Barnes & Noble's Big Bet Isn't Paying Off

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

Barnes & Noble (NYSE: BKS) appears to be accepting the fact that it's just a book store. That's an expensive pill to swallow and makes its future a lot more complicated.

Especially since Microsoft (NASDAQ: MSFT), Pearson Plc, and Liberty Media Corp. all own a piece of the company.

A Good Idea

Barnes & Noble faced a technological moment of truth when Amazon (NASDAQ: AMZN)  destroyed the retail book store model and shifted it to digital delivery. Barnes & Noble was one of the few major chains left standing and had to make a choice between being just a book store or fighting Amazon again in digital books.

The company launched the Nook e-reader to compete with Amazon's Kindle. From the start, Kindle was the leader. Although the Nook has received solid reviews, it simply never caught on. Amazon, meanwhile, has been able to build the Kindle line into a serious competitor to tablet computers. That has given the company a place at the table with companies like Apple and Samsung.

Amazon's top line has gone from around $5 billion a decade ago to over $60 billion last year. However, competition has required massive investment, leading profit margins to fall from the mid single digits to the low single digits. The Kindle is just one of many costly projects. Despite losing money last year, Amazon shares are trading near all-time highs and are only appropriate for aggressive growth investors.

Barnes & Noble, meanwhile, isn't as big and technologically savvy as Amazon, and it's finally admitting it. Based on bad sales results in the just ended quarter, Barnes & Noble announced it was stopping production of color Nooks.

The problem that Barnes & Noble faces now isn't so much what comes next, but what came before. For example, Liberty Media has a 17% stake in the book retailer. And, to make matters more complicated, after the Liberty investment the company broke itself into two groups and took on a second round of investments for just the Nook business. The Nook business is partnered with Microsoft, which took a 16.6% stake in that unit, and Pearson PLC, which has a 5% stake.

Money to Burn

Microsoft's investment, which requires the company to keep giving Nook money for a few more years, now looks like a mistake. While there were rumors that Microsoft was going to try to buy Nook, that didn't pan out and shutting production of the color Nook seems to suggest that it never will. Luckily for Microsoft, the $300 million investment is small change compared to the over $60 billion in cash and investments it had, net of debt, at the end of the March quarter.

While this deal hasn't played out very well, a similar high-risk investment in Nokia has been a bigger success. Nokia's Lumia smart phone has been a great showcase for Windows Mobile. Although the Nook never offered that much promise, this type of low cost/high return investment is a good plan for a cash rich tech giant fighting to regain its industry leading position.

With a yield of around of 2.7%, a top line that's been heading higher since the recession, and a collection of new products and software either in the market (Windows Mobile, Windows 8, the Surface tablet) or soon to be launched (Xbox), Microsoft shares looks like a good option for growth and income investors. Its price to earnings ratio in the high teens is reasonable for a company of Microsoft's scale and potential.

Just a Bookstore

Barnes & Noble, meanwhile, is looking more and more like just a book store. That's not a bad thing, however, since the book store business has been supporting the Nook business. In fact, Leonard Riggio, the company's founder, has been talking about buying the physical book stores for some time, taking them private.

The shares have dropped sharply over the last few weeks, first on weak Nook sales and now because of the decision to shutter the color Nook. Trading in the mid-teens and posting sizable losses in each of the last two years, this is looking more and more like a high-stakes bet on the company's book store business.

That said, Investors should avoid the shares until the company works through its seemingly failed Nook bet. The sizable investments from other companies complicates any corporate actions that might be taken to boost shareholder value. That includes the potential of Riggio buying the bookstores, which could leave the public owning just the money losing Nook business.

Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends The Motley Fool owns shares of 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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