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Why Barnes & Noble, Inc. (BKS) Needs to Spin Off the Nook

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Since day one — day one being April 2012, when Microsoft Corporation (NASDAQ:MSFT) dropped $300 million into the Nook — there have been rumors that the Nook would spin out into its own company. The last two months have been especially tumultuous, with a rumor first confirming a spinoff then denying the same rumor. The newest unnamed source claimed that Microsoft Corporation (NASDAQ:MSFT) wasn’t interested because Barnes & Noble, Inc. (NYSE:BKS) was using Andriod as the operating system on the Nook and Microsoft Corporation (NASDAQ:MSFT) is focused on Windows 8 for tablets.

Barnes & Noble, Inc. (NYSE:BKS)

There is some truth in that. The Nook recently opened up its users to the world of Google Inc (NASDAQ:GOOG) Play, tying the tablet even tighter to the open-source system. But even with that tie, Barnes & Noble, Inc. (NYSE:BKS) investors should hold out hope for a spinoff, which would unlock the value held in the Nook while freeing up Barnes & Noble, Inc. (NYSE:BKS)’s retail operation.

The Nook division
The April investment from Microsoft was the beginning of a ride for the Nook. Later in 2012, the business got another big investment from Pearson PLC (ADR) (NYSE:PSO), which put $89.5 million into the Nook at the end of the year. That investment put the value of the Nook division at $1.8 billion, which was substantially more than Barnes & Noble, Inc. (NYSE:BKS)’s whole market cap at the time — or still.

Since that investment, Barnes & Noble, Inc. (NYSE:BKS) has had a few disappointing announcements. Sales over the holiday season were much lower than expected, and as a result, the last reported quarter came with a 26% drop in Nook division revenue. On the plus side, the drop in revenue came from a decrease in Nook units sold, and digital content sales actually increased 6.8% over the same quarter in the previous year.

That’s the business that Microsoft should be interested in — the digital content business. As Amazon.com, Inc. (NASDAQ:AMZN) has shown with the Kindle, and even as the recent e-book trial  as highlighted, selling hardware and even some content at a loss is how you get more consumers hooked on the content.

The future of the Nook
The high-sales, low-margin business works great, as long as you’re selling enough and have the capital to make that happen. Amazon.com, Inc. (NASDAQ:AMZN), again, is the classic example of volume over value. Right now, Barnes & Noble, Inc. (NYSE:BKS) is trying to re-create that model without the sales volume or available cash. Instead, the Nook division is just racking up a $190 million EBITDA loss in the third quarter.

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