Microsoft enters the e-book wars

April 30, 2012

You think markets are efficient? Check this out: Barnes & Noble stock opened 2012 at $14.75 per share and falling fast; by January 5, the opening price was just $9.50. At that price, the entire company was worth just $550 million, and there was a very real fear that the entire company could go to zero, following in the footsteps of Blockbuster and other real-world retailers selling content more easily bought online.

Today, of course, all that has changed. Barnes & Noble has sold a 17.6% stake in its digital and college businesses to Microsoft, for $300 million — a deal which values B&N’s remaining 82.4% stake at $1.4 billion. And while the $300 million is staying in the new joint venture and therefore not available to help the bookstore chain with cashflow issues, the news does mean that Barnes & Noble won’t need to constantly find enormous amounts of money to keep up in the arms race with Amazon. That’s largely Microsoft’s job, now.

This deal is a bit like one of those high-profile investments by Warren Buffett in a distressed company: a vote of confidence by someone powerful enough to be able to fund the struggling firm through its troubles. Except in this case, the Microsoft investment is much bigger than that, since it comes with deep integration into the Windows 8 operating system. Barnes & Noble no longer needs to sell Nooks, or persuade people to download the Nook app on their iPad: everybody with a Windows 8 device will have the Nook reader built-in.

The e-book market is still young; if Amazon continues to be seen as the enemy, there’s no reason in theory why the Nook shouldn’t become just as popular, if not more so. It’s true that you can’t read Kindle books on your Nook, or vice versa, but over the long term, we’re not going to be buying Kindles or Nooks to read books. Just as people stopped buying cameras because they’re now just part of their phones, eventually people will just read books on their mobile device, whether it’s running Windows or iOS or something else. And that puts Amazon at a disadvantage: the Windows/Nook and iOS/iBook teams will naturally have much tighter integration between bookstore and operating system than anything Amazon can offer.

All of which has lit a real fire under the Barnes & Noble stock price, which opened at $25.79 this morning and looks as though it’s going to close somewhere between $20 and $25 per share. That’s an increase of much more than $300 million in market capitalization, and there’s upside, too: the valuation of the parent is now equal to the value of its stake in the subsidiary. So if the subsidiary rises in value, or if the rest of the company is worth anything at all, then the shares can rise further from here.

The one thing you can certainly expect, though, is volatility. Because Barnes & Noble is no ordinary stock. There are 60.2 million shares outstanding, but of that total the free float — the shares freely traded on various stock exchanges — is just 26.82 million. Meanwhile, at last count, the short interest in Barnes & Noble — the number of shares which had been borrowed by people selling them in the expectation that they would fall — was a whopping 19 million shares.

This, ladies and gentlemen, is what is commonly known as a short squeeze. All those shorts have lost a fortune today, and they’re going to have to cover sooner rather than later, driving the price up artificially. So at least for the next few days, it’s probably worth taking any market valuation for Barnes & Noble with a bit of a pinch of salt: technical factors are likely to overwhelm fundamentals until the shorts have retreated, licking their wounds.

After that, however, we finally have a real three-way fight on our hands in the e-book space, between three giants of tech: Apple, Amazon, and Microsoft. And that can only be good for consumers.


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