Barnes & Noble's Nook Color, left, and Nook Simple Touch e-readers.… (Paul Sakuma, AP )
Barnes & Noble Inc.'s prospects against rivals Amazon.com Inc. and Apple Inc. in the fast-growing digital reader business just got a big lift thanks to a $605-million investment from Microsoft Corp.
For the nation's No. 1 bookstore chain, the infusion will help its Nook business better compete against the top-selling Kindle e-reader and iPad tablet computer and relieves some of the pressure on Barnes & Noble to turn a profit on the Nook.
It's also a good deal for Microsoft, which is spending barely 1% of its $60-billion cash reserve to gain a bigger presence in the e-reader and tablet markets ahead of the widely anticipated launch of its Windows 8 operating software later this year. As part of the deal, Windows 8 will feature a Nook e-reader app, the companies said.
Wall Street took notice, with Barnes & Noble shares nearly doubling before settling back to $20.75, up 52%. Microsoft's stock was little changed, rising 3 cents to $32.01.
The software firm and the retailer — companies that not long ago were considered unshakable industry leaders but have lately lost some of their luster — said Monday that as part of the investment, Barnes & Noble would create a new subsidiary, tentatively dubbed Newco.
Microsoft will make a $300-million initial investment in exchange for a 17.6% stake in Newco, which as a result valued the digital subsidiary at $1.7 billion, more than Barnes & Noble's total market capitalization of $1.2 billion. Microsoft said it also agreed to invest an additional $305 million over several years, primarily to help fund Newco's international expansion.
The deal underscores the importance of the digital book business as consumers increasingly turn to electronic sources to buy and read books, analysts said.
Investors had worried that Barnes & Noble didn't have the capital to support an e-reader business to rival that of Amazon; Nook is the company's fastest-growing business, with a 64% year-over-year sales surge in its most recent quarter.
William Lynch, chief executive of Barnes & Noble, said the collaboration would enable the New York company to "significantly expand" its digital business and reach hundreds of millions of users through the Windows platform.
For Microsoft, the partnership means access to Barnes & Noble's vast collection of digital content — assets it will need as it tries to become a bigger player in the tablet market, said Colin Gillis, a tech analyst BGC Financial.
"This is not a major investment for Microsoft, but it does help fill an important role," Gillis said. "It's not make or break for them. If it pays off, that would be fantastic."
Barnes & Noble has been a strong presence in the market for e-reader devices and the more sophisticated iPad-like tablet computers. The company's black-and-white Nook e-reader controlled 13.4% of the global market for those devices last year, making it the second-most popular electronic reader behind Amazon's Kindle, according to data from IDC.
Its Nook digital tablet was No. 4 behind the iPad and others, accounting for about 5% of global tablet sales. In 2011 tablet makers sold 68 million devices, more than twice the number of e-readers sold worldwide.
But by teaming up with Microsoft, the Redmond, Wash., manufacturer of the bestselling Windows operating system, Barnes & Noble could see its Nook reading software installed on many millions of new computing devices, said Bob O'Donnell, a device analyst at IDC.
Any questions about Nook's long-term viability are now gone, he said, noting that the partnership could help Barnes & Noble catch up to other lower-priced tablet makers. "It's clearly a shot across the bow of Amazon, saying, 'Hey, we're for real.' "
So far, tablets running Microsoft Windows 7 have sold in "extraordinarily small numbers," O'Donnell said. But analysts expect that Windows 8 will be available later this year on tablets and personal computers from firms such as Dell Inc., Lenovo Group Ltd., Toshiba Corp. and AsusTek Computer Inc.
A Microsoft spokesman declined to comment on the specific devices that would run the Nook application.
Analysts also said they viewed the deal as a sign that Microsoft was not interested in pursuing a widespread bricks-and-mortar store network.
"I think this is a vote 'no' on Microsoft stores, perhaps with the executives seeking to make an investment in Barnes & Noble overall should the venture pan out, and stuff the stores with elite Microsoft products," said Brian Sozzi, chief equities analyst at NBG Productions.
If the partnership is successful, "the entire company could get even more of a Microsoft investment," he said.
After a tumultuous 2011, Barnes & Noble announced in January that it was considering separating its digital business. That idea is still a possibility: On Monday, Barnes & Noble said it "intends to explore all alternatives for how a strategic separation of Newco may occur." The company said it had no timetable for the review and didn't know whether a spin-off or the creation of a stand-alone public company would happen.
The partnership ends a patent dispute between Microsoft and Barnes & Noble over the use of Android, which Microsoft says violates its patents, on the Nook. As a result of the settlement, both Barnes & Noble and Newco will have a royalty-bearing license under Microsoft's patents for Nook e-readers and tablets.
Times staff writer Michelle Maltais contributed to this report.