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Microsoft's Nook deal is a real 'game-changer'

CNBC's Jon Fortt reports on the partnership between Microsoft and Barnes & Noble. Rafe Needleman, CNET editor-at-large, explains what this big bet could mean for Microsoft.

The idea of going into a bookstore and walking out with a tablet or other device might sound contradictory, but it could be the future for Barnes & Noble (BKS). 

The bookseller announced this morning a plan to spin off its digital and college divisions into a subsidiary and partner with Microsoft  (MSFT) in a digital reading venture the two companies have dubbed Newco. The Windows creator will invest $300 million in return for a 17.6 percent equity stake in the new business. Goldman Sachs analyst Matthew Fassler called the deal a "game-changer." 

Barnes & Noble shares surged about 60 percent Monday on news. Microsoft shares were flat.

"To me, the key takeaway is this guarantees the long-term viability of the Nook," said Bob O'Donnell, an analyst at IDC.

From a technology angle, it makes sense: Microsoft and Barnes & Noble need each other to better compete in the e-reader and tablet business. Fassler wrote, "Our biggest concern for BKS has been its ability to compete against AAPL (Apple) and AMZN (Amazon), two of the deepest-pocketed players in the technology and media world. NewCo now has an equally deep-pocketed partner."

(Msnbc.com is a joint venture of NBC Universal and Microsoft.)

Barnes & Noble needs Microsoft's global scale and money to grow its ebook business beyond the United States. Amazon has been aggressively rolling out its Kindle reader worldwide; it announced earlier this month that the Kindle Touch 3G is available in more than 175 countries. "It appears strategic to Microsoft to put more skin in the game by partnering with BKS for digital content supply and creation for both the U.S. and international markets," Nomura analyst Rick Sherlund wrote in response to the announcement.

Barnes & Noble and Microsoft also have settled their patent litigation, the companies said.

Microsoft needs Barnes & Noble's presence on college campuses and its textbook business to help it compete against Apple's educational offerings. "Microsoft will want to make sure that ... there is a counter balance to Apple’s growing partnerships for content and creation of interactive educational content," Sherlund wrote.  

It's also a fascinating peek into what could be the future of the bookseller's retail presence. The two companies confirmed the development of a Nook app for Windows 8 but didn't offer any more details about whether or not the bookstores could become a sales channel for Microsoft. 

It's an idea that could benefit both brands, though. Roughly two years ago, Barnes & Noble gave its Nook e-reader a big push with spacious in-store kiosks that have been compared to the Apple store in concept and design. At the time, analysts praised the idea of letting people play around with the devices and ask knowledgeable salespeople how to use them. 

Even as the number of books read on tablets or e-readers increases, Barnes & Noble seems committed to its physical stores, said Michael Norris, senior analyst of the Trade Books Group at Simba Information. "The actual value proposition of a physical store is clearly there," he said, pointing out that Apple's retail presence boosts its brand image as well as its sales figures.

Although the market for e-books continues to climb, analysts say paper books are never going to disappear entirely. The amount of store square footage needed to house this inventory will probably shrink, though, and Barnes & Noble has an enormous real estate footprint. Filling it with more electronics could make sense. 

Microsoft has experimented with branded retail locations in the past, and it has a handful of Microsoft stores around the country, but the response from consumers has been underwhelming. (From tech bloggers, it's been downright derisive.) Being able to sell products under an existing, well-run and admired brand's umbrella would be a good solution.

Analysts also speculate Microsoft could create products designed specifically for the e-reader market. The deal "rais[es] the question of whether MSFT will develop additional mobile devices that can enhance the sale of ebooks," Fassler wrote. The Nook currently runs on the open-source Android operating system.

With Circuit City long gone and Best Buy planning a future of fewer and smaller stores, Barnes & Noble could be an attractive alternative for Microsoft, especially if it had more control over the sales process than it would via a third-party channel. "If something was to ever happen to Best Buy... people still need to buy electronics, so where are they going to go?" O'Donnell said. "Maybe there's an interesting opportunity for Barnes & Noble."

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