Microsoft Deal Adds to E-Book Battle

By MICHAEL J. DE LA MERCED and JULIE BOSMAN

Microsoft agreed to invest hundreds of millions of dollars in Barnes & Noble’s Nook division on Monday, giving the bookstore chain stronger footing in the hotly contested electronic book market and creating an alliance that could intensify the fight over the future of digital reading.

The deal, which gives Microsoft a 17.6 percent stake, values the Nook unit at $1.7 billion — roughly double Barnes & Noble’s entire market value as of last Friday — and bolsters the bookseller’s efforts to make its digital business the linchpin of its future growth.

The announcement was the latest surprise in an unpredictable and rapidly shifting e-book market, which is crowded with technology giants trying to chip away at Amazon.com’s dominance. Amazon once had close to 90 percent of the e-book market, but since then, a handful of players, including Apple, Google and now Microsoft, have edged in.

The alliance binds together two onetime market leaders that have lost ground. Barnes & Noble, which is the nation’s largest bookstore chain and has more than 25 percent of the e-book market but still lags well behind Amazon, has a rich and powerful partner with global reach. At the same time, the deal will give Microsoft a close ally in one of the most important battles reshaping the landscape in technology, retailing and media.

Microsoft has been forced to radically reimagine Windows, its flagship software franchise, for a future in which much Web browsing, movie watching, book reading and other activities occur on tablets.

David Paul Morris/Bloomberg News

Propelled by its Nook devices, Barnes & Noble has more than 25 percent of the e-book market, but it still lags behind Amazon.

This puts it squarely up against Amazon, with its popular Kindle devices, and Apple, which has had runaway success with its iPad. Google, too, has been scrambling to build up its own service with an expansion of its Google Play store.

The deal is “clearly motivated by Apple and Amazon as relatively unstoppable forces, each in their own domain,” said James McQuivey, an analyst at Forrester Research.

David Paul Morris/Bloomberg News
Propelled by its Nook devices, Barnes & Noble has more than 25 percent of the e-book market, but it still lags behind Amazon.

 Many publishing executives fear that Amazon is about to escalate the e-book price wars again. A settlement with several publishers announced by the Justice Department in mid-April has threatened to upend the e-book pricing system by giving Amazon the potential to expand its reach by lowering prices.

As part of the deal announced Monday, the two companies will settle their disputes over an array of technology patents. Barnes & Noble will also produce a Nook app for the forthcoming Windows 8, a revamping of the Microsoft operating system that will take advantage of touch screens. While Windows 8 will have an app store, analysts expect it will need to be more tightly coupled with a service for buying books and other forms of entertainment to better match the offerings from rivals.

In turn, the bookseller will capture additional points of distribution from hundreds of millions of Windows users around the world, potentially reaching consumers who did not associate Barnes & Noble with e-books.

Mr. McQuivey said he expected that Barnes & Noble would eventually create a new line of Nook devices based on Windows 8 that will offer a closer marriage of hardware, software and content services.

Under the terms of the deal, Microsoft will invest $300 million in the division, and it has committed to paying an additional $305 million over the next five years, part of which serves as an advance against future revenue and part to finance the Nook’s expansion into international markets. The partnership is not exclusive to Microsoft, meaning that Barnes & Noble can still pursue other alliances with the likes of Google.

The news on Monday reversed what had largely been a mediocre year for Barnes & Noble. Until last week, the company’s share price had risen just 3 percent in the last 12 months. But investors applauded the partnership, sending Barnes & Noble’s stock soaring to a 12-month high. Its shares closed on Monday at $20.75, up 52 percent.

“This is a great win for shareholders,” Barry Rosenstein, the founder of Jana Partners, a hedge fund that is one of the retailer’s largest shareholders, said in a statement. “When we invested, the market was ascribing no value to the Nook business, which was absurd.”

Barnes & Noble has wagered heavily on the Nook, whose e-readers and tablets have emerged as prominent competitors to the Kindle. The Nooks have been largely well-received, with the latest iteration — a $140 black-and-white e-reader with a glowing screen — drawing positive reviews.

But investors had fretted about the strain the Nook division was putting on the company’s bottom line because of the enormous capital investment it required.

“It gives them a much larger, financially stable partner,” Peter Wahlstrom, a senior analyst with Morningstar Equity Research, said on Monday.

The bookseller had been fielding offers from a number of potential partners since it accepted a $204 million investment from Liberty Media last spring, according to a person with direct knowledge of the matter who spoke on the condition of anonymity. In January, the bookseller acknowledged that it was exploring “strategic options” for the business, a signal that it might consider a sale or spinoff of the division.

It entered into serious negotiations with Microsoft about two months ago, this person said. The discussions were held at the highest levels of both companies, including Microsoft’s chief executive, Steven A. Ballmer, and his counterpart at Barnes & Noble, William J. Lynch Jr.

The company might yet spin off the unnamed division, a move that many analysts endorse. Later this year, Barnes & Noble will begin to break out the financial results of the Nook business from the rest of the company’s results, Mr. Lynch said in a telephone interview.

At the same time, Mr. Lynch added that the digital business would remain closely linked to the brick-and-mortar stores that long made up Barnes & Noble’s empire. Barnes & Noble has 691 retail stores and 641 college bookstores, a spokeswoman said Monday.

“We’re not changing the base number of the stores materially,” Mr. Lynch said, adding that there are many cities with high-income residents that no longer have a bookstore after the liquidation of Borders last year. “We’re looking to play a little offense with the bookstores.”

Like Apple, Barnes & Noble expects a major new area of growth to come from education sales, as more students flock to cheaper electronic versions of textbooks. It is folding its higher-education operations into the new unit.

Publishers appeared to be cheered by the news. Mr. Lynch said that he had received encouraging e-mails Monday morning from chief executives from five of the six major publishers in the business.

But he said the intensity and expansiveness of the talks left little time for celebration by the time the deal was signed at the end of the weekend. Mr. Lynch said he had slept perhaps four hours between the signing of the transaction and the announcement Monday of the investment.

“I have a lot less hair than I did 100 days ago,” he joked.

Nick Wingfield and Azam Ahmed contributed reporting.