By Matt Doiron
Over the last five years, Best Buy (NYSE:BBY) has fallen over 55% as it deals with competition from Amazon (NASDAQ:AMZN), which has more than tripled over the same period. A similar story has played out so far in 2012, with Best Buy down about 15%, Amazon up about 30%. The founder of Best Buy, Richard Schulze, has reacted by proposing a leveraged buyout of the company using his own money (Schulze's net worth was estimated at $2.5 billion in 2011, although given that he still owns about 20% of Best Buy that number has likely declined since then) as well as private equity and debt financing.
His target price is $24-$26 per share; the day before his announcement, the stock closed at $17.63 per share. While Best Buy opened above $20 a share today, the price has since fallen and as of this writing sits at about $19.50 (read more about Best Buy's stock price here). This represents a large percentage gain for the day, but the market seems skeptical that the consortium seeking to buy up the company can actually execute. Therefore, an investor who buys in now would make a good return if a buyout does eventually occur in the $24 range.
Best Buy has actually beaten earnings estimates in its last two reported quarters, which include the crucial Christmas season. In its most recent quarter, that beat was down about 25% from the same period in the previous year, with the decline being due to restructuring charges. Revenue did edge up, but this was entirely due to an extra week of revenue in the quarter compared to the first quarter of last year. Same-store sales decreased 5%, led by decreases in sales of consumer electronics (digital cameras and camcorders are being increasingly replaced by smartphones) and entertainment.
If the buyout does go through at $24, then investors are in a good position. But is the stock a buy assuming that Schulze cannot execute the deal? Best Buy's recent results show a company in decline, and while there should be advantages to being able to provide consumers with models of various electronics products, Amazon has clearly gotten the upper hand so far through the convenience and wider selection (as well as potentially lower pricing) that comes with shopping online. It is likely that pricing comparability in particular is benefiting from consumer deleveraging in the U.S., a trend that is likely to continue in the near future. Sell-side analysts give earnings estimates for the fiscal year ending in February 2014 that imply a P/E multiple of 5 over that year's earnings. And with a solid dividend yield -- 3.5% at a price of $19.50 -- there is a value case to be made even if the buyout is not successful.
On a value basis, Best Buy compares well with Amazon, which has a forward P/E of 96 and even a five-year PEG ratio of 7.8 (Best Buy's is 0.9). Of course, Amazon is also attracting attention for its Kindle line of tablets and for its teased plan to roll out same-day delivery in many U.S. cities. It therefore has much better business prospects than Best Buy, but the gap between the two companies' valuations may be too wide. Wal-Mart (NYSE:WMT) also sells consumer electronics as a small part of its big-box retail business, and trades at a forward multiple of 14. Leaving out the prospect of a buyout, Wal-Mart would certainly be a safer bet but wouldn't have as much upside. Apple (NASDAQ:AAPL), with a forward P/E of 12, also has an electronics retail operation for the purpose of selling its own products.
David Einhorn's Greenlight Capital sold out of its Best Buy position in the second quarter of 2012 (at the end of March, the fund had owned 7.7 million shares), but other hedge funds increased their positions in the first three months of the year. AQR Capital Management, managed by Cliff Asness, nearly doubled its stake to 2.4 million shares of the stock and billionaire Ken Griffin's Citadel Investment Group reported owning 1.7 million shares, well up from what it had owned at the beginning of January. On the short side, JANA Partners recently hinted that it was short a "a big box retailer whose category is being entered by Amazon," which we speculated might have been Best Buy. We think that while potential Best Buy investors should be focused on developments in the buyout process, they shouldn't assume that the worst will follow if the acquisition falls apart. Best Buy could prove to have a value above its current stock price as a public company as well.
Disclosure: I am long AAPL.