RadioShack is a Value Trap

By Tom Gibbs - March 15, 2012 | Tickers: AMZN, BBY, RSH, S, SPLS | 0 Comments

• Email
• Print

Many investors following a strict value investing framework have made extremely successful careers in the location of small, obscure, forgotten, out-of-fashion, and most importantly, cheap enterprises.  If one looks long and hard enough, such firms with an attractive potential upside can be found across the board in many different industries. However, no firm is better representative of the aforementioned value adjectives in the consumer electronics retail space than RadioShack (NYSE: RSH). 

As the long forgotten, and much smaller comparable (in terms of sales) to other brick-and-mortal electronics chains like Best Buy (NYSE: BBY), and even an ancestor of newer and more virtual retailers like Amazon.com (NASDAQ: AMZN), RadioShack has definitely experienced a huge fall from grace since its uprise alongside the growth in the popularity of the DIY electronics craze in the 1970s and 1980s. 

Through a prolonged series of self-inflicted wounds, RadioShack has gone through several changes of incompetent management teams and a desperate search for an identity among the more powerful players in the field.  With a current enterprise value of slightly more than $767 million, RadioShack is more than eleven times smaller than Best Buy (their sales were about equivalent only fifteen years ago), and the smaller retailer only sells for 2.8x the EV multiple (ttm). 

This is by no means expensive, but is RadioShack a buy at current market valuations?

Opportunity Argument 1: RadioShack is entering new and exciting product markets

More now than ever before, operating in a comfortable niche within the consumer electronics retailing sector is of utmost importance.  With the widespread adoption of general consumer electronics (flat screen TVs, video game consoles, appliances) and mobile devices (smartphones, laptops, tablets), the industry is arguably already above the saturation level.  Many of the top retailers in the category are now scrambling to find more service-oriented offerings to supplement the decreasing core sales and depressed margins – as there are now more places to buy the goods and significantly more price competition. 

Retailers like Staples (NASDAQ: SPLS) have added higher margin and value added copying and printing centers, and have also expanded their direct-to-business delivery supply services.  Best Buy not only rolled out its Geek Squad service years ago, but has recently made an acquisition in the IT and cloud services market to further insulate itself from the difficult retailing segment.  Even Amazon.com, which is arguably in the best position in the industry due to the corporation not being burdened with a fleet of high fixed cost brick-and-mortar outlets, continues to expand into other intangible offerings (cloud services, digital music/movies, etc.).

While the competition is slowly attempting to create more meaning to their operations, as opposed to simply being pushers of commoditized consumer electronics, RadioShack has been very intent on entrenching itself deeper into the space.  The corporation, which once enjoyed a meaningful base of captive DIY electronics consumers, is now little more than a smaller version of an older, non-service providing Best Buy.  More than half of RadioShack’s revenues stem from mobility items, including smartphones, laptops, and tablets, and the deeper push into the segment has continually erased any semblance of a competitive advantage that the retailer once possessed. 

Likewise, the push into the segment is alienating old RadioShack loyalists and confusing new consumers.  With so many larger retailer choices from which to purchase such mobility items, not to mention actual carriers’ retail stores (AT&T, Sprint (NYSE: S)), there is little top-of-the-mind awareness among consumers that RadioShack is a legitimate player in the segment.  This being said, RadioShack management has not only had to heavily advertise the corporation’s new market positioning, but it has also had to offer deep consumer concessions to gain a foothold in the space (its “low price guarantee” promise).  Gross margins have significantly suffered as a result, and in realizing the strategy is not playing out as planned thus far, management has stated that it will continue to cut ad budgets for its DIY products – where it can actually create an attractive operating niche – in favor for heavier spending on mobility ads. 

Opportunity Argument 2: RadioShack has an attractive positioning within the market           

It has also been argued that RadioShack operates in an attractive position in the market in terms of convenience and accessibility. 

RadioShack’s image is not necessarily about having “cool” or “sleek” brand appeal, but more about offering the most crucial products at the consumers’ time of need.  A consumer who purchased a high definition television from Amazon.com, for instance, can rely on RadioShack’s almost ubiquitous nationwide footprint to quickly purchase a forgotten HDMI cable.  Management has stated before that with nearly 4,500 stores, RadioShack is located within 5 miles of nearly 95% of Americans’ homes or places of work. 

Most understand that a “cool” factor hardly translates into an economic profit on a stand-alone basis.  Captive customer bases, unbeatable economies of scale, or preferential access to rare materials may be improved by such a coolness boost, but do not require it to create a sustainable competitive moat around a given corporation. 

RadioShack may not have the same cool image in the minds of consumers as do competing retailers like Best Buy and Amazon.com, but its so-called favorable positioning in terms of a convenience/proximity factor by no means grants the corporation access to prolonged periods of above-average profitability.  Building consumer awareness along the lines that RadioShack is where one can purchase an item forgotten during a trip to another retailer is not going to save the corporation from irrelevancy in the consumer electronics market. 

Such an a convenience/proximity argument only acts to bake in the fact that the retailer has little top-of-the-mind awareness, and is simply an easy place to go for quick, single item purchases. 

Opportunity Argument 3: RadioShack is, most importantly, cheap

There can be no doubt that a mediocre company, if purchased at a cheap enough price, can end up being an extremely attractive investment opportunity.  However, for a mediocre retailer like RadioShack, is the current market valuation inexpensive enough? 

Absolute valuations aside (cheap firms can be deserving of cheap valuations), RadioShack does not appear to be absolutely dirt cheap.  The firm sells for around tangible book value, and seeing that inventory comprises 97% of its enterprise value, the corporation is undoubtedly worth considerably less in a liquidation scenario.  Depending on how one estimates the value of the electronics inventory in such a scenario (would it be worth 75% less? 50% less? 25% less?) it would not be unreasonable to calculate that the current price is more than double its liquidation price.  Cheap, yes, but is it value investing, unreasonably cheap?

The RadioShack bull thesis becomes even less attractive when one analyzes the current market valuation of the much larger Best Buy.  At $24.40/share, Best Buy also sells for less than 10x P/E and 3x EV.  Likewise, aside from the fact that Best Buy has a much better likelihood of surviving the transformation into other service-oriented offerings, the larger competitor is also less expensive on a free cash flow basis. 

Assuming that the purchase price per retailer can be expressed on a sellable square footage basis (enterprise value/sales floor square feet), Best Buy’s return (i.e. “Yield” = (FCF/Square Foot)/(EV/Square Foot)) is more than 1,000 basis points higher than that of RadioShack.  Best Buy has yet to release its most recent fiscal year results, and the estimation assumes that the retailer constructed all of the stores it laid out in its 2011 store openings plan in its last annual report, and assumes that fiscal year 2011 free cash flow is more or less equivalent to the free cash flow generated in the twelve months ending November 2011.  Considering that December 2011 sales were equivalent to the comparable month last year, most of the firm's growth spending is included in the first three quarters $616 million capex figure, and that cash from operations in the first three quarters of 2011 was nearly five times greater than the comparable level last year, such projections are not extraordinarily speculative. 

RadioShack may be inexpensive, but the assumed value investment opportunity becomes significantly less attractive when one considers they can purchase a much more powerful, healthy, and cash generative competitor in Best Buy for less.  Similarly, as the consumer electronics retail sector becomes increasingly saturated and the existing players continue to sell the same increasingly commoditized goods, Best Buy is undoubtedly in a better position to expand into insulating product/service offerings. 

Outlook at RadioShack for the upcoming year is also relatively weak, implying that even if the company is inexpensive, there are very few known catalysts that would boost it to a higher valuation.  Sales are expected to experience a modest improvement, but with the firm’s intentions of pushing itself deeper into the mobility product segment with heavier advertising expenditures and more consumer price concessions, fewer and fewer of those dollars will fall to its bottom line. 

• Email
• Print
• Feedback