By Andria Cheng
NEW YORK--The founder and former chairman of Best Buy Co. (BBY),
Richard Schulze, proposed taking the electronics retailer private
on Monday with a bid of up to $8.84 billion, but it looks like he's
facing an uphill battle.
For starters, investors questioned whether he would be able to
secure the financing needed, after he said he was in talks with
interested parties and planned to finance the proposed bid through
a combination of investments from private equity and reinvestment
of about $1 billion of his own equity, as well as through debt
financing.
Schulze also hasn't had luck getting the board's approval, as
required by Minnesota law, to go ahead and submit an official bid.
He said he's gone public with his proposal after Best Buy directors
told him they would need an additional three weeks before
considering his request.
"His offer has increased credibility, but it is still a long way
from a firm bid," said Sanford C. Bernstein & Co. analyst Colin
McGranahan. "Going private with a highly leveraged capital
structure would substantially increase the operating risk" of Best
Buy.
After investors drove Best Buy's stock up by 22% to $21.60, it's
retreated to a gain of 10% to $19.43 in recent trading. That
compared with Schulze's proposed offer of $24 to $26 a share.
Schulze, through a spokeswoman, declined to comment.
Even if Schulze succeeded in pushing the deal forward, he still
faces formidable challenges and a changing industry dynamic -- in
which consumers, armed with smartphones, are using Best Buy and
other retail outlets as so-called showrooms and then spend money
elsewhere, especially at discounters such as Wal-Mart Stores Inc.
(WMT) and online retailers like Amazon.com Inc. (AMZN)
More broadly, Best Buy and its smaller rivals RadioShack Corp.
(RSH) and HHGregg Inc. (HGG) are operating in a business where
there are few hit products, and where demand-driving innovation is
concentrated on a few key players, including Apple Inc. (AAPL),
according to analysts.
"It's unclear what they can do to address some of the issues,"
said UBS analyst Michael Lasser in an interview. "Whatever it might
be has to include rationalizing expense structure, close big-box
stores and try to emphasize its strength like services."
While Best Buy said in March that it plans to shut 50 big-box
stores, cut $800 million in costs by fiscal 2015 and open more of
the smaller Best Buy Mobile locations, analysts said the company
needs to be more aggressive. Best Buy's operating profit margin is
expected to decline to less than 5% this year from 5.6% in fiscal
2010 and from a peak of 6.1% in 2007, Lasser added.
"The consumer-electronics sector is under tremendous
profit-compression pressure," said Stifel, Nicolaus & Co.
analyst David Schick. "Near term there are few sales or
gross-margin opportunities."
The sector may see some gains in demand later this year though
gaming products and release of Microsoft Corp.'s (MSFT) Windows 8
software. Schick added that there could be room for a profitable,
smaller consumer-electronics player if manufacturers keep pricing
consistent online and at brick-and-mortar retailers, and if state
efforts to collect taxes from online sales continue to ramp up.
"To preserve profitability, Best Buy needs to cut costs,"
commented Lasser at UBS. Still, he said Best Buy, with $50 billion
in sales, "isn't going anywhere."
The value of the proposed offer from Schulze was calculated
based on the 339.9 million shares outstanding as of June for
Richfield, Minn.-based Best Buy.
Factoring in Best Buy's capital position at the end of last
quarter, including cash of $1.4 billion and debt of $2 billion,
Schulze likely would have to raise as much as $8.4 billion after
his own investment, said Wedbush analyst Michael Pachter. He added
Schulze will "have to raise at least $3 billion in equity to
complete a deal of this size," because he thinks lenders would be
reluctant to advance more than two times the company's trailing
earnings before interest, tax, depreciation and amortization given
recent profit declines.
"We don't believe this is a plausible scenario, and think that
private-equity investment will be hard to come by," Pachter
remarked.
David Strasser at Janney Capital Markets, for his part, said
Best Buy could be valued at close to $30, which means there would
be a need for Schulze to come up with more than $3 billion in
additional equity.
Best Buy acknowledged it's received the unsolicited proposal
from Schulze and said that it would discuss the offer with
financial and legal advisers, including J.P. Morgan and Goldman
Sachs.
Schulze, who already owns 20.1% of Best Buy shares, said his
adviser Credit Suisse has informed him "it is highly confident it
can arrange the necessary debt financing."
The executive had spent 46 years at Best Buy and its predecessor
company Sound of Music; Schulze was its company's chief executive
and chairman until 2002. He continued in the role of chairman and a
director from 2002 until resigning from the board in June, amid
fallout from controversy involving former Chief Executive Brian
Dunn.
Getting the gang back together
Schulze said that he's developed a business plan that addresses
the problems faced by Best Buy and that he's talked with "many
highly regarded" former Best Buy executives, including former chief
Brad Anderson and former president and operating chief Allen
Lenzmeier, who are interested in rejoining the company.
"Now is the moment of truth for Best Buy and that immediate and
substantial changes are needed for the company to return to its
market-leading ways," Schulze said, adding that he's made "repeated
requests" to Best Buy's board for several weeks before deciding to
make the bid public. "Best Buy's best chance for renewed success is
to implement with urgency the necessary changes as a private
company."
Schulze said that from 1991 through 2009 -- when he, Anderson
and Lenzmeier worked together in executive-leadership positions --
Best Buy's revenue increased from approximately $900 million to
more than $45 billion, while earnings before interest, taxes,
depreciation and amortization jumped from about $30 million to $2.9
billion, and Best Buy generated a total return in excess of
16,000%.
But that was then.
Anderson and Lenzmeier "did a strong job while at the company,
but we would be a bit skeptical that they would be able to come in
and drive this turnaround," said Janney's Strasser. "So much has
changed in the few years since they left the business that the
learning curve could prove to be steep."
-Andria Cheng; 415-439-6400; AskNewswires@dowjones.com
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