Since day one — day one being April 2012, when Microsoft Corporation (NASDAQ:MSFT) dropped $300 million into the Nook — there have been rumors that the Nook would spin out into its own company. The last two months have been especially tumultuous, with a rumor first confirming a spinoff then denying the same rumor. The newest unnamed source claimed that Microsoft Corporation (NASDAQ:MSFT) wasn’t interested because Barnes & Noble, Inc. (NYSE:BKS) was using Andriod as the operating system on the Nook and Microsoft Corporation (NASDAQ:MSFT) is focused on Windows 8 for tablets.
There is some truth in that. The Nook recently opened up its users to the world of Google Inc (NASDAQ:GOOG) Play, tying the tablet even tighter to the open-source system. But even with that tie, Barnes & Noble, Inc. (NYSE:BKS) investors should hold out hope for a spinoff, which would unlock the value held in the Nook while freeing up Barnes & Noble, Inc. (NYSE:BKS)’s retail operation.
The Nook division
The April investment from Microsoft was the beginning of a ride for the Nook. Later in 2012, the business got another big investment from Pearson PLC (ADR) (NYSE:PSO), which put $89.5 million into the Nook at the end of the year. That investment put the value of the Nook division at $1.8 billion, which was substantially more than Barnes & Noble, Inc. (NYSE:BKS)’s whole market cap at the time — or still.
Since that investment, Barnes & Noble, Inc. (NYSE:BKS) has had a few disappointing announcements. Sales over the holiday season were much lower than expected, and as a result, the last reported quarter came with a 26% drop in Nook division revenue. On the plus side, the drop in revenue came from a decrease in Nook units sold, and digital content sales actually increased 6.8% over the same quarter in the previous year.
That’s the business that Microsoft should be interested in — the digital content business. As Amazon.com, Inc. (NASDAQ:AMZN) has shown with the Kindle, and even as the recent e-book trial as highlighted, selling hardware and even some content at a loss is how you get more consumers hooked on the content.
The future of the Nook
The high-sales, low-margin business works great, as long as you’re selling enough and have the capital to make that happen. Amazon.com, Inc. (NASDAQ:AMZN), again, is the classic example of volume over value. Right now, Barnes & Noble, Inc. (NYSE:BKS) is trying to re-create that model without the sales volume or available cash. Instead, the Nook division is just racking up a $190 million EBITDA loss in the third quarter.
Those losses have been offset, largely, by the company’s college bookstore business. Last quarter, management said that the Nook business was “financing itself,” which it turns out meant that the college business was providing a huge chunk of cash. That’s where the value of a spinoff really makes sense.
The Nook needs a nice big cash injection — the kind of injection that it could get by being spun out on its own. That would give it the capital it desperately needs to build its digital content business up to the scale that’s required to use the Amazon.com, Inc. (NASDAQ:AMZN) model. It would also cut the cord between the retail businesses and the Nook business.
Microsoft’s role in the future of Nook should be as big as possible. To help Windows 8 in the tablet world, Microsoft should be investing in the next Nook device. This one is tied to Android, sure — but the next tablet could bring a choice of operating systems. By separating the business out, the Nook division can use some of that fresh cash to develop a new, more flexible piece of hardware that would work better with Windows.
In short, dividing the Nook from the rest of Barnes & Noble seems like a win for everyone. The cash would be a huge windfall for the device, the business, and investors. The freedom from the Nook anchor would help the retail business pick up speed. And investors would unlock the combined value of the separate businesses.
The article Why Barnes & Noble Needs to Spin Off the Nook originally appeared on Fool.com is written by Andrew Marder.
Fool contributor Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Google. The Motley Fool owns shares of Amazon.com, Google, and Microsoft.
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