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Can Best to buy Stock Live Up To Its Name
retailer of consumer electronics, with roughly 19% from the domestic and 5% of the global market. Internationally, Best Buy has a couple of,400 smaller locations in Europe, 300 locations in Canada (such as the Future Shop brand), and 200 stores in China (mainly the Five Star brand). Best Buy's product categories are: electronic devices (TVs, digital camera models, etc. - about 31% of sales), computing and cell phones (laptops,[link widoczny dla zalogowanych], desktops, smartphones,[link widoczny dla zalogowanych], tablets,[link widoczny dla zalogowanych], etc. - 46%),[link widoczny dla zalogowanych], entertainment (gaming consoles, video games,[link widoczny dla zalogowanych], movies and music - 8%),[link widoczny dla zalogowanych], appliances (about 8%), and services (7%).
Once a fast-growing and highly praised retailer, Best to buy has fallen on hard times. retail market. While this appears like a tailwind,[link widoczny dla zalogowanych], the truth is that it has attracted a lot of competition. General retailers like Walmart (WMT) and Costco (COST) expanded their electronics offerings and have pushed aggressive discounts to drive store traffic.
However the bigger blow continues to be the popularity towards buying electronics and entertainment online. During the "Black Friday" weekend this season,[link widoczny dla zalogowanych], consumer electronics were the 4th fastest growing online product category, up 17% from last year. Directly behind it had been video game consoles, up 16%. The #1 grower,[link widoczny dla zalogowanych], digital content and subscriptions (up 25%),[link widoczny dla zalogowanych], also hurts Best Buy because it represents people purchasing digitally-delivered movies,[link widoczny dla zalogowanych], music, and video games, instead of the physical Blu-ray and game console disks sold in Best Buy's stores. In fact, gifs entertainment increased to 31% of category spend last year, up from 20% last year, and it is forecast to include another several percentage points in 2012. To put it simply, trends are moving quickly away from Best Buy's business design.
These trends are plainly visible within the results. Last quarter, Best Buy reported a 18% drop in entertainment sales, and also a 10% drop in consumer electronics. Overall,[link widoczny dla zalogowanych], the company reported another 4% decline in same-store sales, and without taking out any costs, operating profit declined to some minuscule 0.4% of sales, when compared to company's historical 4.5-5% margin.
There are two things to consider when analyzing Best to buy as a potential Magic Formula (MFI) investment. One, what's Best to buy worth being an ongoing company? And 2,[link widoczny dla zalogowanych], will founder Richard Schultze make good on his offer to accept company private, therefore,[link widoczny dla zalogowanych], what is a likely buyout timing and value?
Let's tackle the first question. I am not so worried about the general retailers. In fact,[link widoczny dla zalogowanych], Walmart has begun to reduce electronics space. Online sales,[link widoczny dla zalogowanych], though,[link widoczny dla zalogowanych], really are a bigger concern. To combat these,[link widoczny dla zalogowanych], Best Buy has outlined several initiatives, including a 10% reduction in store footage,[link widoczny dla zalogowanych], an increased focus on mobile devices and salesman knowledge, $400 million inSG cost reductions, and capturing much more of e-commerce spend. The final the first is particularly significant. Best to buy has already been the world's 11th largest online retailer,[link widoczny dla zalogowanych], and has some advantages with special financing offers and in-store pickup.
In my opinion the organization is concentrating on the best things and can eventually (over a few years) right the ship on margins. However,[link widoczny dla zalogowanych], entertainment is a lost cause here - the company cannot contend with Netflix (NFLX),[link widoczny dla zalogowanych], or Amazon (AMZN), or Apple (AAPL) in this space. Overall, I see about an 8% annualized decline in operating income over the next 5 years. This,[link widoczny dla zalogowanych], combined with already-suspended share buybacks along with a likely-to-be suspended dividend,[link widoczny dla zalogowanych], makes the ongoing value of the stock about $15, in my opinion.
Now,[link widoczny dla zalogowanych], how about founder Richard Schultze's ongoing takeover saga? Schulze already owns about 20% of the company, and in August agreed with the company to present a takeover bid expected to be worth $24-26 per share. It had been extended once,[link widoczny dla zalogowanych], after which extended again last Friday. Only a day before,[link widoczny dla zalogowanych], reports emerged that Schulze was prepared to bid $15-18! Now,[link widoczny dla zalogowanych], it's unlikely that any action on the bid can come before late February.
So, what is going on here? Schulze clearly doesn't need more time for research - hefounded Best to buy in 1966, was its CEO until 2002, and sat as chairman until stepping down in June of the year. It seems to me that certain of a couple of things are delaying this bid. One is that his financial backers - reportedly TPG Capital, Leonard Green Partners,[link widoczny dla zalogowanych], and Cerberus Capital - are becoming cold feet thinking about the firm's poor recent performance. Another is that those partners might want to watch for an even better price if fourth quarter answers are similarly poor. After all, the expected takeover bid was already trimmed nearly in half since August!
Frankly, I'm worried that it's more of the former compared to latter. For just one,[link widoczny dla zalogowanych], I believe Best Buy is likely nearing its operational nadir. 2012 was filled with management and board turmoil,[link widoczny dla zalogowanych], which probably slowed down operational action to enhance results. With things calming down and turnaround specialist Hubert Joly now in charge,[link widoczny dla zalogowanych], I think the numbers should start stabilizing. It may have been in the best interests from the private equity to firms to strike while the stock is affordable.
Given this,[link widoczny dla zalogowanych], I'm more inclined to go with $15 like a reasonable valuation for Best Buy. While that represents a decent 30% upside,[link widoczny dla zalogowanych], I am not real excited about it being one of the best MFI picks at present,[link widoczny dla zalogowanych], because of the risks. We'll slap a tentative "positive" outlook on the stock, but it's not Top Buy material.
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