Microsoft's $300 million Nook investment already looks like a clunker

Barnes & Noble's third quarter was a debacle largely due to disappointing Nook sales. Fortunately, the Nook unit has Microsoft cash to back it up as it rethinks its strategy.

Microsoft's $300 million investment in Nook Media LLC, a subsidiary of Barnes & Noble, is already looking like a clunker only after a quarter.

Barnes & Noble's third quarter earnings were disappointing and a big reason was the retailer's investment in the Nook. Simply put, Nook devices didn't sell, failed to generate foot traffic in the stores and now are being rethought completely.



In other words, the Nook strategy needs a complete do-over. That chore is necessary considering Nook sales fell 25.9 percent from a year ago and EBITDA fell 129.9 percent. Barnes & Noble CEO William Lynch said on an earnings conference call:

Despite generating very strong reviews and the highest pre order volume we received on any Nook launch to date sales of those products didn't materialize at the rate we expected through holiday, as heavy competition in the Tablet market negatively impacted our sell-through. In many ways we helped create the portable Tablet category by launching the first ever seven inch media Tablet with Nook color almost three years ago. Since that time, several large technology brands have entered the Tablet market making it more difficult to breakthrough with our award winning products.

We are actively in discussions to leverage our valuable technology and content platform to sell digital content through partnerships. Similar to the partnership we struck with Microsoft on Windows 8. Partnerships are one of the key strategies for growth for our Nook digital content business and we are encouraged by the status and breadth of discussions we're in the midst of. Even with the decline in Nook unit sales in Q3, we grew digital content sales 7% so we've demonstrated we can grow our content business without having to grow hardware sales. At the same time I want to be clear about the fact that we continue to remain committed to the E-reader and Tablet business going forward.

Boy what a difference a few months makes. In October, Microsoft and Barnes & Noble finalized a $300 million investment in the company. The rough plan: Microsoft would help fund Nook's growth in return for a 16.8 percent stake.

Under the Microsoft agreement , Barnes & Noble executives said that the Nook unit gets $85 million a year mostly for international expansion. Analysts were very hung up on the Microsoft cash. Why? They are projecting cash flow and trying to figure out how much Microsoft's dough is keeping the Nook dream alive.

The Nook unit and Microsoft also have a deal on Windows 8 that allows them to split revenue. It's a bit unclear how the revenue split works based on executive comments, but neither the Nook devices nor Windows 8 are spurring widespread buying enthusiasm.

Barnes & Noble CFO Michael Huseby said:

The money that Microsoft invested is being used to help us funnel international expansion and also drive the overall Nook Media business which includes the sales of the Nook devices to drive content sales. We don't track Microsoft cash per se within Nook Media, although we obviously report to them on as we're required. We have a commitment to get them a return on that cash over time and that's what we're going to do. This is the first quarter of the partnership.

It's unclear what exactly Microsoft is getting out of the Nook partnership. It's possible that Microsoft is getting technology and publishing agreements. Perhaps Microsoft gets to pick over the Nook carcass if the division completely flops. In any case, if this first quarter from Nook is any indicator of future success, Microsoft has a $300 million clunker on its hands.

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