The carnage continued at RadioShack (RSH) on Tuesday, as the company reported disappointing fourth quarter results and the stock fell nearly 8%. The stock had previously dropped some 30% on January 31st when the company pre-announced weaker sales and net income for the quarter, and eliminated its previously announced $200 million share buyback program.
In the wake of that announcement, many RadioShack bears jumped to the conclusion that RadioShack's business model was broken, with many comparing RadioShack to struggling Best Buy (BBY) or to now-defunct Circuit City. But, as I argued a few weeks ago, the problems at "the Shack" are largely self-inflicted. Its transition from a retailer of electronics accessories to a one-stop shop for mobile phones, tablets, and other devices has stumbled time and time again. Third quarter earnings were weakened by issues with the company's rollout of products from Verizon (VZ), dropping the stock 11% in the wake of that report. This quarter's weakness was "due in large part to the underperformance of the Sprint (S) postpaid wireless business and reflect further unanticipated changes in Sprint's customer and credit models," according to the fourth quarter pre-announcement. As such, in six months, the agreements with two of the company's three wireless partners (AT&T (T) being the third) have performed below expectations, and the stock has been halved from its late July highs.
Management has made additional mistakes, with the company's $325 million debt issue in April (with much of the proceeds earmarked for share repurchase) being the largest. Just $113 million of repurchases were completed, at an average price of $15.68 per share, more than double Tuesday's close of $7.26. Interest expense from the debt cut 15 cents off of 2011 EPS and will shave 22 cents from 2012 earnings. Between the $60 million in lost value of the repurchased shares, and the hit to earnings, it's likely that the decision alone has hurt RSH's market cap by well over $100 million, or $1 per share.
But it's the difficulty in the mobility business that is the biggest problem for RadioShack going forward. The fourth quarter conference call simply highlighted that problem. Every aspect of the mobility business is under attack right now. The movement to smartphones -- particularly Apple's (AAPL) iPhone 4s, released late last year -- hurt margins, as the higher-priced, but also higher-cost, new releases replaced previous versions. Yet, as Raymond James' Dan Dan Wewer noted on the Q&A, the company's incentive plan does not appear to take those margin changes into consideration. RadioShack's development of kiosks in Target (TGT) stores has yet to bear fruit, as the company cannot add on high-margin accessories to wireless sales given the 16-foot average square footage allotted. Indeed, operating loss in the Target segment increased by $17 million in 2011, according to the 10-K; the company did not break out the net loss for the segment. Still, the additional operating loss alone lowered 2011 EPS by 17 cents per share.
CEO Jim Gooch referred several times in the conference call to the need for the Mobility segment to "mature", meaning that revenue growth must continue in order for the company to leverage its expenses and ensure profitability. But it simply isn't happening. The company's overall revenue growth of 2.6% came primarily from the 646 new Target kiosks, according to the 10-K. But those new kiosks, as noted, are currently operating at a loss. Comparable-store sales dropped 2.2% for the year, a hugely disappointing figure given that the company's mobility strategy must create substantially higher sales in order to compensate for its lower margins. In-store wireless sales rose 5.6% in 2011, but that was clearly not enough to compensate for the weaker product mix. In short, the company's recent emphasis on wireless products has been a failure so far.
In the meantime, the company's legacy business -- accessories, cables, parts, and batteries -- is faltering. The so-called "Signature" segment saw a 4.7% decline in 2011, though the drop was just 1% in the fourth quarter. On the Q&A, Gooch noted that the company had undertaken a series of initatives in the neglected segment, improving fixtures, increasing marketing, and "reconnecting with our DIY [do-it-yourself] customers." The CEO pointed to headphones as a product line that had done well for RadioShack in 2011.
But it is the idea of "reconnecting" with the company's legacy customers that highlights RadioShack's current problems. RadioShack spent 90 years building a brand and a customer base based on having a variety of electronics and components, accompanied by (usually) reasonably well-trained associates who could assist its often loyal customers. With little competition in much of its product lines -- and a series of private label brands, another strategy the company may re-emphasize -- RadioShack enjoyed high margins and solid, consistent profitability. In its so far unsuccessful effort to re-brand as a wireless re-seller, the company has abandoned its traditionally profitable niche.
In an interesting piece at Forbes.com, Will Burns notes the opportunity for RadioShack to position itself not as cool or sleek, but simply as "useful". Burns notes that a consumer who buys a flat-screen from Amazon (AMZN) will drive the (almost always) short distance to RadioShack to purchase accessories -- a forgotten HDMI cable, in his example. What Burns fails to note is that given the margin profiles of the two companies and their products, RadioShack would likely make more money off the cable than Amazon did off the TV.
On a fundamental basis, RadioShack still appears to offer some value. Even while struggling in 2011, the company earned 70 cents per share (95 cents excluding special items) and generated $119 million in levered cash flow, over 16% of its market capitalization. Management guided for lower net income in 2012 (in conjunction with fourth quarter earnings) and "modestly positive" free cash flow (in its third quarter report). The balance sheet remains strong (net debt is below $100 million), allaying any near-term bankruptcy fears. RSH trades below its tangible book value of $7.50, and its dividend yield is nearing 7%. (Gooch reiterated the company's commitment to paying the dividend in the most recent call; given the earnings weakness and the suspension of the share repurchase, the recently doubled dividend's viability had been called into question.)
But, of course, the lower valuations simply reflect the market's dim view of RadioShack's future earnings potential. That potential is based on the company's ability to execute its plans for the Mobility segment, and whether it is willing and/or able to resuscitate its legacy electronics and components business. Management has not done well as of late, focusing on wireless and abandoning its traditional base. If they can turn around, so can RadioShack, and its stock will follow.