Should You Buy Into the Barnes & Noble E-Book Hype?

Should You Buy Into the Barnes & Noble E-Book Hype?

Brick and mortar booksellers have had a rough go of it lately. Just last year, Borders Group Inc., filed for bankruptcy and closed more than 500 Borders superstores worldwide. The fact of the matter is that the publishing industry is being increasingly dominated by e-book sales. While hardcover and paperback sales have fallen over the past few years, sales of e-books jumped 39% from 2008 to 2010. Customers are starting to favor e-books because they are as portable as hardcovers, usually cheaper, and save a trip to the store and storage in your home and office.

So, this morning, investors were delighted to hear that Barnes & Noble Inc. (BKS) has entered into a digital-reading-technology partnership with Microsoft Corp. (MSFT). Basically, the two companies are creating a subsidiary valued at $1.7 billion designed to increase both companies’ exposure to the e-book market. The tentative name of the subsidiary is Newco and Barnes & Noble will have an 82.4% equity stake while Microsoft will own the remainder.

This is a smart move for Barnes and Noble, because while its overall profits have been on the decline, the company’s NOOK e-reader and e-book sales jumped 38% in the third quarter. The company has also just released a new 8GB NOOK Tablet at a very competitive price. By creating a separate e-book business, the company will be able to capitalize on this strength and create business strategies that are better tailored to this new market.

Shares of BKS opened up 85% on Monday morning on this news. It’s great to see such strong investor interest on an otherwise lackluster day, but before you rush in to buy this stock, I urge that you look at BKS’ Portfolio Grader rating. Currently, buying pressure for this stock is keeping BKS at a buy. However, the company still has plenty of room for improvement in terms of its fundamentals. Although Barnes and Noble has firmed up its earnings momentum, the company has failed to beat earnings surprises and its return on equity is quite weak.

So, while I consider this an exciting development for BKS, I would proceed with caution before chasing this stock because it may take some time for the company to reap the benefit of this new deal.

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