Best Buy: Wrong Place, Wrong Time

| About: Best Buy (BBY)

Dying companies have wounds that are more often than not self-inflicted. This is not true for Best Buy (NYSE:BBY) -- it is in the wrong place at the wrong time, facing so many headwinds and downside catalysts it is a miracle the company has held up so well for so long. Of course, even the Spartans (and Thebans, who get shortchanged by history and moviemakers) eventually lost at Thermopylae.

And Best Buy will be defeated for the same reasons the Spartans lost -- delaying actions do not win wars unless followed by a decisive victory. And for Best Buy, there is no victory in sight.

Here is what Best Buy is facing, some of it well-known, some it willfully ignored by analysts.

What is known?

  • The company is facing increasing and lower cost competition from the big discounters – warehouse stores such as Costco, discounters such as Wal-Mart and online giant Amazon.
  • Online shopping is now fully integrated with the retail experience and half of all shoppers go online to explore and investigate before buying something.
  • There is no “next thing” that forces consumers to do an in-person, hands-on review of a new product or technology. The latest “thing”-- 3D television -- is somewhere between a joke and a fad, and there is nothing else on the horizon.
  • The company enjoyed a brief blip of growth due to the bankruptcy of Circuit City. That blip is over.
  • Best Buy has too many stores and too much square footage given current consumer demand for its products and has been slow in closing them.

What should be known and is ignored?

  • For the past couple of years and going forward for the foreseeable future, the great stealth “stealer” of consumer dollars is Apple. Every dollar spent at an Apple store or at is not spent in traditional computer and electronics retailers such as Best Buy. And the iPad is sucking dollars away from smartphone and netbook laptop sales sold everywhere, including Best Buy. Best Buy’s Apple product sales are a drop in the bucket compared to what Apple does for itself. This stealth robbery is not just computers, tablets and phones -- it is also music, iTunes being the bigger purveyor of music in the world with market share growing every hour.
  • The cell phone industry is the also a great “stealer” of consumer dollars. Five years ago consumer spending on phones and other electronics co-existed; today, consumer dollar spent on phones, especially smartphones, are taken from other electronic sales as phones increase in functionality. This is doubly true for tablets. And cell phones have their own retail channel -- the cell phone company store, namely those of Verizon and AT&T. And these stores now sell tablets.
  • Music and DVDs were important to Best Buy, not just to generate revenue and margin but bring in casual shoppers who spent more money or were inspired to spend more money at Best Buy at a later date. iTunes has killed the traditional CD business -- it will be more years before we have a funeral, but the inevitable is, well, inevitable -- and online streaming video is killing DVD sales and rentals of DVDs.
  • An Apple TV is coming. It will probably be expensive; it will probably have that incredible retina display, built in this and ergonomic that; and it will push ever more consumer dollars out of Best Buy’s reach. It is possible Apple will sell its television products through Best Buy; but if history is any guide, the lion’s share of sales will come through the Apple stores and website.
  • Best Buy is seen as an “electronics” store, but that includes a great deal of revenue from the sale of computers. Sales of computers to consumers are flat to negative in the U.S., due to the recession, maturing technology and tablets. Again, Apple has sucked a great many consumers out of the Best Buy world and into the Apple store.

Let’s get a bit more specific -- let’s look at the short term, next quarter to be exact, and how consumers plan to spend, specifically at Best Buy. U.S. consumer confidence is slipping again; a recent ChangeWave research survey conducted in April (part of the 451 Group) showed a significant decline in consumer confidence and with confidence goes spending.

  • The number of respondents in that survey saying they were going to increase spending on home entertainment slipped two percentage points form the previous month and the number saying they would spend less increased on percent, the worst showing in more than a year and the worst of any spending category in the survey.
  • That same survey showed 1% of respondents were planning to spend more money on home entertainment products at Best Buy in the coming 90 days and 6% were going to spend less than the previous ninety days. The numbers for Amazon? 19% more, 6% less.
  • Best Buy’s share of planned purchases was 42% in December of 2010; it was 28% in this April survey. During the same period of time Amazon’s share went from 38% to 44%, Apple from 17% to 23%.

This is all bearish for the company and the stock. Are there any positive out there, any bullish trends? For the company, no. For the stock, these factors need to be taken into consideration before you buy a put or you short the stock outright.

The company is going to go through a series of restructurings that could temporarily boost the stock and earnings. When a company restructures, it gets to bury a good many expenses in its balance sheet. History says analysts wanting to be bullish or contrarian will hail a restructuring as a “great strategic move” and so on even if it really is the next step the cemetery.

  • Best Buy could get rights to sell Apple TVs and that could give the stock a pop.
  • Some idiot company -- there are many, not every CEO or board member sat in the front or the back of the classroom -- could make a run at Best Buy. Or an idiot private equity firm -- you would surprised how many otherwise intelligent private equity guys love retail and have a big enough ego so much they forget their second grade math. Look what happened to Sears.
  • Some very real Internet retailer could decide to try retail using its balance sheet -- ebay or Amazon come to mind. Bezos is not that stupid; on the other hand rumors have Amazon trying out a retail location in Seattle to see how it goes and perfect the systems needed to support traditional retail. John Donahoe of eBay gave an interesting interview in January and was explicit in discussing how consumers are now mixing traditional and online shopping and how this requires a different approach by online retailers. For those of you excited at this prospect, there are plenty of empty big box store structures around the country not in use that would be a lot cheaper to lease than buying a company.

What does this all mean for investors?

If the Best Buy does not do something radical this year in anticipation of shrinking consumer sales, Apple TV and increased pressure from Amazon, the current downward spiral will accelerate at alarming speed and could become irresistible. What can it do to stop -- not slow, but stop -- the spiral? Nothing radical enough in my opinion.

  • Assuming I am right -- big assumption, that, always my favorite -- this spiral will take a while to play out and there will be ups and downs for shareholders due to short-term and temporal upside catalysts.
  • If you opt to short Best Buy, think long term -- LEAPs or, if you are a professional trader, a short position with lots of margin to back it up.
  • Whatever you do, be aware that earnings come out May 22 and who knows what a quarter holds when IRS refunds came out, gasoline prices fell and the economy gave us a head fake and seemed to grow a bit.

Disclosure: I am not short BBY and will not be, but I have recommended puts on BBY in "Michael Shulman's Short Side Trader."