Founder’s offer might be Best Buy shareholders’ best buy

Share

Best Buy Co. Inc. founder Richard Schulze may be opportunistic in trying to buy the company when it's fallen on hard times. But shareholders who think they can and should get more should focus on what the company will be in the future, not what it was in the past.

As VOX columnist, I fell into this value trap just over a year ago when the shares were trading just below $30, roughly 50 per cent above current levels. "Best Buy is cheaper than at any time since the pre-Internet days – a good buy for a retailer that isn't disappearing any time soon," I said.

At the time, I discounted the anecdotes about people using Best Buy as a "showroom" to try out gadgets and then walk out of the store to buy them online. By the end of 2011, however, I recognized that phenomenon as real and revoked my "buy" call on Best Buy.

Two recent analyses from outside Wall Street on how to fix Best Buy take the showroom concept even further.

Vitaliy N. Katsenelson, a Denver money manager, author, and contributor to Institutional Investor magazine, wrote in late June that the company's strategy of closing big stores and opening smaller ones, "was basically turning Best Buy into RadioShack Corp. It would have been great if this approach had worked for RadioShack, but it hadn't."

Instead, Mr. Katsenelson suggested Best Buy "take a page from drug distributors' playbook" and become the showroom for electronic manufacturers.

"A decade ago McKesson Corp. and Cardinal Health found themselves with a broken business model," he said. "For a long time they'd bought drugs from manufacturers ahead of planned price increases, held them for a few months and then sold them to retailers at the higher prices."

But, he says, drug manufacturers began to stuff the distribution channel to make quarterly numbers, U.S. securities regulators cracked down, and a new fee-for-service model emerged where drug companies paid distributors a volume-based fee for handling their products.

"Manufacturers like Dell, Hewlett-­Packard Co., LG Electronics and Toshiba Corp. need the company to showcase and educate consumers about their products," Mr. Katsenelson said. "With the exception of a few regional chains, Best Buy is the last place in the U.S. where you can play with electronics – then, yes, go buy them on Amazon."

"If Best Buy ceased to exist, electronics manufacturers would be forced to start opening their own stores – think Apple – and I seriously doubt they want to do that," he says. "They lack retail expertise, and they'll face the same structural problem Best Buy is battling today. So an outside-the-box model for Best Buy would be to carry very little or no inventory in its stores, but increase the variety of products."

The key, he argues, is that manufacturers would need to subsidize the cost of running Best Buy stores in a fee-for-service arrangement similar to the drug industry's.

Herb Greenberg, a stocks commentator on U.S. cable channel CNBC, floated a similar but potentially crazier idea last week: That Amazon should just go ahead and buy Best Buy.

"I'm not totally nuts," he felt the need to say. "No matter what anybody will tell you, when it comes to new electronics and other products, such as appliances, most people still want to feel, touch, and hold them – and maybe even actively be sold by somebody who can explain how they work."

Amazon's "key advantage" of being exempt from charging state sales taxes is "becoming less of an edge" as more states impose taxes on online sales, he says. Plus, Amazon' sales growth and operating margins are decelerating, Mr. Greenberg notes.

With a purchase of Best Buy, "Overnight Amazon would have 1,000 well-located Internet showrooms with little in the way of inventory (or maybe a lot of inventory – still to be hashed out in my head) but a way to accelerate sales," Mr. Greenberg said.

The purchase would push Amazon close to $100-billion in sales, and, he said, "with its stock trading at 95-times forward earnings, what a better time to use its stock as currency?"

These kinds of ideas illustrate the depth of the structural problem in Best Buy's business. Mr. Schulze's offer of $24 to $26 per share is a large premium to Friday's $17.64 closing price.

Yet the shares struggled to stay above $20 in Monday afternoon trading, suggesting deep skepticism that the offer will succeed. And even deeper skepticism that the chain could fetch $31 to $33 per share, per estimates cited by analyst Brian Sozzi of NBG Productions in a story by Reuters.

If Mr. Schulze succeeds in financing his offer, Best Buy shareholders may find that it's the best buy they can get.