Article by Max Olson.
Tweeter Home Entertainment (NYSE:TWTR) recently announced it will sell one third of its 153 retail stores and lay off over 650 workers. Although such cuts are never good news, these actions may constitute a necessary step for Tweeter to take to further its turnaround effort. With a 2006 net loss of $0.66 per share, Tweeter needs to be as lean and competitive as possible. The company hasn't turned a profit since 2001; clearly something needed to be done.
Management still has a lot more to do to turn things around, and I blame them for Tweeter’s poor performance in recent years. They are not as bad as some others I've seen. They just seem stuck on the idea that people will keep coming to their stores for all their home entertainment needs, regardless of price. A sign in their store reads: “Price should never be a reason to not do business with us.”
Carving a Niche
When you have places like Costco (NASDAQ:COST), Best Buy (NYSE:BBY), and Circuit City (NYSE:CC) undercutting them on TV prices, it's hard to convince customers to buy from Tweeter. The company can’t compete with the category killers and discount retailers on price. A quick online example: A Panasonic 50” Plasma HDTV is on sale at Tweeter, Best Buy, and Circuit City where it sells for $2,498, $1,999.99, and $1,999.99 respectively.
Just because you can’t win on price doesn’t mean you’re dead in the water. Many customers would be willing to pay more for the same products at Tweeter, if Tweeter provided much better service and helped customers solve their problems. This is how Tweeter differentiates itself: by offering consumers an enriched experience, expert information, in-home installation, and an assurance they will be taken care of in the future.
Walgreens (WAG) can price consumer durables at much higher prices than their equivalents at Wal-Mart (NYSE:WMT) and Costco because they give customers something the discounters don't: convenience and speed. Someone who needs a prescription in the middle of the night or a tube of toothpaste isn’t going to make the trip to a discount superstore when there's a Walgreens right around the corner. But, this kind of “service” differentiation only goes so far.
Paying an extra dollar for toothpaste isn’t bad. But, when you’re shelling out a couple grand on a flat-screen TV, saving $500 means a lot. Some home entertainment buyers would like the extra service and knowledge that comes from buying at Tweeter. But, apparently the cost of providing this service is more than the premium charged for that service.
In an article announcing the store closings, the Associated Press wrote:
[CEO Joe] McGuire said Tweeter wants to focus on its strengths, which include seven new ‘playground stores’ featuring simulated home room setups displaying high-end equipment in various installation possibilities.
For Costco or Home Depot (NYSE:HD), opening a few "concept" stores to test some new retail ideas is fine. But, I don't think Tweeter can afford to take that kind of risk right now.
Having seen pictures of the store, I'll be the first to admit I would love to go in one just to take a look around. But, can Tweeter generate enough profit per square foot from these "showcases" to justify the investment? I have a hard time believing it can.
Tweeter's combined opportunity cost for the real estate (about $13 per square foot) and working capital for the stores (about $2 per square foot) comes to $15 per square foot. So, Tweeter needs to generate over $15 per square foot of retail space in operating income (before rent expense) to justify the investment. For 2006, that threshold was about $11 per square foot, including excess depreciation.
That's not too bad. $11 per square foot is slightly higher than Sears/Kmart at the moment – however, Sears Holdings (NASDAQ:SHLD) has a much lower real estate cost. Compare this to Best Buy who has sales of $930 per square foot (vs. Tweeter's $457) and operating income before rent expense of $72 per square foot – which is over six times Tweeter’s profit per square foot.
With the right management team (or a completely different view from the current team) Tweeter could be very successful – both with its stores and with its shareholders. Right now, the stock is trading at approximately 53% of tangible book value. By my calculations, if the company achieved a 1.9% or greater pre-tax free cash flow margin, each share of Tweeter would be worth at least double yesterday's closing price of $1.71.
TWTR 1-yr chart: