What is afoot in the Shares of Best Buy?
After a large decline, the market is beginning to think that $24 to $26 is a fair price for Best Buy (BBY).
Best Buy founder and ex-CEO Richard Schulze, has made an unsolicited bid for the remaining 79.1% of Best Buy he does not already own. In the letter to the board he states:
Based on my analysis of publicly available information, and subject to due diligence, I would propose to acquire all of the common stock of Best Buy for a purchase price in the range of $24.00 to $26.00 per share in cash. This represents a very compelling opportunity for Best Buy shareholders, who would receive the certainty of an immediate all-cash premium of 36% to 47% for their shares based on the latest closing stock price of $17.64 on August 3, 2012.
There has been pessimism present in the shares of Best Buy, which pushed them to the levels noted by Schulze. I wrote the following about that in a previous article:
With the drama of an ousted CEO, a parting founder, a lousy TV market, a poor video game market, and increased competitive pressure from Amazon (AMZN) and other retailers, Best Buy shares are selling at a handsome discount: about 5 times free-cash-flow. That represents a return of 20%--if, and only if, Best Buy can maintain or improve its position. (From The Future Of Best Buy.)
The Value of the Going Private Bid
Let us look at Schulze going private offer as measured by free-cash-flows to try and get a guage as to whether the price is high enough.
If we define free-cash-flow as:
Free-cash-flow (No. 1) = Operating Cash Flow TTM - Capital Expenditures TTM
Then BBY's free-cash-flow on a trailing twelve month basis is $1,594,000,000. At the following share prices we see that P/FCF is:
Free-Cash-Flow (No.1) TTM
Even at a share price of $25, Best Buy shares relative to free-cash-flow are cheaper than 93.4% of the S&P 500. Indeed, some of those which are cheaper in comparison are financial companies who cannot be measured in the same way. Taking that into account, I believe Best Buy is the cheapest in the S&P 500 when measured by free-cash-flow. So when Richard Schulze's notes that his bid is made after reviewing publicly available information--it is the financial statements he is looking at, those which we are all exposed to.
Richard Schulze alludes to the idea that Best Buy might perform better out of the public light when he says:
I feel that the transaction I am proposing would be a "win-win", as it would allow shareholders to receive compelling value for their shares, and it would allow Best Buy to take the actions that it needs to take outside of the public sphere.
Perhaps he thinks this is due to the overwhelming skepticism on the part of investors. To further confirm the idea that common stock shareholders might be unduly pessimistic, he makes it clear that it is possible to debt finance the deal--meaning creditors think Best Buy's future cash-flow would be enough for the interest payments and repayment of debt.
Of course, one should use caution when looking at this whole process. Richard Schulze ends his letter noting:
Of course, neither Best Buy nor I shall be subject to any binding obligation with respect to any transaction unless and until a definitive agreement is executed and delivered.
Banking on a takeover from the Richard Schulze might be too hard to stomach. The upside is that the business might be worth even more than a price to free-cash-flow of 4.28 (at $19.91), or 5.37 (at $25). The pessimism in the shares is still present (just like its "showrooming") but basic math shows the sell-off might be over done.
If Shulze is to succeed, he would have bought a company doing $50 billion in sales, with trailing-twelve-month free-cash-flow of $1.59 billion, for about $6.8 billion ($8.5 billion offer * 79.1%). He would use debt for all but $1.0 billion of that. That debt of about $5.8 billion could be paid off with the free-cash-flow figure above over 3 years 7 months. Not a bad deal for Schulze if Best Buy can maintain its position.