Is Microsoft Hitting Up Barnes & Noble For Some Nook(ie)?

By Stephen D. Simpson, CFA | May 09, 2013 AAA

Even though Barnes & Noble (NYSE:BKS) still sports a billion-dollar enterprise value, investors and analysts have hardly been bullish about its standalone prospects. Now it sounds as though its partner Microsoft (Nasdaq:MSFT) may be about to make a move that would significantly transform the company. While a deal for Nook Media would likely be a real positive for Barnes & Noble, I have a harder time seeing how Microsoft gets its money's worth with such a deal.

Just A Rumor … For Now
Barnes & Noble's Nook Media business (both the e-reader/tablet operations and digital media) has been the target of ample M&A speculation for quite some time, with Microsoft and Liberty Media (Nasdaq:LMCA) figuring prominently in the speculation. Now it sounds as though a real bid could be on the way.

TechCrunch reported that Microsoft is preparing a $1 billion bid for Nook Media – a business in which it owns a roughly 18% stake. As there has been no formal comment or confirmation from either Barnes & Noble or Microsoft, details are scarce. Presumably Microsoft would pay cash, but it's unclear what assets the company would be buying, particularly the chain of college bookstores.

A $1 billion valuation is higher than where most analysts are in their valuations of the Nook Media business. Amazon (Nasdaq:AMZN) and Apple (Nasdaq:AAPL) have effectively kept Nook from gaining any real traction, and Barnes & Noble has yet to establish that this is a viable business that can generate worthwhile economic profits over the long-term. To that end, it's worth pointing out that the value of Nook Media was about $1.7 billion when it was established in April of 2012 (with a $300 million investment from Microsoft) and about $1.8 billion in December of 2012 when Pearson (NYSE:PSO) invested about $90 million. Since then, though, Barnes & Noble saw a pretty unimpressive Christmas season and has been trying to move product through aggressive pricing.

SEE: Which Tablet Should You Buy?

A Business Still In Transition
I think it's also noteworthy that TechCrunch's report mentioned that new tablets from Nook Media would be discontinued by the end of fiscal 2014. It wasn't clear whether this decision was tied to the rumored Microsoft bid or not, but it would seem unlikely that Microsoft would have any particular need to continue their production (though keeping the Nook brand name could have some value).

As previously mentioned, it's not as though Barnes & Noble has gained real share with its tablet/e-reader products. Relative to Apple, Amazon, and Samsung, the Nook product line is effectively a non-factor. What's more, it's not as though it has demonstrably funneled a meaningful stream of proprietary business to the company's digital media operations. Getting rid of the hardware, then, could be an opportunity to do away with what is likely a loss-leader and focus instead on the “razor blade” model of digital content – though here, too, the business models are all still in flux.

Where's The Value To Microsoft?
I think Barnes & Noble would be happy to take Microsoft's $1 billion and move on from the Nook Media operations. What I'm not so sure of is what Microsoft would gain from this transaction.

Given Nook's share in the tablet market, the brand value doesn't seem to be worth that much. I'm also not sure why Microsoft would think it would unseat Amazon or Apple in digital media, even if it integrates it with other properties like Bing. After all, it's not like the company's ventures into digital entertainment have been breakaway successes, and that's after many, many years and widespread popularity of console gaming.

Along these lines, it would be a risky deal for Microsoft management. The money is almost trivial – Microsoft has tens of billions of dollars of cash on the balance sheet and generates tens of billions in free cash flow each year. What isn't trivial is how investors perceive management and the dissatisfaction that has grown with Microsoft's M&A practices, from the $6 billion write-down of aQuantive to the still very much unproven Skype purchase. Were Microsoft to do this deal, and do so without a very convincing rationale, it would likely just stoke the fires of resentment that are already warming the seats of the board of directors.

SEE: Microsoft Vs. Apple

The Bottom Line
Given how many rumors have swirled around Barnes & Noble over the past two years, investors should take any new rumor with a heavy pinch of salt. Though a billion-dollar bid for Nook Media would certainly be a win for the company (and push fair value well into the $20s, if not the $30s), this may be another idle rumor. Consequently, this is really only a catalyst for traders and speculators, not investors. For Microsoft, we'll see what happens. I can't see how this would really improve the company, and it could be a marginal negative for a stock that's already too cheap … in large part due to negative perceptions about management and their ability to generate real growth again.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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