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Did Microsoft Reveal Its Next Takeover Target in a Reddit AMA?

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Reddit, the so-called "front-page of the Internet," is famous for hosting AMAs (ask me anything). Entertainers, authors, and actors -- even the President of the United States -- have used Reddit AMAs as a way to drum up publicity.

On Thursday, alongside the release of Windows 8.1, Microsoft (NASDAQ: MSFT  ) held its own Reddit AMA, where the company took questions on its Windows strategy.

Perhaps Microsoft's most notable response concerned digital books. Microsoft confirmed that yes, like Apple's (NASDAQ: AAPL  ) iBooks, it plans to incorporate digital book sales into the Windows ecosystem. Given that Microsoft already has a large investment in Barnes & Noble's (NYSE: BKS  ) NOOK division, the long-rumored acquisition could finally come to fruition.

Why digital book sales matter
To Microsoft, investing in digital books may seem superfluous; compared to Windows and Office, digital books are a tiny market, already well-served by a number of heavy-weight incumbents, most notably Amazon.

But bringing digital books to Windows 8 would help Microsoft tremendously, as the company aims to establish a Windows ecosystem. Microsoft's recent reorganization centers the company around "devices and services" -- a strategy similar to the one Apple has been employing for years.

Apple's ecosystem creates loyal buyers, and digital book sales are a big part of that. If a consumer buys a digital book from Apple, they are limited in how they can access it -- iBooks are only available on Apple's devices. Someone who has invested hundreds -- perhaps thousands -- of dollars on iBooks is stuck; if they abandon Apple for a competitor's product, they'll lose access to their digital library.

Barnes & Noble is a sinking ship
Apple's competitors, such as like Amazon and Barnes & Noble, make their digital books freely available on most platforms; nevertheless, Apple's iBooks has become big business, accounting for about 20% of the market. Given that Amazon has an estimated 50-60%, Apple's market share is not noticeably smaller than Barnes & Noble's.

While you have to give Barnes & Noble credit for attempting to transition with the times, the company's play on digital just hasn't worked out -- the NOOK business has cost Barnes & Noble shareholders millions in recent years; NOOK posted a $55 million EBITDA loss just last quarter.

Barnes & Noble's retail business is still making money, but not as much as before. Its retail operation generated $65 million of EBITDA last quarter, but that was about 15% less than the prior year. The company blamed the decline on the lack of mega hits -- 50 Shades of Grey and The Hunger Games were big sellers in 2012 -- but the growth of digital books, fueled by the widespread adoption of tablets, cannot be overlooked.

Barnes & Noble's founder, Leonard Riggio, had offered to buy the company's retail business outright earlier in the year, but perhaps after seeing the ongoing decline, changed his mind.

Microsoft's big bet on the NOOK
Despite the company's struggles, Barnes & Noble shares have been supported by the persistent hope that Microsoft could acquire the NOOK business. Last year, Microsoft invested $300 million into Barnes & Noble's NOOK, buying up a 17.6% stake. In May, Microsoft was rumored to be mulling a $1 billion bid for NOOK outright. Obviously, that hasn't come to pass, but I think it's still likely; the Reddit response only reaffirms the possibility.

Since Microsoft already owns part of NOOK, why not acquire the rest? Microsoft wouldn't need the NOOK hardware, but the NOOK's digital bookstore would be a welcome addition to Windows 8, giving Microsoft a competitor to Apple's iBooks.

At this point, $1 billion may be excessive -- Barnes & Noble's current market cap is only about $826 million -- but a large cash infusion, along with the loss of a money-losing division, should benefit Barnes & Noble shareholders. I'm not sure if a deal will get done -- Microsoft could accept the $300 million NOOK investment as a loss and develop its own, competing digital book store -- but it remains a strong possibility.

Barnes & Noble's future may look bleak, but this has a runway for growth
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  • Report this Comment On October 20, 2013, at 5:29 PM, prginww wrote:

    I've seen one prediction of bookstore earnings of $3/share at Is that for real? and how would MSFT paying an additional, say, $500 million, affect BKS share price?

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