Best Time for Best Buy Bid Now as Founder Exits: Real M&A
June 10, 2012
By Tara Lachapelle and Chris Burritt
There’s never been a cheaper time for private-equity firms to gamble on Best Buy Co. (BBY) (BBY), with founder Richard Schulze’s 20 percent stake up for grabs and the electronics retailer near its lowest-ever valuation.
The world’s largest seller of consumer electronics is trading at 4.8 times earnings after reaching a record low of 4.3 times last month, according to data compiled by Bloomberg. With Best Buy’s price-earnings ratio making it the least expensive U.S. retailer greater than $1 billion, buyout firms could get a company that generates the most free cash relative to its stock price in the industry.
Once valued as high as $29 billion, Best Buy has plunged to $7 billion and posted its first annual loss in two decades as same-store sales (BBY) fell in seven of the last eight quarters. Schulze, who resigned last week as chairman after failing to inform the board of allegations the chief executive officer had an inappropriate relationship with an employee, is exploring “all available options” for his stake. That may spark interest from buyout firms, said Telsey Advisory Group, for a deal that would be the biggest in the U.S. retail industry since 2005.
“It’s easy to see the benefit of them being private right now,” Matt Arnold, an analyst at St. Louis-based Edward Jones & Co., said in a telephone interview. “It comes down to whether there’s an interested buyer that sees value in Best Buy and is willing to take on the risk. Even though there are pressures, it’s still generating pretty substantial profitability, especially as measured by free cash flow, which is how private equity is going to be thinking about this.”
Best Buy declined to comment, said Bruce Hight, a spokesman for the Richfield, Minnesota-based company. Meghan Stafford, a spokeswoman for Schulze, said he declined to be interviewed.
Shares of Best Buy have tumbled 30 percent (BBY) in the last 12 months for the third-worst performance among retail companies in the Standard & Poor’s 500 Index. The stock has declined in three of the last four years as Best Buy lost sales to Amazon.com Inc. (AMZN) (AMZN) and other online retailers.
Best Buy posted a net loss (BBY) of $1.23 billion on revenue of $50.7 billion for the fiscal year that ended in March, its first annual loss since 1991, data compiled by Bloomberg show. Same- store sales (BBY) slipped 1.7 percent because of a pullback in discounts after the holiday shopping season. To trim costs, it’s now shutting 50 big-box locations in the U.S. this year while upgrading its website and accelerating the opening of stores to sell mobile phones.
The company’s price-earnings ratio (BBY) of 4.8 on June 8 was cheaper than all other 71 U.S. retailers with market values exceeding $1 billion and less than a third of the group’s median, according to data compiled by Bloomberg.
Best Buy’s results for the most recent quarter included a month of overlap with the previous quarter after the company moved the end date for its fiscal year a month earlier. The multiple is based on the sum of earnings from continuing operations in the last four quarters.
“If you think the company is going to survive, then it’s very cheap,” Joe Feldman, a New York-based analyst at Telsey Advisory, said in a phone interview. “We’re in the camp that there’s a place for Best Buy. It just has to transform and change a bit.”
The stock’s depressed valuation relative to the amount of free cash flow Best Buy generates may appeal to leveraged buyout firms, Feldman said. The excess cash could be used to pay off debt used to take the company private, he said. The retailer had $2 billion in debt (BBY) and $1.4 billion in cash as of May 5.
Best Buy was valued last week at just 4.3 times (BBY) its cash from operations for the last 12 months after deducting capital expenses. That’s cheaper than every other retailer in the world with a market capitalization larger than $1 billion and less than a quarter of the industry’s median free cash flow multiple of 19 times, data compiled by Bloomberg show.
Private-equity buyers may see an opportunity to boost profit by more aggressively downsizing Best Buy’s big-box stores, which would reduce rent and employee costs, according to Edward Jones’ Arnold. That would enable the company to sell merchandise at lower prices and better compete with Web retailers like Amazon, he said.
“It’s not like there’s a lack of interest or demand in consumer electronics,” Arnold said. “It’s that the stores are too large. With smaller locations it’s easy to cover overhead costs and generate a good level of earnings power.”
Best Buy shares extended their drop after Brian Dunn, 52, resigned as CEO in April at the outset of a board investigation that found he had an inappropriate relationship with a 29-year- old female employee with whom he e-mailed and texted frequently. The probe found he also loaned her money and gave her free tickets to concerts and sporting events.
A month later, Schulze, who founded the company in 1966, said he would resign as chairman after Best Buy’s annual meeting June 21 for failing to relay the allegations about Dunn’s conduct to the board. Schulze, 71, planned to remain a director through the 2013 meeting.
Instead, last week Schulze announced he was resigning immediately as chairman and from the board (BBY) and would explore options for his 20.1 percent stake, which makes him the company’s largest shareholder (BBY).
Some investors are speculating Schulze’s resignation is a sign he may want to lead a buyout of the company, said Michael Pachter, an analyst for Wedbush Securities Inc. in Los Angeles.
“He’s either going to sit there and watch his asset waste away over time, or he’s going to do something,” Pachter said. “It’s not like he had to resign from the board to become activist, but he did need to resign if he wants to do an LBO.”
It will still be challenging for Schulze to find private- equity firms willing to take on the risks associated with Best Buy and to help fund a transaction, he said. According to Pachter, Best Buy’s cash flow will keep declining and the company will continue to lose money.
A buyout of Best Buy would cost at least $30 a share to convince long-time investors to sell, said Anthony Chukumba, an analyst at BB&T Capital Markets in New York. That would be a 50 percent premium to last week’s closing price and equate to a total deal value of about $11.2 billion, including net debt.
“The probability of an LBO is very, very low,” Chukumba said in a phone interview. “Not only do you have a bad macroeconomic environment, which generally makes lenders skittish, but you’ve also got a company with declining comparable-store sales, deteriorating profit margins (BBY), rising competition” and too many stores, he said.
At $11.2 billion, taking Best Buy private would be the largest U.S. retail deal since 2005 when Federated Department Stores Inc., now Macy’s Inc., agreed to buy May Department Stores Co. for almost $17 billion, including net debt, data compiled by Bloomberg show.
“It would be a big LBO,” Scott Rostan, a former M&A banker and founder of Training The Street, which trains new hires at banks on mergers, said in a phone interview from New York. “But with a branded name of this caliber, it could potentially be feasible if there is some certainty around those cash flows. I’m sure there are financial sponsors out there who are evaluating this.”
While a takeover isn’t imminent as Best Buy focuses on a turnaround and its search for a new CEO, Schulze’s possible sale of his ownership stake removes one barrier to a deal, said R.J. Hottovy, an analyst for Morningstar Inc. in Chicago.
“It probably would be better off as a private company in the sense that it would allow them to make a lot of the changes they need to make,” he said. “It is certainly a brand that people still recognize. There’s a big opportunity to shed a lot of excess costs in this business model right now and that’s a hallmark of a private equity situation.”