"What seems obvious at one time is no longer obvious at a later time." - Edward Lampert, CNBC interview, April 4, 2012.
In the above quote, Lampert had been referring to mid-$3 gasoline prices. In 2007, such high prices nearly crippled the auto industry, as demand for new cars waned and consumers flocked to fuel efficient vehicles such as hybrids. Now, five years later, gas prices are at roughly similar levels, yet consumer behavior is drastically different - the auto industry is not in the throes of despair and hybrids are not nearly as important.
Switching gears to retail consumer electronics, the death knell of the industry (like $3.50 gas was for the auto industry), is "showrooming" and all its related sins, such as "high overhead." In this article I examine these criticisms from a contrarian perspective, and also add some quantitative valuations of Best Buy (BBY) and RadioShack (RSH) (the perceived losers) and Amazon (AMZN) (the perceived winner).
Is an Online-Only Presence Really an Advantage?
So far, the showrooming argument has been incredibly two-dimensional and goes something like this: "people visit a bricks and mortar store to try a product, then purchase the product online for a lower price." This argument is good as far as it goes, but central to it are at least two premises (1) online retailers always have lower prices; (2) a lower price, alone, will always suffice to persuade someone to purchase a product.
With respect to the second premise, let's take a subset of consumer electronics, appliances. A plausible argument could be made that an online-only presence would be a serious disadvantage. Imagine purchasing a washer and dryer from Amazon. Could they come to your house and install it? No. Do they have the technical capabilities (service) to assist you if it breaks? No. If you don't like it, could you return it? Not as easily as to a bricks and mortar store in your back yard. In this instance, the convenience of having a retailer in your neighborhood probably greatly outweighs any incremental savings.
Also, many commentators have failed to recognize that bricks and mortar electronic retailers also have a presence online. Best Buy, RadioShack, and every other bricks and mortar retailer is arguably at no disadvantage online, as they have all built strong websites similar to their online-only competitors. In fact, an argument could be made that bricks and mortars' online presence, coupled with their physical presence, is a competitive advantage. For example, a customer may comparison shop, purchase something online from a bricks and mortar's website, then return or exchange it locally at the store without having to pay return shipping, repackage and ship, etc. For sheer convenience and ease of use, a combination of bricks and mortar and online presence cannot be easily beat.
In addition, a retailer with a strong return policy, such as Costco (COST) or strong repair or customer service (such as Best Buy), has additional competitive advantages that a broad line internet retailer may be incapable of creating.
Indeed, Apple (AAPL), considered probably the most tech-savvy, cutting-edge, innovative, and not to mention cool manufacturer and purveyor of electronics is actually seeking to grow its offline retail presence, from the 360 stores it has already opened, all in the last decade. Surely if Apple sees a future in bricks and mortar electronics, it can't be all bad?
Valuation - Even if You're Right, Will You Get Paid?
The chart below summarizes valuations for three of these companies (fiscal year 2011 financials compared to market value as of 7/1/2012):
|Price to Book||0.53||1.90||11.7|
|Price to Sales||0.09||0.14||2.14|
|Price to Earnings||5.3||5.6*||163|
* In FY 2011, Best Buy recorded a non-cash impairment charge that distorted reported earnings, resulting in an accounting loss of $1.23 billion. I instead used FY 2010 earnings as a proxy.
The valuations table is, in my opinion, very telling. Investors are paying an extraordinary premium for future growth. Even if all of investors' predictions come true, and bricks and mortar retail electronics dies a slow and terrible death, they are paying nearly 20 times RadioShack's sales and 30 times RadioShack's earnings for the privilege of participating in this future growth.
When something seems obvious, maybe it is, but then again maybe it's not as obvious as it seems on the surface. Either way, investors in high-flying online-only retailers have discounted any and all negative characteristics of such businesses, while others have discounted any and all positive business characteristics of bricks-and-mortar retailers. Although far from certain, there may be values hiding in plain sight.