Best Buy Preparing Bull Trap

Dana is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Best Buy (NYSE: BBY) is preparing a bull trap for investors this summer.

The company's shares are up 126% so far this year, spurred by a strong dividend and stock buybacks. The company has continued to rise in value even as founder Richard Schulze, who holds 20% of the shares, ended his push to take over the company and returned to work as “chairman emeritus.” 

Explaining Microsoft's move

Schulze has done very well by his dance for control, essentially doubling the value of his holdings while doing nothing to actually increase value. The latest move in that direction is to basically give Microsoft (NASDAQ: MSFT) control over its PC sales, and while some are calling this “a critical strategic move”  it's really nothing of the sort.

That's because Microsoft has had de-facto control over BestBuy's computer sales for years. BestBuy was never a Macintosh shop. In past years it trotted a bunch of Microsoft OEM boxes and waited for the customers to arrive. Their failure to arrive is behind the company's fall.

So this is a move of weakness on both sides. BestBuy knows its old strategy was a loser and has nothing to replace it. Microsoft will use its control over 600 BestBuy locations to push its broader strategy of tablets and phones, not just PCs.

BestBuy numbers a sad story

Meanwhile, BestBuy's financial results make no sense in context of its stock's move. The company eked out an operating profit for the quarter ending May 4, but it was the first such profit since last summer, and a fraction of the $158 million earned in the same period a year earlier.

On top of that the company is shrinking, due to store closings. Sales for the May quarter were $9.3 billion, down by nearly a third from the Christmas period but, more important, down 10% from the same quarter in 2012, when sales were $10.37 billion.

Despite this, the company continues to pay a dividend, $0.17 per share. That's over $60 million going out the door each quarter – the company hasn't been able to sustain such a dividend pace since 2011.

BestBuy holds its annual shareholders meeting in June, where it will ratify Schulze's two new appointments to the board, in order to maintain peace there. But it next reports earnings in August, and by that time it will be impossible to hide what's actually happening from shareholders.

I believe Schulze is waiting for that opportunity. The stock crashes, he comes in with a new buyback offer, at a price much lower than he previously contemplated, and looks like a hero, while he squeezes the newly-private company for enough cash to come out ahead.

So buy Microsoft?

Microsoft has been engaged in something similar since April, boosting its stock price 24% with hope rather than actual results. That's a $50 billion increase in the market cap without any change in the market fundamentals. 

The company's most recent results, for the quarter ending in March, show that it is on a profitable path, albeit one with only limited growth. Revenue was $20.5 billion, net income $6 billion, and about $2 billion went out the door in the form of dividends.

Microsoft has had some victories. Its Xbox game machine has taken command of the U.S. gaming market, and Office has maintained its share with lower prices and online subscriptions.

But the Windows franchise remains under threat, because the company is just not competitive – on prices and feature – with iPad tablets and Android phones. The BestBuy stores are meant to address that problem, as is Windows 8.1, a replacement for last year's failed Windows 8 which is being rolled-out free to those customers, but betting on success is a speculation, at best.

You can believe in the Microsoft story, in other words, but that will be fueled by belief, and not reality. Stories like that do work in technology, sometimes. But only sometimes.  

My Foolish take

Once the August numbers are out, however, there will remain time for you to get out, because you'll probably read a lot of stories about Microsoft engineering a buyout, about how it “has” to buy BestBuy because it's so wedded to that company's channel.

Don't buy it. Sell when you have a profit. Let the Schulze-Microsoft-BestBuy board machinations take care of themselves. Whoever wins that game, shareholders are almost certain to lose it, because there's no one else they can squeeze out for their profit.  

Investors are much better off in Microsoft than in BestBuy, but I'm not personally convinced that Microsoft is getting off the mat here, so I'll remain on the sidelines. 

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Dana Blankenhorn has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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