On Tuesday, August 21st, Best Buy (BBY) will report its second quarter earnings before the market opens. Investors will be watching closely to see whether the company's results can put some life back into the stock price, which sold off in response to news that talks between the Board and founder Richard Schulze had halted.
Best Buy has traded in a 52-week range of $16.97 to $28.52, and now is at the $18 level. This is despite earnings exceeding consensus for the last two quarters, and the expectation that Q2 results will benefit from the purchase of CPW's profit interest. Investors foresee declining margins due to higher costs and the continuing erosion of same store sales in response to pressure from online retailers - and Amazon (AMZN) in particular.
Earnings, of course, are not the major driver of the stock price right now. Since founder and former Chairman Richard Schulze offered to take the company private at $24-$26 per share, the stock has risen and fallen on the prospects for that deal, which would require Schulze to raise as much as $10 billion in equity and debt financing. The Board offered Schulze and his yet-to-be identified buyout group an opportunity for due diligence, but asked for an 18-month standstill agreement, which made the diligence a useless exercise. When Schulze refused, the Board hired a new CEO, Hubert Joly - known as a turnaround expert but with no retailing experience - and essentially told Schultz to "put up or shut up", giving him 60 days to come forward with a full -financed offer. Considering that Schulze knows the company as well as anyone, two months should have been sufficient if a deal could be done.
Now that investor appetite for a deal has been whetted, Hubert Joly and the Board have very little time to act if they are to fend off Schulze and whatever other bidders might surface. They must quickly articulate a plan to get the stock price up and to demonstrate catalysts such as improving margins that might drive value improvement. Management must demonstrate that it can close the gap between online retailers' costs and those of Best Buy's big box stores so that it will have a chance to compete on price. If a viable plan can be put forth to investors and management can win their confidence, Best Buy could be a great turnaround story - right up Hubert Joly's alley. However, it is doubtful that Richard Schultz will go away quietly.
What are the chances that a deal could be completed? First of all, Mr. Schulze would have to raise billions in equity and ratchet up the debt. In order to raise the equity portion, private equity would have to come in and put their money out of action for whatever period - likely a few years - that would be required to turn the company around and position it for sale through acquisition or IPO. Richard Schulze's in-depth knowledge of Best Buy should allow him to determine with precision how the numbers would work in such a buyout. He must convince others that the deal can be supported. That would take a lot of faith, as a turnaround of that magnitude would be a challenge to achieve.
So if Best Buy reports a blowout quarter tomorrow, what's an investor to do? First, listen carefully to the conference call for hints of a turnaround plan to come. Second, evaluate Hubert Joly's track record and decide whether he can turn the company around amid declining fundamentals despite his lack of retailing know how. Third, watch the stock price. The further it declines, the more pressure there will be on the Board to deal with Schulze and the more doable a deal will become. Then ask yourself, in the immortal words of Clint Eastwood's Harry Callahan, "Do I feel lucky? Well do ya, punk?"