I would never recommend buying a stock based solely on takeover potential, but valuations on some stalwart retail names have gotten so low it's worth pointing out there is significant value for longer term investors, including private equity. On the top of this list for me is Best Buy (NYSE:BBY), a stock that has been under significant pressure lately and now trades at under 4x trailing twelve month earnings before interest, taxes and depreciation (TTM EBITDA) and under 3.5x forecasted 2010 EBITDA. Given its low valuation, strong brand, $4.20 in cash & investments per share ($1.05 net of debt) and its cash generating ability ($3.72 in free cash per share last year, estimated $4.50 this year), Best Buy looks very attractive.
It has been reported in the media (NY Times and others) that private equity firms have about $500 billion in uncommitted capital to invest. In retail, buyout rumors have swirled around Saks (NYSE:SKS) most recently, RadioShack (NYSE:RSH) not too long ago and others this year. In my opinion, this makes considerable sense as consumer discretionary stocks appear to be undervalued for an investor that can take a view beyond the current economic cycle.
Currently, there are retailers that are trading at or near 3x-5x TTM EBITDA and could be bought in the 5x-6x range, assuming a decent premium. Five years ago, retailers were being bought at 9x-10x EBITDA and it was considered a bargain if the acquirer was paying 7x-8x. TTM EBITDA for retail as a whole is arguably depressed now given weak consumer demand. Assuming moderate annual EBITDA growth over the next 2-4 years and a return to market valuations closer to 7x-8x, it’s not hard to believe there are some deals worth investigating in retail right now.
Best Buy is at the top of my shopping list. The largest consumer electronics retailer in the US by a wide margin with market share approaching 25%, Best Buy is the poster boy for consumer discretionary spending and as such has seen its stock decline 36% from its high on April 23rd as macroeconomic concerns have grown. BBY shares are now trading at only 3.8x TTM EBITDA or 3.4x the consensus forecasted EBITDA for this year. Even assuming a 20% haircut on this year’s earnings (20% is arbitrary, but considering I think current forecasts will be met- even exceeded- in the upcoming 2Q report, 20% is conservative in my view), the stock is trading at under 4.5x EBITDA. Importantly, Best Buy is a swing stock, where investors can go from overly pessimistic to overly optimistic when business conditions change, driving a significant increase in the company’s valuation.
Besides valuation, Best Buy has much to offer:
- Low risk acquisition- While “broken” companies are sometimes viewed as more favorable buyout candidates given the upside potential a buyer has from fixing a business, there is also a much higher degree of risk that may not be palatable in today’s uncertain environment. Best Buy is not your fixer-upper. It’s a highly successful company in an industry that is challenging right now, trading at the multiple of a "broken" company. A buyer would not need to make aggressive and risky changes to Best Buy's business model to realize the value of its investment.
- Strong brand and a dominant position in consumer electronics- Best Buy has roughly twice the market share of its closest competitor, Wal-Mart (NYSE:WMT). This is a volatile industry, but over the long term it is one of strong growth averaging in the 5%-6% annually over the last 15 years, by my estimation. While there are concerns about competitive threats from discounters and online retailers, these are not new. In fact, they are same arguments that have been around since I started following the industry a decade ago and since then Best Buy has continued to grow its market share every year.
- Cash and cash generating ability- Best Buy has $4.20 per share in cash ($1.05 net of debt) that an acquirer would have access to and strong free cash flow at $3.72/share last year, an estimated +$4.50-$5/share this year.
- Strong management team already in place- Best Buy has a winning corporate culture and deep management team. In hindsight, while not all strategic decisions have worked out as planned, the company has steadily grown its market share, margins and influence in the industry for the last 15 years. This was due in no small part to good stewardship.
- More profitable international growth- Best Buy has been spending a lot of money setting up initial stores in places like Mexico and Turkey, as well expanding in China and Europe. Some of these costs were one-time, sunk costs that should hopefully bear fruit over the long term. Still, this is one area a financial buyer might find significant costs to pare back.
I believe Best Buy is a compelling investment all on its own at the current price. The idea that there are significant amounts of private equity dollars sloshing around eyeing retail is just some additional enticement.
Disclosure: Long BBY, Long RSH