On Thursday, June 14, 2012, the Wall Street Journal published a story titled Chasing China's Shoppers." The article outlined Best Buy's (BBY) attempts to tap into a growing Chinese middle class through its subsidiary 5 Star. Seeking Alpha picked up the story and summarized it by indicating that Best Buy found a bright spot in China. The next day, the Minneapolis / St Paul Business Journal carried a story titled "Best Buy's success in China is due to a growing middle class."
The stories identified above were in addition to a number of other news events about this struggling retailer that appeared to point to signs that a turnaround for Best Buy is in works. For example, Kate McShane, an analyst for Citigroup, upgraded the company from "sell" to "neutral." That article is here. Then Carphone Warehouse (LON:CPW), a UK/European subsidiary of Best Buy, announced that it was going to try to improve earnings at its key European unit in 2013.
These stories helped to push Best Buy's stock price from $19.38 at Wednesday's close of market, to a high of $20.04 on Friday, June 16, 2012. This article analyzes the information presented by the recent news to show readers why the future of Best Buy and its partners in Europe, China, and in general, may not be as bright as the company wants you to believe.
Best Buy Is Speaking Out Of Both Sides Of Its Mouth
The article titled "Chasing China's Shoppers" tried to portray Best Buy as a company that had learned from its mistakes in China. It explained to readers how Best Buy was now pushing the 5 Star store brand after initially trying to enter the Chinese market by opening "US style" stores that did not appeal to Chinese consumers. A former Best Buy manager acknowledged the shortcomings of this strategy by indicating that "[Best Buy was] stupid and arrogant" and the article confirmed that "Chinese consumers are different."
Of course in true Best Buy fashion, and in spite of the supposed realization that Best Buy needs to understand Chinese consumers in order to be successful in China, the company's current management team is moving full steam ahead to open 15 new Carphone Warehouse (a UK/European subsidiary/partner) stores in China.
Additionally, the Wall Street Journal article reported that Best Buy plans to increase the number of existing 5 Star Stores in China by up to 150 percent before 2016. In light of recent economic news indicating slowing growth in China, one has to question whether increasing the company's footprint overseas by dramatically growing the number of 5 Star storefronts makes good business sense, especially in light of the most recently announced domestic plans to cut costs by reducing footprint in a slowing US economy.
These mixed messages projected by the company indicate that Best Buy management is either very confused, or they are trying to confuse investors. Neither scenario bodes well for the company.
The Facts Presented Do Not Support A Conclusion of Success
None of the facts in the articles identified above supports a conclusion that Best Buy's subsidiaries were having success in Europe or China. Factual numbers to support a conclusion of success were either withheld, or supported a conclusion of poor performance. For example, 5 Star declined "to disclose last year's sales" and Carphone Warehouse executives admitted that there was a "5.5 percent drop in revenue at Carphone Warehouse's European unit." Each article improperly linked a conclusion of future success with plans to expand in each of the two regions identified, and on opinions of the possibility of future growth.
Although the articles show that executives inside Best Buy, and the executive teams of Best Buy's partners, are very bullish about the company's future, all factual indicators show that their beliefs are likely misguided. Europe is without a doubt facing some serious problems. Growth in China is slowing, as described here. In the US, the most recent data released by the Census shows that consumer electronics spending is down again for the second consecutive month, as described here. Sure, there might be a growing middle class in China, as defined by households spending between $10 and $100 a day on average, but the Wall Street Journal article failed to inform readers where the majority of those households fall. If most of those households fall closer to the $10 spending category, Best Buy's plans to spend money to expand in China may be very misguided.
The Wall Street Journal article also made it clear that the 5 Star brand was not popular with Chinese consumers who think that it's "stodgy." The article never made it clear whether the company has had any success in changing the "stodgy" image with the new brand campaign that uses a "cartoon character that appears to be drawn by Hollywood animators." More importantly, if US style stores did not work for Best Buy in the past, what makes Best Buy's corporate management think that Hollywood style animations, rather than Chinese style animations, are going to help Chinese consumers change their minds about the company?
Best Buy is facing stiff existing Chinese competition that is about to get stiffer now that RadioShack (RSH) announced its recent decision to enter into that market, as described here. Sadly, based on Best Buy's confused message and strategy, it appears that the company still doesn't understand what it takes to be successful in the Middle Kingdom, or anywhere else for that matter. A more insightful look into Best Buy's failing strategy in China from a Seeking Alpha member who indicates that they previously worked in the consumer electronics industry in China can be found here.
Limited Additional Downside…In The Short Term?
On June 14, 2012, Citi analyst Kate McShane upgraded Best Buy to "Neutral" from "Sell." The rating upgrade was based on the conclusion that the stock had hit rock bottom and that additional downside was limited in the short term. First and foremost, it's important to note that Best Buy's stock price as of Friday, June 15th's close is less than 5 percent from the Citigroup target price of $21 (which had previously been $18). The motivation for the upgrade is questionable, after taking into account the minimal difference between prior and current price targets. Whether potential buyers should consider buying the stock now is also, and even more, questionable based on the very small differential between the actual current price levels and the newly revised target.
Additionally, the logic of Kate McShane's ratings upgrade appears to be flawed since it seems to completely ignore all the news coming from Europe, raw facts, and global economic data which point to actual decreasing sales in consumers electronics in the immediate term and the real potential for a global economic recession in the short term. While there is hope that Central Banks around the world will act to prevent a global recession (assuming we're not in one already), the simple fact that action is being contemplated shows that there is plenty of future short term downside risk to be concerned about for all companies, including Best Buy.
Finally, Kate McShane indicated that she thought that the potential for a leveraged buy out in Best Buy's future was not likely. It confirmed the position taken by the article here. If she truly does believe this, then it means that the shares of stock currently owned by Mr. Richard Schulze, Best Buy's founder, could be up for grabs. If this is the case, then the short term risk for Best Buy is very high as identified by the rapid drop in the stock price when the possibility that Best Buy's founder could dump his shares was first announced. An article describing that rapid drop can be found here.
In sum, the facts presented by all the information above should help show readers that many questions surrounding Best Buy's strategy still remain unanswered. They paint a picture which shows that Best Buy's present management is currently focused more on its stock price in the short term, rather than on fixing the real structural problems facing the company. The company seems to be spending more money and is more obsessed with trying to change the minds of investors on Wall Street, than with changing the minds of consumers on Main Street. This calls into question the judgment of the current Best Buy management team, as previously described in the article here. The facts in each of the articles identified above also show that Best Buy's management missed opportunities when it first entered China. Unfortunately no lessons seem to have been learned from those mistakes.
Finally, although the recent upgrade by Citigroup's Kate McShane, might have helped Best Buy's stock price in the short term, investors should dig into the logic behind the upgrade to determine whether they agree with the basis for her decision. If not, then it could just be another case of "birds of a feather, who are flocking together," as both Citigroup and Best Buy are the two of the three largest holdings of the AdvisorShares Active Bear ETF (HDGE), which aggressively takes short positions on companies that have suspect accounting practices, and which is an ETF that has outperformed the market significantly. An article describing that ETF can be found here. Most importantly, the facts in each of the articles should be critically analyzed so that investors can come to their own conclusions, rather than relying on the conclusions of the authors', including those being proposed here.