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Shares of Barnes & Noble (NYSE:BKS) rose 52% today to $20.75 per share after trading as high as $26 per share earlier. The spike comes after the company announced a strategic partnership with Microsoft (NASDAQ:MSFT) which will invest $300 million in the company's Nook.

The Deal

Under the deal which was announced this morning Barnes & Noble and Microsoft announced a formation of a strategic partnership in newly formed Barnes & Noble subsidiary. The partnership will accelerate the developments of the e-reading division of the company and will combine the Digital and College business of Barnes & Noble.

Microsoft will make a $300 million investment in the division in exchange for a 17.6% equity stake which values the division of $1.7 billion. This compares to a valuation of $1.25 billion at today's close for the entire company Barnes & Noble. Under the deal Microsoft can built out its ecosystem by acquiring hardware for a reasonable price, while Barnes & Noble gets access to Windows 8 and it lacks capital to invest in the business.

The deal means that hedge fund Jana Partners which recently acquired a 12% stake in the company made a killing on its investment. Furthermore the news sparks imagination in the hardware space as a tech giant is willing to pay a premium for hardware assets. Shares of Research in Motion (RIMM) rose 2.5% in a reaction to the news.

Valuation

Barnes & Noble ended 2011 with $27 million in cash and $102 million in long term debt, for a net debt position of $75 million. At today's valuation of $1.25 billion shares are valued at merely 0.2 times 2011's annual revenues in a year in which the company lost $74 million.

The company has steadily been seeing margin erosion in its traditional brick-and-mortar business while the relative success of the Nook has surprised many analysts amidst fierce competition from Amazon's (NASDAQ:AMZN) Kindle. This has apparently caught the eye of Microsoft which led to the announcement of the strategic partnership today.

Amidst the financial difficulties, the company has stopped paying a dividend last year.

Investment Thesis

Shares in Barnes & Noble have seen a steady downward move from highs of $46 in 2006 to lows of $10 in 2011. After today's news shares have doubled to levels around $21 after peaking at $26 this morning.

At today's valuation of $1.25 billion it implies that Microsoft values the brick-and-mortar operations at a negative value. The valuation of the strategic partnership values the "Nook" at $1.7 billion (according to Microsoft). This leaves a lot of value creation as the wind down of the retail operations could generate significant positive cash flows.

Investors could built up a speculative long position.

Source: Barnes & Noble - Speculative Buy After Strategic Partnership With Microsoft