Barnes & Noble's Google Play Puts The Ball In Microsoft's Court

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Last week, Barnes & Noble (NYSE:BKS) announced that it had reached a deal with Google (NASDAQ:GOOG) to bring the Google Play store, in addition to other Google apps such as Chrome and Gmail, to the Nook HD and HD+ tablets. This is not terribly surprising; something needed to change. The Nook, which was supposed to be the saving grace of Barnes & Noble in the era of the e-book, actually hindered the profitable brick and mortar store in recent quarters. It is noteworthy that when founder Leonard Riggio made an offer in February to take the company private, he only wanted the physical book stores and the website. The Nook business has become a financial drain, and has been kept afloat by substantial investments by Microsoft (NASDAQ:MSFT) and Pearson PLC. The arrival of Google Play is generally positive for everyone involved, with the exception of Microsoft.

Nook Media LLC (a subsidiary of Barnes & Noble that includes the Nook division and the company's college bookstores) has been a significant player in the tablet market with its designs, only being kicked out of the top five tablet makers by Microsoft in first quarter 2013. There has been a significant problem with the machines, however: they were less full tablets and more e-readers that could do some tablet functionality on the side. This wasn't due to any technical limitations; it was due to the paltry 10,000 or so apps available in its separate app store. Many key apps were present, such as Netflix and Pandora, but they were clearly unable to elicit much interest from developers. Overnight, they've gone from having 10,000 apps to more than 700,000 via Google Play.

The biggest winner here is Google. The roughly one million Nook HD and HD+ tablets that have been purchased so far just became new vectors for app and media sales. Up to this point, the Nook had been a closed ecosystem with closed apps, with Google's profits coming only from online searches by dint of being the default search engine. Nooks are now part of the larger Google world. The built in Gmail and Chrome apps will allow them to deliver even more advertising to Nook users than they already have been. While this probably won't move the needle much for Google, a million users (assuming every Nook HD user upgrades) gained all at once is nothing to sneeze at.

For Barnes & Noble (minus Nook Media), this is a sensible development if it intends to disengage from the Nook business. The plan to use the Nook as a source of e-book and app revenue has failed; clearly the products haven't been compelling enough for customers. If it is going to spin off Nook Media as its own publicly traded company, it would want it to be as strong as possible so that it can have a successful IPO (assuming it doesn't just take the brick and mortar store private and change the stock ticker to NOOK), and having access to the most extensive app store outside of Apple's (OTC:APPL) iOS is a great start.

For Nook Media itself, these developments carry good and bad implications. The effect of products like Amazon's (NASDAQ:AMZN) Kindle Fire, the Google Nexus and the Nook itself has been to severely drive down the prices of Android tablets. This has happened because the business model for all three brands has been as follows:

  1. Sell tablets/e-readers at a tiny profit, at cost or at a small loss (depending on the company and the model).
  2. Make up the difference by locking customers into an app and media ecosystem for the long haul. Someone who buys a Kindle Fire is less likely to buy a Nook later, since they would have to buy their books all over again. Amazon and Google also monetize their tablets through advertising, while Barnes & Noble hasn't.

The existing Nook app store isn't going away, but it clearly isn't going to be as important going forward. This means that Nook Media is selling cheap tablets at or below cost, and the only hope is that it sells enough e-books on the back end to earn a profit (unless Google is giving it a cut of app sales or advertising, which I haven't seen any evidence for or against). To the best of my knowledge, the Nook hasn't ever made a profit, and now whatever app revenue it was making is probably going to dwindle. On the flip side, now that the Nook is a full Android tablet instead of an e-reader with some extras, customers might well find it more compelling. I would argue that it is better off overall, since this will probably move some more units, and it takes a lot of e-book sales to make up for thousands of unsold Nooks sitting around.

The biggest loser here is Microsoft. It owns a 17% share of Nook Media that cost three hundred million dollars, and now it has become cozy with Google. In fact, Microsoft now has a bigger presence on the Kindle than on the Nook, since Bing is the Kindle Fire HD's default search engine. This is clearly a sign that Mr. Softy doesn't have nearly the influence over Nook Media that one might expect; I had been predicting that Bing integration would come to the Nook, followed by possible Windows-based Nooks. It appears that I was dead wrong. Mea Culpa.

As I see it, Microsoft has three options. It can just take its share of whatever profits a fully integrated Android tablet maker can give it (which will take time, if it happens, and will come at the expense of possible Windows tablet share), sell the stake in Nook Media (almost certainly at a loss, and depriving the company of what influence it does have) or buy out the rest of Nook Media to shut it down and take what's worth having (which would likely cost more than one billion dollars). None of these alternatives seems especially pleasant. Personally, I think the last one has possibilities; having the Nook store installed on every Windows 8, RT and Windows Phone 8 device as the default e-reader could be lucrative, though it would take time for them to earn a profit. Whichever course it takes, Steve Ballmer must be fuming over in Redmond.

This deal between Google and Barnes & Noble has the potential to change the fortunes of the Nook; the question is, by how much? Nook tablets are well-made devices stymied by an inadequate app ecosystem. Now that this issue has been solved, customers may well give this also-ran of the tablet wars another look. Existing customers will be the biggest beneficiaries, as their tablets just gained hundreds of thousands of new apps, followed by Google, which will see revenue increase as new and existing Nook owners take advantage of their new options. What I'll be looking for is the response from Microsoft: Redmond is the wild card. Will it wait and see, or take direct action? Barnes & Noble investors should keep an eye on any such developments, as well as how Nook sales (both hardware and media) shake out. Until and unless they decouple from Barnes & Noble proper, any Nook losses will continue to drain valuable resources from the company.

Disclosure: I am long MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.