Possible Tablet Spin-off?

Mike is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

London-based Pearson PLC (NYSE: PSO) recently announced that it had spent about $89 million to purchase a small stake in Barnes & Noble's (NYSE: BKS) Nook Media division. Although the stake amounts to just 5 percent of the rapidly-growing division's value, the purchase fueled already-rampant speculation that Barnes & Noble would spin off Nook Media in the coming months. The company's recent downward revisions of its earnings estimates added to mounting shareholder pressure for a course correction. Finally, Barnes & Noble CEO William Lynch has publicly indicated that he is "exploring options" to shop the $1.8 billion division.

Any potential Nook Media spin-off or sale would normally be a straightforward parting of ways between a struggling old-media retailer and its fast-growing digital arm. However, the situation is complicated by the fact that Barnes & Noble is not the sole owner of the Nook business. After the Pearson purchase, Seattle-based tech giant Microsoft (NASDAQ: MSFT) still owns nearly 17 percent of the division. Any change in Nook's ownership would have to involve one of the world's largest technology companies.

Well-known to investors and consumers alike, Microsoft was once the world's most promising technology company. While it remains a corporate behemoth that employs nearly 100,000 full-time employees and earned about $16 billion in adjusted income during the 2011 fiscal year, some of its luster has faded with the rise of younger and more nimble competitors. Although the company's Windows operating system remains the dominant platform for personal computers and laptops, Microsoft is locked in a vicious battle with Google and Apple for a share of the fast-growing mobile market. Faced with declining margins and weak hardware sales, Microsoft may prefer to maintain its stake in the e-reader market for the time being.

With the liquidation of Borders, New York-based Barnes & Noble is the last remaining "nationwide" bookstore chain in the United States. Although the company has diversified into digital media and publishing, it continues to operate nearly 700 retail bookstores and an equal number of academic bookstores that reach about 4.5 million college students per year. Much of Barnes & Noble's retailing now occurs online through the company's "eBookstore" and Nook Media division. It continues to expand its lineup of Nook products and now offers a tablet version of the Nook e-reader. 

Pearson PLC is a British education and publishing firm that specializes in producing textbooks, ready-made course curricula and testing materials. The company also operates two semi-autonomous publishing arms: the FT Group and the Penguin Group. The former publishes the popular Financial Times daily newspaper and administers the paper's FT.com web portal. The latter publishes a wide range of children's books and adult fiction through several niche publishing houses.

Many investors are puzzled as to why Barnes & Noble would publicly shop its only major growth asset. Although the company now has an effective monopoly in the shrinking bricks-and-mortar book-selling business and has absorbed much of Borders' e-commerce infrastructure, Barnes & Noble continues to shrink its physical footprint. Over the past several years, the company has consolidated dozens of physical locations and looks certain to continue this trend.

Then again, the Nook e-reader has proven to be surprisingly unprofitable for the company. After investing hundreds of millions of dollars into the division, Nook Media lost nearly $300 million during the 2012 fiscal year. By contrast, the company's retail and academic businesses were solidly profitable. While it still offers tremendous potential in an exciting new market, it now appears unlikely that Nook can out-compete its higher-volume tablet and e-reader competitors like Apple's iPad and Amazon's Kindle. By focusing exclusively on its bricks-and-mortar and e-commerce retail operations, Barnes & Noble may be able to remain profitable for some years to come.

In fact, competing e-reader sellers like Amazon (NASDAQ: AMZN) may benefit most from Barnes & Noble's loosening grip on Nook Media. According to TechCrunch, the Kindle's sales accelerated in 2012. Should Barnes & Noble choose to spin off Nook Media in its somewhat weakened state, it would be a natural acquisition target for Amazon. Such an acquisition would provide Amazon with a ready-made tablet interface and might enable it to compete with Apple on more equal footing. 

However, Amazon would likely have to pay a premium for the division. If Microsoft is unwilling to part with its $300 million investment in Nook Media, the world's largest online retailer would have to engage in a bidding war with the world's largest platform-maker for control of the property.

There are currently no formal Nook Media spin-off proposals on the table. Likewise, Pearson has announced no formal plans to increase its stake in the division in the immediate future. However, it appears likely that any spin-off would initially have to involve an agreement between Pearson, Microsoft and Amazon. It is unclear whether such a spin-off would necessitate an IPO for Nook Media or simply involve a joint buyout of the property. Until Barnes & Noble's executive team can provide more guidance on the matter, the company's shareholders will be left to speculate about what the future holds.


mthiessen has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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