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Not the Best Buy

by Richard Collings | Published June 13, 2012 at 9:29 AM

Richard Schulze's resignation as chairman of Best Buy Co. may be his signal to potential private equity buyers that the time is right to buy the company he founded in 1966.

Yet industry sources said the former chief executive will likely have a difficult time wooing potential private equity bidders to make a deal. The size of a potential deal -- sources said a price tag could eclipse $10 billion -- will limit the playing field to only a handful of the largest private equity firms. In addition, 46-year-old Best Buy faces increased competition from Internet retailers such as Amazon.com Inc., as well as better-positioned big-box retailers including Wal-Mart Stores Inc., making it a turnaround situation for any buyer.

An industry banker said that when Schulze announced his intention on June 7 to explore strategic options for his 20.1% stake in the company, he was signaling to potential private equity buyers that he would not be an obstacle to a buyout, and perhaps even a facilitator of such a deal. The banker questioned, however, how big of a role Schulze would play in a buyout or how much risk he's willing to take on, as he is now 71.

A representative for Schulze declined to comment beyond his resignation announcement. Best Buy spokesman Bruce Hight also declined to comment.

An industry analyst said that Schulze has a track record of being a gambler, at one point putting a mortgage on his house in Best Buy's early years to keep the retailer afloat. However, the analyst said it is unlikely that any private equity or strategic buyers would emerge for Best Buy.

A private equity source at a firm that invests in retail said his firm would not go anywhere near Best Buy, as it believes its business model is fundamentally flawed and the risk too great for a turnaround.

The PE source said the retailer struggles due to competition from Internet retailers and because Best Buy devotes a large amount of square footage in its stores to DVDs and CDs, products that are likely to be phased out over the long term in favor of newer technology.

Both the analyst and the private equity source, as well as a source familiar with the electronics retail sector, said the potential size of a Best Buy buyout is also a hurdle. If a 30% premium was applied to the company's current market capitalization, the deal's price tag could eclipse $10 billion, the source familiar with the sector noted. A deal at that size would limit participation to only larger private equity firms such as Kohlberg Kravis Roberts & Co. LP, TPG Capital and Bain Capital LLC, for example, the source added.

Another difficulty would be obtaining the necessary financing in today's credit market environment for a buyout of Best Buy, particularly due to Best Buy's limited fixed asset value and deteriorating fundamentals, the source said. A second industry banker pointed to Blockbuster Inc. (now Blockbuster LLC), which was able to obtain financing as a declining business of about 4 times Ebitda in its October 2004 spinout from Viacom Inc.

In Best Buy's case, the covenants would have to be tight and the lenders would likely not provide extended maturity dates on the debt, wanting to get paid back quickly.

According to investment bank Financo Inc.'s credit monitor, Best Buy generated Ebitda over the past 12 months of nearly $3.3 billion.

In addition, private equity suitors might be loath to make a run at Best Buy because it would be a difficult business to exit, due to the company's size and declining fundamentals. Also, turning around Best Buy would be the equivalent of starting a new business, as it is fully built out, and would have to convert all of its stores to a new model, which is capital intensive and difficult to predict in terms of cost.

While the analyst said there are no likely strategic or private equity bidders for Best Buy, he believes the company does have plenty of cash flow to service its debt and to provide it with the capital to effect a turnaround. The analyst said that Best Buy is testing smaller square footage concepts, but the results of those stores won't be known until after the coming holiday season. As a result, it is difficult to estimate how much capital Best Buy would have to pour into shrinking the square footage of its stores.

And while it is true that CDs and DVDs do take up a certain amount of square footage, those categories are not making money for Best Buy, the analyst said, so exiting such items should improve the retailer's performance.

According to Securities and Exchange Commission filings, Best Buy's entertainment segment, which includes video games, CDs and DVDs, constituted 14% of store sales and had a comparable store sales decline as a category of 13.3% in fiscal 2012 as consumers continued to shift to digital entertainment.

Best Buy had revenue for the 2012 fiscal year ending March 3 of $50.7 billion and a net loss of $1.2 billion, compared to revenue of $49.7 billion and net earnings of nearly $1.3 billion the year before. Best Buy reported $480 million in short-term debt obligations, nearly $1.5 billion in long-term debt obligations and almost $1.2 billion in cash and cash equivalents.

Best Buy traded at $19.90 a share on Tuesday afternoon, giving it a market capitalization of $6.81 billion.

-- Paula Schaap contributed to this report.

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