Why Barnes & Noble Should Hold On to the Nook

Shares of Barnes & Noble (NYSE: BKS  ) crashed yesterday on the news that I had purchased a Nook over the weekend -- or possibly because the rumor that Microsoft (NASDAQ: MSFT  ) was going to buy the Nook looks to have been nothing more than a rumor. The jury is still out on the final cause.

Barnes & Noble had jumped more than 20% last Thursday, after TechCrunch released a report claiming that internal Microsoft documents pointed to a $1 billion buyout of the Nook business. The documents also allegedly pointed to the end of the Nook as a tablet business, moving instead to being a content distributor. Yesterday, a source within Microsoft denied that the rumor had any merit, and the shares fell 10% in the afternoon.

What's in it for Barnes & Noble investors?
The reason the shares jumped is that the Nook is like a treasure chest, hidden deep in the world of Barnes & Noble. Microsoft purchased a $300 million stake in the Nook business last year, and then late in the year, Pearson (NYSE: PSO  ) spent $90 million on a 5% stake. That purchase valued the Nook business at $1.79 billion, up from a $1.7 billion valuation based on Microsoft's investment.

Right now, Barnes & Noble is still trying to bring Nook sales back in line with their previous position. Over the holidays, sales of the tablets disappointed, and shares fell as a result. In its earnings call, Barnes & Noble said that the Nook business was still running on the cash generated by the company's college business, but that it hoped to have it self-financed soon.

Currently, the whole of Barnes & Noble only commands a $1.25 billion market cap. The value that could be generated for Barnes & Noble investors through a sale is huge, which explains the quick rise and subsequent fall of the shares based on the recent rumors.

Should the Nook stop tablet production?
One of many rumors that have been floating around since early in the year is that Barnes & Noble is going to dial back the hardware side of the Nook business. An unnamed source claimed that the company was coming to the realization that something about its approach to hardware was fundamentally flawed. As a result, the source claimed that Barnes & Noble was going to focus more on its digital content and less on making tablets.

Right now, that would be bad news for investors. The value in the Nook is still in its capability as a tablet. With the opening up of the entire Google Play store, Barnes & Noble is just now starting to see what the Nook can do if it's given more room to run. Microsoft -- or any other buyer looking to drop over $1 billion -- probably isn't going to be as enticed by a content provider as it is by a top-tier tablet maker.

If Barnes & Noble can keep tweaking the business in response to its users, then it can offer a truly competitive tablet. I think the argument can already be made that the Nook is one of the best tablets on the market. With better marketing and more features slowly being added, Barnes & Noble can turn the business into something that can truly be spun off as a self-supporting company.

I think that move requires a strong tablet business, and I think Barnes & Noble is capable of turning the existing Nook business into the company that investors are looking for. I'm glad the Nook is staying with Barnes & Noble -- for now.

It's been a frustrating path for Microsoft investors, who've watched the company fail to capitalize on the incredible growth in mobile over the past decade. However, with the release of its own tablet, along with the widely anticipated Windows 8 operating system, the company is looking to make a splash in this booming market. In a special premium report on Microsoft, a Motley Fool analyst explains that while the opportunity is huge, so are the challenges. The report includes regular updates as key events occur, so make sure to claim a copy of this report now by clicking here.


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