However, this news has raised some major questions. Without the Nook Media segment, all Barnes & Noble, Inc. (NYSE:BKS) will have left is its low-growth business of selling books through brick-and-mortar and online channels. Meanwhile, Microsoft Corporation (NASDAQ:MSFT) will gain a loss-leading tablet, which runs on Google Inc (NASDAQ:GOOG) Android, as its own. How could this deal possibly benefit these two parties?
What the Nook means for Barnes & Noble
During its third quarter earnings, reported in February, Barnes & Noble, Inc. (NYSE:BKS) reported a major decline in sales of e-books and its Nook e-book readers. Sales of digital media – which include digital books, newspapers, magazine and Android apps – climbed just 7% year-on-year last quarter. Sales had previously risen 38% in the second quarter and 46% during the first quarter. Therefore, it didn’t come as much of a surprise when the Nook unit’s sales slid 26% year-on-year to $316 million. Nook’s college bookstore unit also posted a 2% decline in sales to $517 million.
As a result of these losses, Barnes & Noble, Inc. (NYSE:BKS)’s top line declined 9% year-on-year to $2.22 billion, missing Wall Street’s consensus estimate of $2.4 billion. The Nook unit also exacerbated a 7.3% decline in total same-store sales. Excluding sales from the Nook unit, same-store sales only declined 2.2%.
Therefore, if Barnes & Noble sells the entire unit, then it can receive a quick cash infusion of $1 billion and post slightly better (but still negative) same-store sales. While that could be give a short-term top line boost, it’s hard to imagine how Barnes & Noble, Inc. (NYSE:BKS) can revive long-term sales growth again. The company has already reduced its total brick-and-mortar stores to 689, down from 720 in 2010.
Sales of the Nook were tepid during the 2012 holiday season, and the company has been increasingly putting heavy discounts on new tablets for weeks at a time. The company’s flagship 10” Nook HD+ is now sold for $179, down from its original price of $269. This price reduction was apparently made to stay competitive with Amazon.com, Inc. (NASDAQ:AMZN), which recently reduced the price of its 7” Kindle Fire HD from $199 to $179 for Mother’s Day. Amazon’s 8.9” Kindle Fire tablet still sells for $269.
What the Nook means for Microsoft
TechCrunch also speculated that Microsoft Corporation (NASDAQ:MSFT) was buying Nook to halt production of its Google Inc (NASDAQ:GOOG) Android-based tablets by the end of fiscal 2014. Microsoft would then distribute its Nook content through apps on other platforms, such as iOS, Android, and Windows. Last April, as part of its initial $300 million investment in Nook, Microsoft gave Barnes & Noble, Inc. (NYSE:BKS) a $180 million advance to develop Nook content for its Windows 8 devices.
In my opinion, a more expensive and ambitious route would be to turn the Nook into its own low-end Windows 8 tablet platform, as Microsoft Corporation (NASDAQ:MSFT) has done on the smartphone front with Nokia. The Nook has only sold 10 million units since its 2009 release, compared to Apple Inc. (NASDAQ:AAPL)’s 58.3 million iPads sold in fiscal 2012 alone.
However, that idea has major flaws. Amazon.com, Inc. (NASDAQ:AMZN)’s success with the Kindle stems from its ability to sell the tablet at a loss in order to recover the lost revenue through sales of digital content. To remain competitive, Microsoft Corporation (NASDAQ:MSFT) would have to continue selling the Nook at breakeven or negative margins with the hope of recovering the sales from its digital media segment, which has been posting steep sequential declines.
What’s really going on here?
That brings me to my theory of why Microsoft Corporation (NASDAQ:MSFT) might take the Nook off of the market – to simply keep it out of the hands of its competitors.
Barnes & Noble recently inked a deal with Google that allows Google Inc (NASDAQ:GOOG) to install its Google Play store on Nook devices. Prior to the agreement, Nook had been using a forked version of Android, similar to the Kindle Fire, that locked users out of the Google Play app store. The reason was simple – both Barnes & Noble, Inc. (NYSE:BKS) and Amazon wanted their tablets to be recognized as unique products that showcased their digital media, rather than cheap Android tablets that funneled advertising and app store revenue to Google Inc (NASDAQ:GOOG).
However, desperate times call for desperate measures, and Barnes & Noble finally relented and added the Google Play store, which increases the Nook’s 10,000 available apps to 700,000. Amazon.com, Inc. (NASDAQ:AMZN), on the other hand, still locks users out of the Google Play store, although most Android apps can be legally “sideloaded” onto the devices. Google clearly benefits the most from this deal, as it now has 10 million additional devices connected to its Google Play ecosystem. This will open up Google music and video purchases for Nook users as well.
Meanwhile, there have also been persistent rumors of Amazon bidding for the Nook Media unit. If Amazon were to purchase Nook Media, it would gain a valuable brick-and-mortar partner in Barnes & Noble, Inc. (NYSE:BKS), turning a former adversary into an ally. Amazon could possibly use Barnes & Noble locations as fulfillment and local pick-up centers for online purchases. Barnes & Noble could in turn help launch physical versions of Amazon’s self-published digital offerings, which have experienced lackluster sales. Most importantly, Amazon could phase out the Nook and replace it with its Kindle devices, which would make it the undisputed king of the e-reader market with access to books from both Barnes & Noble and Amazon.
Therefore, with Google Inc (NASDAQ:GOOG) already taking full advantage of the Nook’s weakness and Amazon possibly dreaming up the massive synergies of merging its operations with Barnes & Noble, Inc. (NYSE:BKS), Microsoft thought the best tactic was to simply take Nook Media off of the market.
The Bottom Line
Of course, that still leaves investors pondering what’s next for Microsoft Corporation (NASDAQ:MSFT). Over the past three quarters, Nook Media posted an operating loss of $190.9 million on revenue of $2.18 billion. In its current state, Nook will simply drag down Microsoft’s margins and profits. That leaves Microsoft with two choices – to discontinue Nook’s hardware segment completely or to fund it more heavily to create a flagship line of Windows 8 tablets.
Judging from the dismal sales of the Surface, however, I believe that Microsoft Corporation (NASDAQ:MSFT) will simply discontinue it and reduce it to a cloud-based ecosystem for multiple mobile platforms. That strategy cuts Google Inc (NASDAQ:GOOG) out of the picture, and keeps Amazon at bay. Therefore, investors should view Microsoft’s recent strategy as defensive posturing rather than a real offensive move into the e-books market.
The article Why Does Microsoft Need the Nook? originally appeared on Fool.com.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
