Best Buy Goes Electric: Consider Using LEAP Options

 |  About: Best Buy Co. (BBY)
by: SA Editor Rocco Pendola

When Bob Dylan went "electric" at the Newport Folk Festival in 1965, some people scoffed, others laughed, a whole bunch got mad, and plenty walked out on his performance. In hindsight, most agree that Dylan's controversial move was pivotal for rock-n-roll. Fast forward to 2011 and companies, as well as individuals, face the same types of reactions when they decide to go electric.

Best Buy (NYSE:BBY) appears to be entering the electric vehicle (EV) space from several angles at a slowly, but surely pace. As I noted in other articles, EVs do not have to go mainstream for those who associate themselves with them to profit modestly. If EVs garner half of the hype and market share of hybrids over the next few years, it will probably spell success for many companies; that list could include Best Buy. If, however, EVs do more than that -- and I think they will -- companies who got on board first could profit handsomely.

I have nothing but respect for companies that see the writing on the wall and adjust accordingly. Best Buy realizes it cannot survive as a purveyor of appliances, electronics, gadgets, and media alone in what basically amounts to a big-box setting. Some companies ignore the warning signs and trudge along doing the same old thing. As the man once billed as "the next Dylan," famously sang, It's a death trap, it's a suicide rap. Given recent attempts at righting the ship and diversifying its business -- proactively and progressively -- I don't think Best Buy sails head first into the abyss.

As BBY President of the Americas, Shari Ballard, noted on the company's Q42011 conference call, Best Buy continues to move aggressively to operate more efficiently. As an aside, it's impressive to note that, according to her bio at Best Buy's website, Ballard started with the company in 1993 as an assistant store manager.

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Even more interesting than the smart move to basically downsize is Best Buy's forward-looking, yet cautious approach to the EV market. Best Buy included a line its latest 10K that affirms its intentions:

As part of our strategy [to lessen our impact on the environment], we are also investing in emerging technologies such as home energy management systems for all the connected devices in a home, renewable energy technologies and electric transportation.

For the past couple of years, the company's name has popped up as a potentially visionary EV industry player. It started with the news that Best Buy would sell electric bikes, scooters, and motorcycles at its retail stores in select cities across the nation. From a July 2009 Los Angeles Times story:

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On Thursday, a Best Buy spokesperson told me that the company offers scooters and a bike in 250 U.S. locations during the biking season. Best Buy also continues to test the availability of two-wheel products online. However, the company recently discontinued broader two-wheel electric vehicle in-store experiments in 27 U.S. markets.

Best Buy has also emerged as a key player with regards to EV charging infrastructure. It has signed assorted deals to include charging stations at its stores. Earlier this year, Best Buy announced that its stores will offer household charging stations for Ford's (NYSE:F) forthcoming EV, the electric Focus. From sales to setup to servicing, repair, and warranty issues, Best Buy's Geek Squad will deal with Focus buyers who wish to outfit their home with a platform that can charge the car in three to four hours. It inked a similar deal with Mitsubishi Motors of North America.

One thing I can confirm after speaking with the company is this: AutoWeek was wrong when it announced earlier this week that Best Buy intends to sell actual four-wheel electric vehicles at its retail stores. The reality is that Best Buy is in discussions with the major automakers as well as startups about several initiatives. At the moment, all the company has committed to is providing cradle to the grave sales, installation, and service for Ford and Mitsubishi home EV charging stations. Best Buy has also signed deals with NRG Energy (NYSE:NRG) and Ecotality (ECTY) to include EV chargers at its stores, similar to recent deals these companies executed with retailers, including Macy's (NYSE:M) and Walgreen (WAG). Expect the company to expand these efforts, possibly into Southern California, in the near future.

Best Buy does not appear set to become a car dealer. Frankly, when I read the AutoWeek story I thought it was absurd, particularly in light of Best Buy's aggressive moves to make its stores smaller. What Best Buy wants to do is become part of the burgeoning and potentially lucrative EV scene. The company will use its Geek Squad to leverage its position as an authority on electronics vis-a-vis the EV space.

Best Buy looks at EVs as a computer on wheels of sorts. Just as customers trust the Geek Squad to take apart their computer, Best Buy hopes to establish its retail employees as individuals who can educate consumers on, and help facilitate their purchase and subsequent use of what, at the moment, remains foreign automotive technology to most. As barriers to EV adoption continue to get broken down, expect Best Buy to be there as part of the process and one of the bigger players, as far as multi-billion dollar companies go.

How to Play It. I like that Best Buy has not sat on its hands, refusing to reinvent itself in the face of writing on the wall that strongly suggests it must. I also think the company is approaching the EV space properly. As it stands, Best Buy has several R&D experiments, if you will, on going with respect to where it can go and what it can do with EVs.

As large and small automakers and dealers start selling EVs, they will clearly need to be able to service them. The big automakers, of course, are probably in the process of training mechanics. That process will likely be an ongoing one, given how the technology rapidly evolves. That said, Best Buy could serve as a valuable middleman in the traditional auto dealer-EV car buyer relationship. EV owners might be more receptive to receiving at least some service from Best Buy as opposed to oft-mocked dealer's service department.

Smaller dealers could benefit even more. EVCARCO (EVCA.OB) intends to roll out dealerships nationwide that only sell EVs and other alternative-fuel vehicles. For a startup, the additional cost of having to service what they sell could prove prohibitive. Best Buy could provide the solution. And Best Buy is completely open to talking to startups; that's the one thing AutoWeek got right.

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As an investor, I fully realize that its current and potential EV plays alone do not make BBY a buy. I have confidence in the company, however, because it is not afraid to change on the fly. From scaling back its stores to a willingness to get involved in unchartered territories, Best Buy impresses me. It also recognizies its Geek Squad as an asset. And the company intends to leverage that asset with respect to EV technology.

BBY has taken a beating. I was bullish on the stock in a Seeking Alpha article from March 18th. At the time, the stock traded at $31.53. It closed Thursday's session at $31.69, up $1.26 on no news that I could find.

(Chart courtesy of Schwab's StreetSmart Edge)
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After the beating it took, the stock has stayed rangebound for a while. Not only do I believe in the company's prospects for the reasons I mentioned, but let's not forget that BBY currently trades at a P/E of 10.3. And it pays a modest dividend, yielding two percent.

Over the next 6 to 12 months, I think Best Buy's shift to less square footage will begin to pay off. Even if it cannot astonish investors with attendant improvements to its bottom line right away, I think management can begin to instill confidence that it's on the right track.

If the dividend does not mean much to you and you want to limit your risk, consider using LEAPS options to play potential upside in BBY. I am as bullish on using LEAPS as I am on any stock. You don't have to worry as much about time decay, relative to near-dated options, when you use LEAPS, at least not right away. And you only have to put up a fraction of the capital an outright stock purchase would require.

(Quotes courtesy of Yahoo! Finance)
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I am bullish enough to buy two out-of-the-money calls (somebody dabbled into the $55 calls on Thursday) for every in-the-money call I buy. As far an in-the-money calls go, a breakeven price of $35.60 on the BBY January 2013 $30 calls makes me feel more than comfortable considering expiration does not occur for more than 18 months.

Disclosure: I may initiate a long position in BBY, ECTY over the next 72 hours.

Additional disclosure: Author holds a substantial position in EVCA.OB.