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Why You Shouldn’t Fall for Barnes & Noble’s Massive Run-Up

If you purchased Barnes & Noble (NYSE: BKS) shares Friday morning, you might not be reading this right now. Instead, you’re probably busy celebrating the insane surge in share price on Monday.

The stock blasted 90% virtually overnight on news that Barnes & Noble is spinning off its digital book and college textbook segments, and partnering with Microsoft (Nasdaq: MSFT) in the process.

Pardon me while I interrupt your champagne uncorking, but let’s take a look at why this move has investors tuned in… and why you should practice caution if you’re thinking of following their lead.

E-Readers’ Questionable Future

Partnering with Microsoft was obviously a huge part of investors’ excitement. The software giant contributed $300 million toward the deal, making it a 17.6% stakeholder and valuing the new business at $1.7 billion.

That’s about $500 million more than Barnes & Noble’s current market cap and double its market cap last week. This certainly underscores the importance the company is placing on its Nook digital content business.

Indeed, Nook e-reader sales and digital content revenue were up 38% and 85%, respectively, last quarter. And partnering with Microsoft should help drive sales higher. As Morningstar Equity Research analyst, Peter Wahlstrom, told The New York Times, “It gives [Barnes & Noble] a much larger, financially stable partner.”

The problem is that the dedicated e-reader business could be on the outs…

Last week, Fast Company’s Kit Eaton wrote, “E Ink Holdings, the firm behind the allegedly easy-on-the-eyes daylight readable electronic paper that once made your Kindle or Nook so great, has just reported its first loss in 10 successive quarters… What we think is happening is that the era of the e-reader as a must-have device is drawing to a close.”

I tend to agree.

As tablet devices continue to gain popularity, it’s going to get tougher for consumers to justify dishing out cash for a dedicated e-reader. After all, tablets are capable of running e-book apps just fine, while giving users access to other popular applications as well.

I know, e-ink displays are much easier on the eyes and much better in sunlight than the backlit displays on tablets. But you get over it, believe me.

As an owner of the original Nook, I swore up and down that I would still use it for reading after I got an iPad. But a month later, I only used the Nook when I was reading outside. A month after that, I put it in a drawer and never looked back.

So with e-readers losing steam, that just leaves Barnes & Noble’s (non e-ink) tablet business to pick up the slack, which isn’t exactly stellar right now, either.

Windows 8 or Bust

After launching the $249 Nook Tablet in November, the company’s share of the global tablet market actually dropped last year to 3.5% from 4.5% in 2010, according to IDC.

At the same time, Amazon’s (Nasdaq: AMZN) $199 Kindle Fire tablet has been crushing it. In fact, comScore reported last week that Amazon claims more marketshare with the Fire than any other Android tablet on the market today.

Barnes & Noble is trying to keep up, though. It launched a cheaper Nook Tablet in February at the same $199 level. But in March, Amazon responded with a price drop of its own, bringing the price of its refurbished Kindle Fire down to $139. And the device sold out immediately.

And – surely in response to the recent Barnes & Noble news – Amazon announced that the same offer is back on today. Nice touch.

Bottom line: With tablets quickly becoming the best way to dominate in the digital content space, Barnes & Noble’s weak tablet offering will make it difficult for the company to steal e-book marketshare from Amazon.

I’m convinced that Barnes & Noble’s only hope of staying competitive in the space is to leverage its new partnership with Microsoft and release a device that runs the new tablet-centric Windows 8 operating system. That way, it can offer a superior user experience that might sway some consumers on the hunt for a low-cost iPad alternative.

In the meantime, invest with caution.

Good investing,

Justin Fritz

Justin Fritz

, Executive Editor

View More By Justin Fritz