drove Barnes & Noble shares to a 52-week high of $26 during trading Monday. Investors later floated back to reality, and the shares closed at $18.58 on Wednesday.

The partnership with Microsoft, though exciting, may not solve all of Barnes & Noble’s problems. Peter Wahlstrom, an analyst with Morningstar (Nasdaq: MORN), said Barnes & Noble executives dove into the digital book market in 2010 without taking a deeper look at the potential cost. “They didn’t realize how much money it was going to consume. They basically funneled all their free cash from the retail business into the development of Nook.”

In January, Barnes & Noble announced plans to explore the separation of its digital content business. It is still weighing its options, which include spinning off this subsidiary. In spite of the investment by Microsoft, Wahlstrom said Morningstar projects Barnes & Noble will record an operating loss for fiscal 2013.

The new partnership makes some sense, since it will offer Barnes & Noble breathing room to work on its plans to compete. It also will give Microsoft a presence in e-books, where Apple Inc. (Nasdaq: AAPL), Google (Nasdaq: GOOG), and Amazon.com Inc. (Nasdaq: AMZN) have already made gains.

The battle for e-books is getting a bit testy. On Wednesday, Target Corp. (NYSE: TGT) said that it would stop selling Amazon’s Kindle tablets this spring. The reason ostensibly stems from the overall competition Amazon poses to Target’s brick-and-mortar operations. Other tablets, such as the Nook, will remain on the retailer’s shelves.

Adoption of digital books is expected to grow, but Wahlstrom said the business has not yet been profitable for Barnes & Noble. The new subsidiary, which does not yet have an official name, encompasses Barnes & Noble’s digital content and college educational material businesses. The partnership with Microsoft includes the development of a Nook app that will make Barnes & Noble digital books, newspapers, and magazines available to Windows 8 users.

This collaboration is not guaranteed to win over consumers, he said. “Just because you get access to Microsoft’s Windows 8 platform and millions of users, this doesn’t mean they are going to buy from Barnes & Noble.”