The Decline of Traditional Brick and Mortar's

By Peter Pham - September 22, 2012 | Tickers: AMZN, BBY | 0 Comments

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Best Buy (NYSE: BBY) has struggled as a mix of bad economic conditions and massive changes in retailing which has them in a similar situation to other large footprint chains like Sears and, to a lesser extent, even the mighty Wal-Mart.  Many of them are dealing with entrenched real estate holdings that are losing revenue potential and, by extension, market value.  Not only are fewer people shopping at their stores because of changes in what people go to retailers to shop for, fewer people are even going to retail outlets to shop in the first place so there is no demand for their legacy assets by other retailers. 

The CEO chair at Best Buy has been one on a pretty quick swivel in recent years and the lack of consistent leadership from that position has muted its response to the obvious changes happening in selling technology in the past 2-3 years. 

Inventory is not the Best Policy

Best Buy’s business model is rooted in the 20^th century and has not adapted adequately to the changes in technology ushered in by the smartphone.  E-tailing and showrooming have gotten so bad that even the traditional retailers such as Wal-Mart and Target are suffering, as they all cannibalize each other’s easily cross-shopped technology revenue.   Wal-Mart has joined Target by no longer selling Amazon’s (NASDAQ: AMZN) Kindle Fire in protest. 

By contrast, Amazon’s global sales went up by 29% in year over year in the 2^nd quarter and 36% to customers in North America. Amazon’s ecosystem attacks many of these retailers at the core of their business, even for things like food and clothing, once one adds in things like ‘subscribe & save’ for items like coffee and packaged staples like peanut butter and canned goods. 

The problem is that a low price environment engenders a mercenary attitude on the part of consumers.  Couple that with the lack of connectedness the big retailer has to your town or home and it becomes very easy for someone to be seduced by the deal of the day.  In the U.S. where haggling over price is not done the problem is made even worse.  And even then who’s going to go through the hassle of trying to haggle with a manager at a Wal-Mart, if you can find one in a store the size of a small town?  Best Buy, of course, has more leeway with salespeople on the floor but the point is similar.

Buy the Numbers

In Q2 2012, Best Buy reported net income of just $12 million, net margins of 0.11%, versus $150 million, 1.2% net margins, in the same period in 2011.  Top line revenue contracted 7.9% to $10.55 billion US.

Same store comps were down 3.2% in China, where Best buy owns 204 Five Star stores and is facing stiff competition from GOME and Suning both of which struggled this quarter as well.  Comps were off 1.6% in the U.S. and 8.2% internationally.  Among the few positives from this past quarter was a small bump in revenue per square foot as its retail footprint dropped 4%.  Investors should be looking for that number to jump considerably this holiday season.

Let a Thousand Kiosks Bloom

Management is in the process of closing 50 stores, cutting out on 400 corporate jobs and $800 million in costs.  It’s a good start, but it should be looking at closing a lot more than that.   It has written a large part of that cost off while shifting the retail footprint to smaller, mobile-device focused kiosks.  There are now 305 Best Buy Mobiles in the U.S. with 100 more on the way before the end of the year.

Using Best Buy’s brand to aggregate mobile device service and replacement, regardless of where the phone was bought should be management’s focus.  If they sell a carrier’s phones they should provide direct customer service for them.  Cut the deals to make that happen.  People get quick and painless service.  This will drive word-of-mouth sales and be a win-win for the carriers, especially the smaller ones, who don’t have to maintain a separate retail footprint, and Best Buy, who would become synonymous with mobile device service.  Between that and partnering with a company like Dell, who is rebuilding themselves as a small business vertical solutions vendor more than just a black box builder, and using GeekSquad to be their on-site service provider, they can speed up response time for replacement devices, etc. for local businesses. 

Instead some of their franchisees are spending money redesigning their existing stores to be laid out like your home, as one store in San Antonio, TX is apparently doing.  So, instead of getting rid of showrooming, some of their store owners are embracing it, like they are selling furniture or something.  Again, this points to a lack of clear direction from management. 

As we move our data to the cloud device service and replacement will become a higher margin business as the pain of losing one particular device and the data stored on it locally will not be as catastrophic as it was in the past.  The company that becomes the local point of contact within a community to be that quick turnover, service-oriented provider will find themselves in a very good position.

Best Buy Looks for Buyout?

Richard Schulze, the founder and still largest shareholder, offered to buy the remaining shares in the range of $24-26 a share. Even though this initial offer by Schulze was rebuffed the board has green-lighted him to begin his due diligence for a potential takeover.  Schulze will need to raise an additional $7-9 billion to finalize the deal. 

Hubert Joly as the CEO, who is known as a turnaround expert with his successful restructurings at both EDS and Vivendi will have to accelerate the transition path to a nimbler, more mobile company quickly.  With $680 million in cash and short-term equivalents, Best Buy not in a great position to affect this. 

It will take a strong 3^rd and 4^th quarter from an operating perspective to cover their costs.  They are carrying $7.6 billion in inventory and goodwill, and backing that out the company lost $1.8 billion in assets in the past year.  If those numbers don’t improve by the end of CY 2012 I wouldn’t give much for their long-term chances.  Investors would be wise to wait and see where the global economy goes this fall before deciding to play a hunch on a messy big box retailer in an era of structurally high unemployment and rising food and energy prices. 

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