A Barnes & Noble Nook Coluor eReader, left, is shown next to a Nook Simple Touch eReader.
Microsoft is jumping into the fast-growing e-books market by investing $US300 million in Barnes & Noble's Nook e-reader and university business, as it looks to unlock Amazon.com and Apple's grip on the exploding tablet computer market.
The move comes just six months before the world's largest software maker is due to launch its new touch-enabled Windows 8 operating system, and the inclusion of a Nook app on Windows tablets should allow them to compete with Apple's iPad and Amazon's Kindle Fire.
It also gives Microsoft a direct interest in electronic publishing just as the market for downloadable university textbooks starts to take off and the publishing industry undergoes a radical shift toward electronic distribution.
"It's a good strategic deal," said Sid Parakh, an analyst at fund firm McAdams Wright Ragen. "It gets Microsoft in the game for e-readers, and gives them access to a market that has been growing nicely and they've basically sat out of. It also makes Windows 8 a more compelling platform from an e-readers perspective."
Shares of Barnes & Noble soared 60 per cent, while Microsoft shares, which recently hit a four-year high, were flat. Microsoft's initial investment values the new unit at $US1.7 billion. Over the next five years, Microsoft has committed to invest another $US305 million.
The deal - initially worth only 0.5 per cent of Microsoft's cash hoard - is financially small, but strategically important for both companies.
"The deal brings Microsoft technology and engineers into the Nook business - that talent will be tapped to make the Nook even better," said Albert Greco, a book industry expert at the business school of Fordham University in New York. "It gives Microsoft a tablet already, and Barnes & Noble global reach for the Nook platform, through Windows 8."
Barnes & Noble Chief Executive William Lynch told Reuters that the investment would go primarily to fund the international rollout of the Nook's digital bookstores and new reading software for the Windows platform.
Microsoft backs Android
Under the deal, Microsoft will take a 17.6 per cent stake in a new Barnes & Noble unit combining the bookseller's university bookstore and Nook businesses. Those areas make up about 40 per cent of Barnes & Noble's total business.
Microsoft, which will get a share of the new unit's sales, will pay $US25 million a year for the first five years to help with development costs and acquiring content, and will make an upfront payment of $US60 million a year for the first three years after the launch of Windows 8, essentially guaranteeing minimum sales of that amount to Barnes & Noble. That means Microsoft's total outlay will be at least $US605 million.
As part of the deal, Microsoft has dropped a patent lawsuit against Barnes & Noble over the Nook, which runs on Google's Android system, and will get royalties on those patents. There is a possibility that future Nook models will be based on the Windows operating system, but executives would not comment on that in a call with analysts.
Barnes & Noble gets a much-needed capital injection and a way to enter the digital books market outside the United States. The new unit will be run by Barnes & Noble and will maintain a relationship with the U.S. bookstore chain's nearly 700 stores.
Barnes & Noble's Nook has found a strong following, allowing it to garner some 27 per cent of the U.S. e-books market in the 2-1/2 years since the device was launched, compared with Amazon's 60 per cent and Apple's 10 per cent. But battling Amazon's market-leading Kindle has proved expensive.
"It gives them a much larger partner with deeper pockets, it gives them increased reach," said Morningstar analyst Peter Wahlstrom. "In the last two years they've had their backs against the wall."
Last year, Barnes & Noble suspended its dividend to direct more cash into developing Nook, which resulted in a well-reviewed glow in the dark Nook introduced last month.
In January, however, it lowered its sales and profit forecasts as it faces pressure from Amazon's aggressive pricing strategy which has prompted it repeatedly to lower the prices on its own devices.
Nook to go global
Barnes & Noble has poured tens of millions of dollars into developing the Nook. The first version hit the market in 2009, two years after the Kindle.
The company's e-readers, tablets and electronic book sales have helped it offset a broader decline in book sales. Same-store sales of books at its brick-and-mortar stores have edged up again largely thanks to the bankruptcy last year of Borders Group.
But the Nook has been available only in the United States and the company said last year it wanted to take its digital business to new markets.
Barnes & Noble said in January that it might spin off its digital business, which includes the Nook, arguing that investors were not giving the company enough credit for that growth.
The company did not say on Monday if it would take the new venture public.
Barnes & Noble put itself up for sale in 2010 but attracted only one firm offer - a bid for $US17 per share, or $US1 billion, last May, from Liberty Media, which was drawn by the Nook's growth.
Liberty ultimately decided to invest $US204 million rather than buy the company outright. It now has preferred shares it can convert into a 16.6 per cent stake in Barnes & Noble at a strike price of $US17.
Barnes & Noble shares were up 60 per cent at $US21.94 on the New York Stock Exchange on Monday afternoon. Microsoft shares were up 0.1 percent at $US32.00 on the Nasdaq.