On June 26, 2012, the Wall Street Journal reported that "Best Buy (NYSE:BBY) Co. founder Richard Schulze is working with a Wall Street bank to explore taking the electronics retailer private, according to people familiar with his thinking." The Wall Street Journal also "reiterated that Schulze could still sell his stake." Source information can be found here and here.
After Schulze publicly announced his early resignation a few weeks ago - more than a few articles have explored the likelihood of whether he was going to lead a leveraged buy-out (LBO) to take Best Buy private. Some analysts even numerically quantified such a possibility. For example, Kate McShane, the CitiGroup (NYSE:C) analyst who recently upgraded Best Buy from "sell" to "neutral," indicated that she believed that Schulze had less than a 20 percent chance at taking over the company. Other analysis making the case against a buy out for Best Buy can be found here.
First, it's important to note that all options for Schulze are still on the table but that his preference is to take the company private. It also appears that his search for other partners is still in its early phases, as described here.
While the news of the Best Buy buyout probably made Best Buy bulls quite happy, this article provides some analysis on why Best Buy bears might have two reasons to smile as well.
Richard Schulze Might Not Buy 'Best Buy,' He Might End Up Selling It:
First, there is the distinct possibility that Richard Schulze will not be able to find partner(s) with enough equity to take Best Buy private. If international talks between governments which are scheduled later this week in Europe do not result in any meaningful changes to address the economic problems facing that continent, potential partners with the necessary equity may not be as interested in taking over one of the largest consumer electronics retailers in the world. This is especially true in light of a potential global recession, slowing demand for consumer electronics, and the rise of competition in the consumer electronics business from both e-commerce websites (i.e. Amazon (NASDAQ:AMZN) and E-bay (NASDAQ:EBAY)) along with discount brick and mortar consumer electronic retailers (i.e. Coscto (NASDAQ:COST), RadioShack (NYSE:RSH), Target (NYSE:TGT) and WalMart (NYSE:WMT)).
Without the necessary capital to take the company over, Richard Schulze may end up selling his stake in the company to Credit Suisse in one large "en bloc" sale. Generally the buyer of an "en bloc" stock transaction will be given a lower purchase price (as compared to what the stock would be trading at in the open market), in exchange for acquiring such a large volume of stock in one single deal. An example of such an "en bloc" transaction was recently executed between Vivendi (OTCPK:VIVHY) and Deutsche Bank (NYSE:DB) in November of 2011, which saw Vivendi sell 35 million shares of its stake in Activision (NASDAQ:ATVI) to Deutsche Bank for $12.20 apiece." An article describing that transaction can be found here. Shares of Activision had previously been trading at $12.80 - $13.00 the week prior. After that sale was consummated and announced, the stock price of Activision fell by five percent.
If this is the scenario that plays out and Schulze actually ends up selling his stake in Best Buy rather than acquiring the company, those individuals who have held their short positions in the stock could be well rewarded. The effect of a Schulze sale could be devastating on the stock price because it would immediately establish a new lower price floor for the stock (i.e. the price that the "en bloc" transaction was consummated at which will generally be lower than the market price), it will terminate any support that the stock had previously received from the rumors of a buyout, and confirm the former owner has "no confidence" in the company's current management team and direction. An article describing the rapid drop in stock price when Schulze's resignation announcement was first made can be found here.
There Is The Possibility That The Takeover Fails:
Another possibility is that Richard Schulze teams with Credit Suisse and successfully finds partner(s) with enough equity who are willing to try to take Best Buy private. This scenario assumes that the company's current management team and board of directors are not simply willing to roll over and let Schulze have his way with them. Defending a takeover attempt is a serious possibility based on the posture taken by the Best Buy board of directors and management at the last annual shareholder's meeting, where the ownership threshold for calling a special meeting was raised to 25 percent from 10 percent (as described here).
If Best Buy wants to successfully defend itself from the takeover, it would likely need to acquire specialized expertise. Goldman Sachs, along with Wachtell, Lipton, Rosen, & Katz, are among two of the best known leveraged buyout defensive strategists and have successfully defended other companies from takeover attempts in the past. In fact, this was the same team that successfully defended Circuit City from being taken over in February of 2005. An article describing those events can be found here.
If a battle for control over Best Buy ensues between the company's existing management and Schulze's takeover bid team, steps that might be taken to prevent a takeover (e.g. substantially reducing the company's cash position, etc.) and the costs associated with high priced expert defensive teams, could leave the company in a much weaker position at the end of a failed takeover bid. Some might even argue that such steps to draw down cash have already been taken in an effort to thwart any takeover attempt, and would point to the interim CEO's plans to expand the company internationally despite a significantly slowing global economy. An article analyzing Best Buy's confused international plans can be found here. They might also point to the $2 million "continuity" bonus payouts that were made to existing management for simply staying on with the company, as discussed here. Many might even also begin to draw more parallels between Best Buy's current situation and the events that led to the eventual demise of Circuit City in 2008, which went bankrupt after busting its cash position in order to prevent a takeover of the company in 2005.
Best Buy bears would welcome such a scenario since a successful defense of the company gives existing management a very large incentive to draw down free cash flow and cash on hand. In doing so, Best Buy management would effectively eliminate two of the strongest features of the company which make it such a big draw for value oriented investors.
As an aside, such a scenario would be incredibly ironic if it did unfold since it would result in the company's founder destroying a business he was trying to save.
There is no question that the possibility of a Best Buy takeover favors Best Buy bulls. It seems highly unlikely that Schulze will act anytime soon, so investors with long positions in the company may be able to ride the green wave of a steadily increasing stock price while the former founder continues to explore his options. It also helps to force most Best Buy bears off their short positions because without a foreseeable timeline, it will be impossible to know if and when a potential short squeeze could be right around the corner.
This means that only those Best Buy bears with the biggest appetites for risk will be left on short side of this position. Of course if the stock price steadily increases while uncertainty continues to swirl, the potential for huge gains for those individuals willing to take the risk will increase as well.
And of course, while many Best Buy bulls will probably read this article as a rationalization of the author's current short position, others might consider the possibilities that each scenario might present, and hedge their positions accordingly.
The information presented in this article is only a starting point to provide ideas and analysis to investors. All individuals reading this article are strongly encouraged to conduct their own due diligence prior to opening a position or closing a position in any investment.
Disclosure: I am short BBY.
Additional disclosure: I am long ATVI. I have no positions in any of the other stocks listed, but may initiate one within the next 72 hours.