Can a Knight in Shining Armor Save Barnes & Noble?

Shares of Barnes & Noble (NYS: BKS) skyrocketed today, following the announcement that Microsoft (NAS: MSFT) will inject $300 million into the ailing bookseller's digital-book division and college texts unit in exchange for a 17.6% stake in the businesses.

The saga continues
For those of you who have been following this saga, you'll recall that Barnes & Noble acknowledged earlier in the year that it was exploring a separation of the Nook division. At the time, many investors and analysts wondered how it could do so, and what such a spinoff would be worth.

These questions are now largely answered. In the first case, the two companies created a new business entity, creatively named Newco for the time being, to house the partially spun-off units. While it will remain a subsidiary of Barnes & Noble, this makes any eventual and complete separation much easier to effect. According to the bookseller's press release: "The company intends to explore all alternatives for how a strategic separation of Newco may occur."

And second, we now have a much better idea about what the bookseller's digital business is worth. Microsoft's $300 million investment for a 17.6% stake puts a $1.7 billion valuation on the venture. For those of you who were wondering, this is more than twice the pre-announcement market capitalization of the bookseller's entire business, which was approximately $820 million when the market closed on Friday.

A fortuitous alliance of strange bedfellows
It's no exaggeration to say that the two companies make for strange bedfellows. The software giant sued Barnes & Noble last year claiming the Nook infringed on a number of Microsoft patents. As a result of the present alliance, the two parties have settled the suit and Barnes & Noble will now have a royalty-bearing license to use Microsoft's intellectual property.

In addition to resolving the outstanding legal issues, the partnership and capital injection will unquestionably help the bookseller compete against the likes of (NAS: AMZN) and Apple (NAS: AAPL) , both of which have a looming presence in the digital book business and much more money to throw at the market.

While its competitors continue building their war chests -- for instance, after generating $14 billion in cash from operations over the past three months alone, Apple now has more than $100 billion in mostly liquid assets on its balance sheet -- Barnes & Noble's is in a state of perpetual depletion.

In its most recent fiscal quarter, Barnes & Noble's digital business reported a loss before interest, taxes, depreciation, and amortization of $93.7 million. This was notably worse than the $50.5 million loss from the same quarter a year ago. And as I discussed at the beginning of the year, the company is burning through its cash and has been forced to take on a dangerous amount of debt just to stay afloat.

A history of interest and one outstanding question
Like a carcass being picked over by vultures, Barnes & Noble has been the subject of much interest by activist investors going back nearly two years.

At the end of 2010, in what fellow Fool Alyce Lomax dubbed the market's strangest plot twist, William Ackman and his investment firm Pershing Square Capital Management announced in a regulatory filing that they had offered to finance a $963 million bid by the now-extinct Borders for Barnes & Noble.

Six months later, in May 2011, Liberty Media (NAS: LCAPA) proposed to buy Barnes & Noble for roughly $1 billion, or $17 in cash per share.

And just last week, Jana Partners -- a hedge fund with both a track record and knack for meddling -- accumulated a 14% stake in company, spurring Fool Andrew Marder to ask: What does a hedge fund want to do with this retailer? I think we have our answer, as the firm has now doubled its investment in less than a week. The only question, of course, is whether Jana Partners knew about the proposed agreement or not before staking its position -- though this is a topic that must be left for another day.

Foolish bottom line
For Barnes & Noble shareholders, the recent announcement will be greeted with enormous relief, as shares in the company haven't traded above $20 since last summer. For those of you thinking about getting in, however, I'd urge you to read our free report "The Motley Fool's Top Stock for 2012" before doing so. It details a much less speculative retailer that some have even called the next "Costco of Latin America." Access this free report while it's still available -- it's free.

At the time thisarticle was published Fool contributor John Maxfield's 401(k) fund holds share in Barnes & Noble. The Motley Fool owns shares of Microsoft,, and Apple.Motley Fool newsletter serviceshave recommended buying shares of Microsoft, Apple, and, creating bull call spread positions in Microsoft and Apple, and writing puts on Barnes & Noble. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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