The chance to earn over a 30% return in a short-term investment is commonplace. Armed with hindsight, investors can see several instances each month where massive returns could be made if only they picked the right stock. Rarely is this opportunity thrust in public, played on national news, and talked about constantly at work. This opportunity is obvious. But there's a shocking factor-the 30%+ of 'quick upside' is actually part of the downside for an investment in Best Buy (BBY) stock. I believe that Best Buy stock is worth much more in the long-term.
The 'Quick' Upside
On August 6th, Richard Schulze, the original founder of Best Buy, offered to pay $24 to $26 per share to take Best Buy private in a large equity and debt deal valued at roughly $8.84 billion.
Best Buy stock briefly crossed $21 on Monday, but has since been range-bound in the high $19s, closing on August 8 for $19.86 a share. For investors entering at this price, if the offer goes through at $26, a quick profit of 30.9% will occur.
30.9% is nothing to laugh at, but I believe the true value is in the long-term investment, or even better for most parties, a stronger takeover bid. If the $24-$26 offer goes through, only one party will reap ultimate profits: Richard Schulze and his private equity team. Even short-term investors will be essentially robbed of profits that should be doubled ($28-$32 takeover) at the minimum.
The Real Best Buy
Best Buy alongside its similar, albeit more specialized, counterpart Gamestop (GME) has been treated very unfairly by investment media (Forbes & MSN examples). Analysts often dismiss these companies, suggesting their irrelevance in a digital age and suggest potential bankruptcy. Jim Cramer recently tweeted that "Best Buy is a take the money and run situation." It doesn't end there. US News just reported "Best Buy's best days are probably over," and in their article the analyst mentions a "loss" in Fiscal Year 2012. Almost every time I bring up Best Buy as a great investment idea, someone mentions the recent 'loss' and a strong chance of bankruptcy.
The loss was only on paper; Best Buy actually had a record year in terms of revenues ($50.7B), operating cash flow ($3.3B), and Adjusted EPS ($3.64). Free cash flow of $2.5B was Best Buy's second best result ever. Simply stating that Best Buy had a huge loss in Fiscal 2012 is absurd. Its poor reporting by news people, lacks due diligence by investment professionals, and frankly should be an embarrassing statement for anyone in the financial business. The truth is that Best Buy wrote off an enormous investment in European operations, took paper charges for an acquisition of a British joint-venture, and spent money on essential restructuring. The Press Release for FY12 is here, and for a more in-depth look, check out the 10K on the SEC Edgar.
$8.84B represents approximately 2.7X operating cash flows or 3.5X free cash flows. In an EPS sense, $26 per share is 7.14 trailing adjusted P/E and a forward P/E of 6.84-7.43 based on Best Buy's latest guidance. At a minimum, with the advantage of running a private company, I believe that Best Buy should sell for 10x forward P/E. This is a price of $35-$38 per share. This is a premium of 76%-92% from Wednesday's close price. If the current deal goes through, most investors really will be stuck with the 'downside' of probable scenarios. I believe that Best Buy as a long-term investment is worth over $30 per share, and offers the following traits at $19.80:
- High and safe dividend: 3.43% annual dividend yield with a payout ratio of less than 19%
- Strong repurchases: 140M shares repurchased (29%) in past 5 yrs
- Continuing repurchases: Up to $1B (50M shares or 15% of outstanding) slated for FY13
- Results in a tough industry and poor economy: 5-yr annualized revenue growth of 7.1%
It appears that Jefferies & Co.'s Daniel Binder also has stated that Schulze's offer is "too low" and suggests a bid range of "high $20s to low $30s." I believe that even this range is still low, but it is encouraging to see more analysts wake up to the realities of Best Buy's position. I believe that Binder's report will force more analysts to give BBY's books a deeper look and to discard the fairy tale about losses and bankruptcies. The shocking part is that the market didn't respond positively.
The Wall Street Journal has stated from a source "familiar with the matter" that Best Buy's Board wants to wait until after earnings on August 21st to discuss the deal. If results are expected to be poor, this move makes no sense. The likely scenario is that the results will be in-line or even exceed guidance (run rate for $3.50-$3.80 annual EPS). With the share repurchases, it is likely that adjusted EPS growth will be very strong. These results will push the stock higher and force Schulze to renegotiate his offer. This is a strong positive, but the market isn't reacting.
I believe that the best case scenario for all investors is a buyout for at the aforementioned $35-$38 range; however, long-term results could be even better if Best Buy's new CEO can provide much needed vision for the future. Regardless, Schulze knows what he is bidding for, and $24-$26 is a laughable offer. The saddest part is that both financial media and the 'efficient market' do not realize this. Best Buy at $19.80 could soon prove to be a textbook example of the failure of rational pricing by the so-called efficient market.