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Shares of Barnes & Noble (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 (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.


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 (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