Best Buy's Bold New Vision To Become The Next... RadioShack?

| About: Best Buy (BBY)

On May 22, 2012, Mr. George L. Mikan, III held his first earnings call as Best Buy's (NYSE:BBY) interim CEO. This opportunity gave general shareholders an opportunity to hear how the company fared the past quarter and for Mr. Mikan to advance his vision for the future of Best Buy.

Since the earnings call, many articles discussed the "earnings beat" posted by the company. Few identified the fact that the "earnings beat" would not have occurred without the help of some financial sleight of hand. In sum, the quarterly earnings report would have been very different if it had not been for the extra week (BBY used 14 weeks in Q1 this year vs. 13 in Q1 last year), the lower tax rate (30.6% compared to 34.6%), and the substantial drop in outstanding shares due to the company's repurchase program (4.6 million shares repurchased at a price of $25.07 for a net paper loss of about $30 million based on the BBY stock price as of June 1, 2012). An article discussing some of the details behind the numbers is here.

Since the earnings call, many articles have also discussed the fact that Mr. Mikan picked up 100,000 shares of stock in the company, implying that Mikan must believe that BBY's stock price will rise in the future. Few have discussed Mr. Mikan's desire to be named permanent CEO and how his interim compensation package has been deemed "overly generous" by corporate governance experts. None that I am aware of have linked Mikan's stock purchase to his ambitions for the permanent CEO position. Mr. Mikan's decision to use about half of his newfound "overly generous" compensation package to purchase BBY stock helps to provide support to the stock's price in the short term for a variety of reasons. Short term price support for the stock helps to keep the board of directors (of which Mr. Mikan was once a member) happy and increases Mr. Mikan's chances of being named the permanent CEO. By being named permanent CEO, Mr. Mikan ensures that he nets a very generous annually recurring compensation package, along with what will probably be a very nice severance package if he is ever let go by the company (if the $6.6 million severance package that Best Buy gave to Dunn is any indication). Articles discussing some of these points are here and here.

While some of the concerns outlined above create serious questions regarding whether the company will be able to turn around the significant decline it has experienced over the past few years, none compare to the alarm raised by the turnaround strategy announced by Mikan during the Q1 earnings call. This article outlines the serious issues with Mikan's turnaround strategies and identify why they are flawed.

One of the goals outlined in Mikan's strategy was to cut physical footprint without reducing and maybe even growing the number of Best Buy storefronts. Specifically he stated: "My goal is to continue to shrink the company's physical footprint and substantially reduce our cost structure. Total square footage will go down as we make decisions about the best use of space and resources. But as we assess opportunities, our total storefronts may stay the same or even grow somewhat, though with a smaller and more focused presence."

This strategy outlined by Mikan is problematic because it essentially outlines a strategy for BBY to become the next RadioShack (NYSE:RSH). BBY's main strength is in its big box storefronts which give the company the ability to showcase expensive electronics products and appliances to consumers. The average customer is rightfully hesitant to spend hundreds or thousands of dollars before actually seeing the picture quality of a big-screen TV, the size of a refrigerator, or before hearing sound quality of a speaker system. While this strength has brought the company much criticism in the past few months because customers look at products in the store and then buy them at lower prices from online sources, the answer to resolve this problem should not be to eliminate the main draw and one of the biggest reasons why people walk into the store in the first place.

Rather than build upon the company's strengths and try to identify new and innovative ways to leverage the things that helped Best Buy become the great retailer it once was, Mikan's speech outlined a plan to lower overhead costs and grow profitable square footage by reducing footprint and increasing the number of Best Buy storefronts. It is also the exact same strategy that RadioShack announced in the Spring of 2006 as described here. Although reducing footprint is absolutely essential to the viability of Best Buy, the idea that the company needs a larger number of storefronts is absurd. Additionally, we have all seen how well that strategy has been working for RadioShack, which has seen a decline in its stock price of about 90 percent since June of 2007.

Unless BBY's future smaller footprint storefronts means that it will become the retail arm for Apple (OTC:APPL) products (which is not likely since this article here shows that Apple has already announced plans to open its "store within a store" model at Target (NYSE:TGT) stores), or unless BBY intends to exclusively sell mobile products at the new "smaller footprint" locations (a relatively low margin business with few moats as discussed here and as evidenced by mobile phone sales centers in every Costco (NASDAQ:COST)), the idea to shrink footprint but keep or grow the number of storefronts, places the company in direct competition with a struggling retailer that is already in the marketplace that Mikan wants to enter (i.e. RSH).

As for the other ideas he threw out during the Q1 earnings call, well they amount to nothing more than placing BestBuy in even more direct competition with Amazon (NASDAQ:AMZN) (i.e. "We will rightsize the company to better meet customers wherever they want, whenever they want, in the neighborhood store or online with a strengthened e-commerce capability that opens markets at home and abroad.").

And does anyone really think that Best Buy will generate real revenue by selling subscriptions to senior citizens in tough economic times when costs for things like prescription drugs and consumer staples are already eating into their fixed incomes (i.e. "Another example is the new program we just launched to provide millions of AARP members access to Geek Squad services. It's a comprehensive subscription model that supports AARP members with their personal technology through access to Geek Squad agents by phone, online and in-store.") Targeting senior citizens may have worked when Mr. Mikan was an insurance healthcare executive, but the world of consumer retail is a different animal.

If implemented, the half-baked ideas thrown out by Mikan, place Best Buy in direct competition with AMZN and RSH, but leaves Best Buy playing second fiddle to both companies since BBY lacks the experience developed over time by each of the other retailers. Most importantly, it also shows that the sacred cows that need to be addressed by the company come in the form of BBY's current management team and its board of directors - who seem to be more interested chasing ideas already implemented by other companies and in protecting insider interests, rather than trying to innovate new ways to leverage the strength of the existing business and advancing the interests of the company's common shareholders.

Disclosure: I am short BBY.