What Best Buy's Earnings Mean for its Buyout Offer
Young is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
On Aug. 6, Best Buy (NYSE: BBY) founder Richard Schulze issued a formal public written offer to take back the company he once owned for approximately $24-$26 a share. Since receiving that offer, the Best Buy Board has been somewhat reluctant to reject it outright and has indicated that they will consider the offer after Q2 earnings results are released on Aug. 21.
One thing the public does know about the Best Buy buyout offer is that Schulze's multiple requests to conduct due diligence were all initially rejected by the Best Buy Board of Directors. In an interesting turn of events, it appears that Schulze rejected the Board's most recent offer to allow him to conduct due diligence this past Friday. This means that the deal that Schulze put together was most likely based on the financial information available from the company's Q1 results and prior to Schulze's resignation.
Industry analysts and pundits have already identified many of the obvious hurdles and headwinds facing a buyout. For example, Schulze's informal offer had multiple contingencies and most analysts believe that the price being offered by Schulze for the stock is too low (which is also why multiple law firms have already started to conduct investigations into any potential sale).
Of course most investors also know that the leveraged buyout concept is generally contingent on financing the purchase of a company through a combination of both equity and debt, where free cash flow and assets of a company are used to secure and repay the debt used to acquire the company. This is why the viability of Schulze's buyout offer will likely hinge in large part on Best Buy's Q2 results.
Even assuming that Schulze's buyout offer was fair, the valuation would require him to raise approximately $8-$9 billion in additional capital from both private equity and in debt to consummate the deal. This is where the company's current financial situation could play a big role in whether Schulze will be able to find private equity partners necessary to take Best Buy private. If Best Buy's overall revenue and free cash flow have decreased since Q1 and if debt has increased, then Schulze may find it difficult to convince private equity partners to come on board to the deal that was previously offered to the Best Buy Board of Directors.
In a leveraged buyout, strong revenue and large amounts of free cash flow would be used to help those buying the company to secure and repay debt, and would play a role in helping to finance the acquisition of the company. Without strong revenues and large amounts of free cash flow, private equity capital may want to re-consider whether a leveraged buyout of the company makes good financial sense since a corresponding amount of debt (to equal the amount of cash that the team expected would be there) would likely have to be added to the deal to make it happen. It also doesn't help that Best Buy already has an impending $1.5-$1.65 billion poison pill coming in the form of bond offerings that would have to be repaid if the company's debt is downgraded. It helps even less that S&P has already downgraded the company's debt rating to near junk status, making future debt even that much more expensive.
Based on the history of the Best Buy Board of Directors, it's likely that the company has already taken steps to reduce cash while increasing debt. The public knows that the Best Buy Board of Directors has been anticipating the buyout offer for months and has already taken steps to ensure that the company is situated to prevent it from happening. This is why during the last annual shareholder's meeting, Best Buy's leadership set the minimum threshold of ownership required for a shareholder to call a special meeting related to a change of control, to 25 percent (right above the amount owned by Schulze). Additionally, Best Buy's cash position was likely further reduced via the company's recent plans to expand internationally with its international partners, (5-Star and Carphone Warehouse), the cash payouts that have been given to its management team to simply stay with the company, acquisitions of other companies during the past quarter, along with Best Buy's plans to change to a new store format.
These moves by Best Buy's Board of Directors and its management team are likely to have reduced free cash flow while boosting both debt and assets (assets that would have to be discounted if used for security in any impending buyout but which would have to be figured into the value of any buyout deal). Finally, overall revenues are likley to have decreased for Best Buy in Q1 of this year, since electronic retail sales (as reported by the Census Bureau) were poor overall for the quarter, and as evidenced by the Q2 earnings reports of hhgregg (NYSE: HGG) and RadioShack (NYSE: RSH). As a recap, owners of hhgregg shares saw the stock price fall from $11.54 at the close of the bell on July 10 to as low as $6.08 in the days after the company reported advance Q2 guidance below analysts estimates and after the company lowered full year guidance. Owners of RadioShack took a similar hit as they watched that company's stock price fall from $3.65 at the close of July 24 to as low as $2.36 in the days after RadioShack reported its earnings miss last month. To date, neither stock has fully recovered to the pre-Q2 earnings announcements levels. Assuming Best Buy, the largest consumer electronics retailer in what might be a declining industry, shares a similar fate this past quarter, private equity might no longer have an interest in trying to privatize a company with lower free cash flows and greater amounts of debt.
The information gleaned from Best Buy's Q2 earnings report may give private equity the opportunity to conduct the due diligence they were previously denied, and may allow private equity firms considering the deal to determine whether it makes sense to try to take the company private. Of course don't expect the initial offer made by Schulze to be rescinded by the company's former founder, or to be rejected by the company's Board of Directors. As long as the offer remains on the table, it provides a level of support for the stock price, regardless of how unlikely it is that such an offer would ever be consummated.
Those interested in whether Best Buy will be taken private will probably also be closely watching to see exactly how much of Best Buy's free cash flow is still left in the company's vaults, its overall revenues for last quarter, and how much more debt the company has taken on since Q1. The numbers associated with those figures might send a pretty strong message about whether a takeover will be likely to really happen and how cooperative the Best Buy Board of Directors will be with the prospect of a buyout.
I am short BBY via September 2012 and January 2013 puts. I have no other positions in any other stocks mentioned in this article. Nothing in this article, or any subsequent comment (from the author or from any other member) should be construed as legal advice. The opinions expressed in this article are solely the personal opinions of the author. Readers are cautioned to do their own due diligence prior to opening a position in any equity. The Motley Fool owns shares of Best Buy and RadioShack. Motley Fool newsletter services recommend hhgregg. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.