Bringing Back The Best Buy Buyout

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Bringing Back The Best Buy Buyout

As talks of taking the big-box retailer Best Buy (NYSE: BBY) private have cooled off, the announcement that a Dell buyout is in the works rekindled my interest in the struggling retailer. Mainly, is the Dell buyout signaling a loosening of the credit markets? Will Best Buy founder Richard Schulze be able to raise the necessary capital to take the retailer private?

Both the Dell and Best Buy buyout attempts could be investors' last hope, at least in the interim, to see positive returns from the stocks. Although the Dell buyout would cost over four times that of Best Buy, there appears to be greater value hidden in Dell, with the ability to restructure and focus on its enterprise business. Meanwhile, the Best Buy restructuring plan includes closing some big box stores, revamping of stores, and adding Best Buy Mobile stand-alone locations. The longer-term cost savings plan includes reducing costs by $800 million by fiscal 2015. Schulze's plan also includes a radical approach of cutting costs by closing a number of stores and revamping customer service, which will likely strain the retailer's bottom line, and he believes this is best done without the scrutiny of the public markets (read more about Best Buy's fight for its life).

RadioShack (NYSE: RSH) is another struggling retailer, but with a $260 million market value, Radioshack could easily be touted as a takeover candidate as well--but would it be worthwhile? The company recently ended a partnership with Target to provide mobile stations in Target stores. The mobile stations were losing money, but the long-term positive was going to be more distribution outlets. Overall, the prospects remain poor for RadioShack, and its expected 5-year EPS will be down 150% annually according to Wall Street analysts. 

Amazon (NASDAQ: AMZN) is one of the fundamental issues within the retail industry, taking market share from many of the brick-and-mortar companies. The massive e-tailer continues to post robust growth even with its high market share, expecting to grow EPS at 37% annually over the next five years, according to estimates. Amazon's entry into the tablet market has only further helped the company snatch up more market share, where its Kindle Fire is even gaining on Apple's iPad in  market share.

Wal-Mart (NYSE: WMT) and Target (NYSE: TGT) are two other brick-and-mortar retailers indirectly competing with Best Buy. However, the product portfolio of these companies has helped it better manage the infringement of Amazon on the retail market. Wal-Mart is expected to continue growing nicely over the near-term, and should see revenues up 5.5% in fiscal year 2014 on the back of 9% growth in its international segment. 

Target's December holiday comp sales came in below expectations, but the company expects to meet full year 2012 EPS estimates based on pre-holiday sales strength. Just as Wal-Mart is being driven by strong international growth, Target has plans to open almost 50 stores in Canada by the end of spring 2013.
 
Undoubtedly, Best Buy trades much cheaper than chief rival Amazon and other peers Wal-Mart and Target: 
<table> <tbody> <tr> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"><strong>Best Buy</strong></td> <td colspan="1" rowspan="1"><strong>Wal-Mart</strong></td> <td colspan="1" rowspan="1"><strong>Target</strong></td> <td colspan="1" rowspan="1"><strong>Amazon</strong></td> <td colspan="1" rowspan="1"><strong>RadioShack</strong></td> </tr> <tr> <td colspan="1" rowspan="1">Price to Earnings (next year earnings)</td> <td colspan="1" rowspan="1">7.1</td> <td colspan="1" rowspan="1">13</td> <td colspan="1" rowspan="1">12.8</td> <td colspan="1" rowspan="1">158</td> <td colspan="1" rowspan="1">n/a</td> </tr> <tr> <td colspan="1" rowspan="1">Price to Sales</td> <td colspan="1" rowspan="1">1.5</td> <td colspan="1" rowspan="1">3.1</td> <td colspan="1" rowspan="1">2.5</td> <td colspan="1" rowspan="1">17</td> <td colspan="1" rowspan="1">0.4</td> </tr> </tbody> </table>

The strong holiday performance has helped lift the stock over 30% year to date. Holiday sales came in at $12.8 billion, which was relatively flat year over year. Although the stock is back up over $15 after fears that a buyout might not materialize had driven the stock to $11.20 in 2012, this is still a ways from the $24-$26 that Schulze said he might consider as a buyout price. 

The cheapness of Best Buy and RadioShack is likely for good reason. The overbearing weakness of Best Buy is its exposure to the electronics market, namely tablets, PC's, and TV's. This exposure has lead to weakness in sales, namely comp sales, which were down 6.4% year over year for the holiday season, and has put a strain on Best Buy's cash position.

Compared to other major retailers, Best Buy operates at a lower debt load relative to capital, which is a minor bright spot, as its cash position still continues to deteriorate. 

<table> <tbody> <tr> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"><strong>Best Buy</strong></td> <td colspan="1" rowspan="1"><strong>Wal-Mart</strong></td> <td colspan="1" rowspan="1"><strong>Target</strong></td> <td colspan="1" rowspan="1"><strong>Amazon</strong></td> <td colspan="1" rowspan="1"><strong>RadioShack</strong></td> </tr> <tr> <td colspan="1" rowspan="1">Debt to Capital</td> <td colspan="1" rowspan="1">36%</td> <td colspan="1" rowspan="1">43%</td> <td colspan="1" rowspan="1">51%</td> <td colspan="1" rowspan="1">--</td> <td colspan="1" rowspan="1">53%<span> </span></td> </tr> </tbody> </table>

The company has seen its cash on hand dwindle to $300 million, an 85% year over year decline, bringing into question its dividend payment -- a $230 million annual payout. The company has suspended its share buyback program and refrained from providing earnings projections for 2013.

A quick LBO model simulation and the value per share could be upwards of $18.50 per share, even accounting for restructuring related to store closings and margin compression: 

<table> <tbody> <tr> <td colspan="1" rowspan="1"> </td> <td colspan="5" rowspan="1"><strong> Projected Fiscal Year </strong></td> </tr> <tr> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"><strong>2012</strong></td> <td colspan="1" rowspan="1"><strong>2013</strong></td> <td colspan="1" rowspan="1"><strong>2014</strong></td> <td colspan="1" rowspan="1"><strong>2015</strong></td> <td colspan="1" rowspan="1"><strong>2016</strong></td> </tr> <tr> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> </tr> <tr> <td colspan="1" rowspan="1"> EBITDA </td> <td colspan="1" rowspan="1">           1,278</td> <td colspan="1" rowspan="1">    1,647</td> <td colspan="1" rowspan="1">       765</td> <td colspan="1" rowspan="1">    1,614</td> <td colspan="1" rowspan="1">    1,647</td> </tr> <tr> <td colspan="1" rowspan="1"> Plus:  Synergies </td> <td colspan="1" rowspan="1">                   -</td> <td colspan="1" rowspan="1">            -</td> <td colspan="1" rowspan="1">            -</td> <td colspan="1" rowspan="1">            -</td> <td colspan="1" rowspan="1">            -</td> </tr> <tr> <td colspan="1" rowspan="1"> Less:  Integration Costs </td> <td colspan="1" rowspan="1">              -</td> <td colspan="1" rowspan="1">        -</td> <td colspan="1" rowspan="1">        -</td> <td colspan="1" rowspan="1">        -</td> <td colspan="1" rowspan="1">        -</td> </tr> <tr> <td colspan="1" rowspan="1"> EBITDA </td> <td colspan="1" rowspan="1">           1,278</td> <td colspan="1" rowspan="1">    1,647</td> <td colspan="1" rowspan="1">       765</td> <td colspan="1" rowspan="1">    1,614</td> <td colspan="1" rowspan="1">    1,647</td> </tr> <tr> <td colspan="1" rowspan="1"> Less:  Depreciation & Amortization </td> <td colspan="1" rowspan="1">              821</td> <td colspan="1" rowspan="1">       780</td> <td colspan="1" rowspan="1">       765</td> <td colspan="1" rowspan="1">       765</td> <td colspan="1" rowspan="1">       780</td> </tr> <tr> <td colspan="1" rowspan="1"> EBIT </td> <td colspan="1" rowspan="1">              456</td> <td colspan="1" rowspan="1">       867</td> <td colspan="1" rowspan="1">            -</td> <td colspan="1" rowspan="1">       850</td> <td colspan="1" rowspan="1">       867</td> </tr> <tr> <td colspan="1" rowspan="1"> Less:  Taxes </td> <td colspan="1" rowspan="1">              146</td> <td colspan="1" rowspan="1">       278</td> <td colspan="1" rowspan="1">            -</td> <td colspan="1" rowspan="1">       273</td> <td colspan="1" rowspan="1">       278</td> </tr> <tr> <td colspan="1" rowspan="1"> Tax-Effected EBIT </td> <td colspan="1" rowspan="1">              310</td> <td colspan="1" rowspan="1">       589</td> <td colspan="1" rowspan="1">            -</td> <td colspan="1" rowspan="1">       577</td> <td colspan="1" rowspan="1">       588</td> </tr> <tr> <td colspan="1" rowspan="1"> Plus: Depreciation & Amortization </td> <td colspan="1" rowspan="1">              821</td> <td colspan="1" rowspan="1">       780</td> <td colspan="1" rowspan="1">       765</td> <td colspan="1" rowspan="1">       765</td> <td colspan="1" rowspan="1">       780</td> </tr> <tr> <td colspan="1" rowspan="1"> Less: Capital Expenditures </td> <td colspan="1" rowspan="1">            (685)</td> <td colspan="1" rowspan="1">      (650)</td> <td colspan="1" rowspan="1">      (637)</td> <td colspan="1" rowspan="1">      (637)</td> <td colspan="1" rowspan="1">      (650)</td> </tr> <tr> <td colspan="1" rowspan="1"> Change in Working Capital </td> <td colspan="1" rowspan="1">                   -</td> <td colspan="1" rowspan="1">         40</td> <td colspan="1" rowspan="1">         13</td> <td colspan="1" rowspan="1">            -</td> <td colspan="1" rowspan="1">        (10)</td> </tr> <tr> <td colspan="1" rowspan="1"> Unlevered Free Cash Flow </td> <td colspan="1" rowspan="1">              447</td> <td colspan="1" rowspan="1">       759</td> <td colspan="1" rowspan="1">       141</td> <td colspan="1" rowspan="1">       704</td> <td colspan="1" rowspan="1">       708</td> </tr> <tr> <td colspan="1" rowspan="1"> Terminal Value </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1">    9,880</td> </tr> <tr> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> </tr> <tr> <td colspan="1" rowspan="1"> PV of Free Cash Flow </td> <td colspan="1" rowspan="1"> $1,729</td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> </tr> <tr> <td colspan="1" rowspan="1"> PV of Terminal Value </td> <td colspan="1" rowspan="1"> $4,535</td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> </tr> <tr> <td colspan="1" rowspan="1"> Present Value </td> <td colspan="1" rowspan="1"> $6,264</td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> </tr> <tr> <td colspan="1" rowspan="1"> Implied EV/EBITDA </td> <td colspan="1" rowspan="1">4.9x</td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"> <div> </div> <div> </div> </td> </tr> </tbody> </table>

An $18.50 per share buyout would be an over 15% upside from the current stock price. This upside might not mean much for investors who have owned the stock since 2004, since the price is still the lowest in eight years.  The question is, is 15% enough upside to outweigh the risks? The potential buyout was first announced in August of 2012, but the stock has trended lower on questions of whether or not the deal will come to fruition. It's unlikely the Schulze will still offer $24-$26 per share, but he has until the end of February to put together a formal offer (see the prospects of Best Buy going private).

From an EV/EBITDA multiple perspective, the market value of Best Buy comes in at $5.34 billion and an enterprise value $7.0 billion. A 30% premium on its enterprise value would require $2.7 billion in cash. Richard Schulze owns 19.6% or 66.41 million shares, which if he rolls into the deal would cover almost $1 billion of the required payment. The above EV/EBITDA simulation would lead to a buyout price of around $18.20 per share. Best Buy has seen quite the decline in earnings of late, going from a 3.0 EV/EBITDA multiple to a 16.5 multiple over the last year. Meanwhile the industry is at only 6.5. 

Overall I see the competitive pressure as too much for the retailer and hope that Schulze can put together the funds to pull off a buyout. Although it is unlikely that Best Buy will end up like Circuit City, the stock still has a long way to go, and without a buyout could remain in its depressed sub-$16 per share trading state (check out the hedge funds backing Best Buy).


mhargra has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com and RadioShack. The Motley Fool is short RadioShack. 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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