NerdWallet’s Scoreboard: Playing the Odds With Best Buy

Investing, Investments

Is Best Buy (BBY) a solid investment?  Investors should stop thinking about Best Buy’s past and start looking to its future.  Instead, it appears that share prices are sensitive to deteriorating results from today’s operations when they should be reacting to how the firm will change in the future.

NerdWallet Scoreboard: Best Buy

  • Thesis: Best Buy faces a reinvention of itself but is also a takeover candidate.
  • Risks: Management resisting takeover offers or changes to old strategy.
  • Catalysts: News about a takeover deal.
  • Recommendation: Hold. Shares are speculative.
  • Downside: Short term drop on pessimism, as low as $9.32.

There are four radical outcomes in the cards for Best Buy. We can get reasonable per-share value estimates for each possible future and then think about about the probabilities for each:

1)     The firm is taken private.

Best Buy’s founder and former chairman Richard Schulze is currently attempting to put together a takeover bid for the firm. Assuming a 30-day extension, a 90-day window to propose a buy back offer to the company expires in mid-November.  This plan has a fair chance of succeeding since Schulze already owns about 20% of Best Buy’s equity. Initially his plan was to buy out Best Buy’s equity for $24 to $26 per share.

2)     Share prices fall to where activist investors buy shares and gain control of the company.

Activists would probably try to break up the company by geography and by format. Yes, there is more to Best Buy than the familiar big box format. Best Buy’s international footprint and its diverse set of brands and formats are summarized on page 4 of Best Buy’s 2011 10-K:

“The International segment is comprised of: (i) all Canada operations, operating under the brand names Best Buy, Best Buy Mobile, Cell Shop, Connect Pro, Future Shop and Geek Squad; (ii) all Europe operations, operating under the brand names The Carphone Warehouse, The Phone House and Geek Squad; (iii) all China operations, operating under the brand name Five Star and (iv) all Mexico operations, operating under the brand names Best Buy and Geek Squad.”

In the United States it operates as Best Buy, Geek Squad, Best Buy Mobile, Magnolia Audio Video, and Pacific Sales Kitchen and Bath Centers.

We can estimate the value of Best Buy shares as an activist investor play by applying price multiples of another activist investor dominated firm which sells appliances in an old retail format: Sears (SHLD).

3)     Best Buy follows Radio Shack (RSH) into irrelevance and obscurity.

Best Buy is considering a move into strip-mall locations which will focus on smartphone sales. We can estimate this outcome by applying the price-to-sales ratio of Radio Shack to Best Buy.

4)     Best Buy follows Circuit City into bankruptcy.

Since the firm is well capitalized and has a flexible lease-based location strategy, bankruptcy would require severe managerial negligence involving sustaining failing locations, clinging to failing strategies, launching ludicrous new spending projects, or both.

We can approximate this outcome as $0 per share. Current price-to-sales, price-to-book, and price-to-tangible book ratios are presented below:

Ticker

Company

P/E

P/S

P/B

P/TB

BBY

Best Buy

NA

0.10

1.45

2.80

RSH

RadioShack

NA

0.06

0.34

0.36

SHLD

Sears Holdings

NA

0.16

1.5

9.02

 

 

 

 

The most conservative valuation ratios were applied to Best Buy for the second and third scenarios:

Scenario

Valuation Method

$/Share

Optimistic Probability

Pessimistic Probability

1) Takeover

Proposed Value

$24.00

40%

20%

2) Activists

P/B

$24.27

30%

15%

3) Radio Shack

P/TB

$1.95

20%

45%

4) Bankruptcy

Worst Case

$0.00

10%

20%

Expected Value

 

 

$17.27

$9.32

Cash takeover offers tend to go through over 80% of the time once accepted. Essentially, a 40% probability is assigned to a successful takeover based on the assumption that Richard Schulze has a 50% chance of proposing an acceptable offer.

The expected values of $17.27 and $9.32 flank Best Buy’s current $15 share price. The stock itself cannot be recommended as a buy candidate. The outcomes are too disparate and the downside to a pessimistic outlook is too extreme.

(Sophisticated investors who wish to speculate on a potential takeover announcement ought to use out of the money calls that expire in Jan 2013 instead of buying the stock. Make no mistake, this is gambling.)

Risks

Management could hard-headedly try to fight the future. This does not seem to be an issue since top executives at Best Buy are leaving and because the firm is testing many new business strategies.

The firm could fail to attract investors. This is entirely possible if the firm’s lenders stymie debt-financed leveraged buy-out bids. S&P credit analyst Jayne Ross said, “The transaction, if completed, would materially weaken Best Buy’s credit protection metrics because we believe it will add a significant amount of debt.”

In the future investors could find the net assets of the company to be substantially worthless.  As of its last quarterly filing the accounting value of its assets were $15.8 billion. After considering liabilities and removing intangible assets this translated to a relatively small $1.8 billion net tangible asset value. Write downs of tangible assets or future losses could chisel away at this number.

Catalysts

News surfacing about a takeover deal by mid-November would send shares higher. If such a takeover attempt never materializes or fails, filings by activist investors which disclose the accumulation of Best Buy shares would send shares higher.

Conclusion

Best Buy shares are highly speculative. Maintain your current positions at today’s prices.

Disclaimer

Any forward looking statements and recommendations are exclusively the thoughts and opinions of the author.  NerdWallet does not endorse any specific recommendations; we believe all investment decisions should be made using research and judgment by the individual investor.