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Best Buy Founder Schulze May Have Herculean Task

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 Subscribe to WSJ: http://online.wsj.com?mod=djnwires

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