By Phil Wahba
(Reuters) - Microsoft Corp will invest $300 million in Barnes & Noble Inc's Nook e-reader, gaining a foothold in the fast-growing e-books market as the bookseller gets more firepower to compete against Amazon.com's Kindle and Apple Inc's iPad.
The move comes as Microsoft is looking to generate excitement around its tablet-friendly Windows 8operating system, expected on the market around October.
The deal announced on Monday includes Microsoft taking a stake in the bookseller's college bookstore division. It also means that the two companies have settled their patent dispute.
Shares of Barnes & Noble soared nearly 70 percent on Monday, while Microsoft shares were nearly flat.
The agreement values the Nook and textbook businesses, which will form a new subsidiary, at $1.7 billion.
"This is not a financial investment. It's a strategic investment to strengthen Windows 8 as a platform for tablets and e-reading," said BGC Partners analyst Colin Gillis.
Barnes & Noble gets a much-needed capital injection and a way to enter the digital books market outside the United States.
Microsoft will receive a 17.6 percent stake in the new company, temporarily called Newco. It will be run by Barnes & Noble and will maintain a relationship with the U.S. bookstore chain's nearly 700 stores.
Barnes & Noble's Nook has found a strong following, allowing it to garner some 27 percent of the U.S. e-books market in the 2-1/2 years since the device was launched. But battling Amazon's market-leadingKindle has proved expensive.
"It gives them a much larger partner with deeper pockets, it gives them increased reach," said Morningstar analyst Peter Wahlstrom. "In the last two years they've had their backs against the wall."
Last year, Barnes & Noble suspended its dividend to have more cash to develop Nook. In January, it lowered its sales and profit forecasts.
The companies also said on Monday that they have settled their patent litigation. Last year, Microsoft filed lawsuits for patent infringement against Barnes & Noble over the Nook in part of its assault on devices running on Google Inc's Android system.
NOOK TO GO GLOBAL
Barnes & Noble has poured tens of millions of dollars into developing the Nook. The first version hit the market in 2009, two years after the Kindle.
The company's e-readers, tablets and electronic book sales have helped it offset a broader decline in book sales. Same-store sales of books at its brick-and-mortar stores have edged up again largely thanks to the bankruptcy last year of Borders Group.
But the Nook has been available only in the United States and the company said last year it wanted to take its digital business to new markets.
Barnes & Noble's CEO, William Lynch, told analysts on a conference call Microsoft's reach would help in that regard.
"We will have the opportunity to collaborate on developing best-in-class reading technologies for those Windows users and extend the digital bookstore to hundreds of millions of people in the U.S. and internationally," he said.
The company had said in January that it might spin off its digital business, which includes the Nook, arguing that investors were not giving the company enough credit for that growth.
The company did not say on Monday if it would take the new company public.
Barnes & Noble put itself up for sale in 2010 but attracted only one firm offer - a bid for $17 per share, or $1 billion, last May, from Liberty Media, which was drawn by the Nook's growth.
Liberty ultimately decided to invest $204 million rather than buy the company outright. It now has preferred shares it can convert into a 16.6 percent stake in Barnes & Noble at a strike price of $17. A spokeswoman for Liberty Media was not immediately available for comment.
Some 71 percent of Barnes & Noble is held by its top four shareholders, making the stock's moves more volatile. It is also one of the New York Stock Exchange listed shares with the highest short interest, adding to their jumpiness.
Barnes & Noble shares were up 67 percent at $22.85 late on Monday morning. The company was valued at just above $823 million at Friday's close.
Microsoft shares were unchanged at $31.98.
(Reporting by Phil Wahba, Martinne Geller and Sinead Carew in New York; Additional reporting by Mihir Dalal in Bangalore; Editing by Lisa Von Ahn, Maureen Bavdek, Dave Zimmerman and Matthew Lewis)