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The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
Best Buy (NYSE:BBY) will host its 2012 Analyst and Investor Day at the Best Buy Theater in New York City on November 13 at 1pm ET (with check-in at 12:30pm ET). The event will be webcast, and hosted by Hubert Joly, President and CEO.
Due to the timing of the analyst event, we expect Best Buy suitor Richard Schulze to publicly update his takeover plans. Mr. Schulze had previously expressed interest in a private equity-led buyout in the $24 – 26 per share range; the recent share price performance may cause him to re-evaluate the price he is willing to pay, and we expect a bid for the company (assuming he finds equity funding) at no higher than $21 per share, and more likely at $18 – 19 per share.
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A buyout offer at $24 suggests an enterprise value of $9.6 billion, and we believe $3.2 billion of equity would be required to get a deal done at this level. Mr. Schulze is willing to put up $1 billion; at $24, $2.2 billion of additional equity funding would be required. At lower prices, less equity would be required.
We believe Best Buy’s declining free cash flow limits the potential for private equity investment. We calculate that Best Buy generated approximately $2 billion in free cash flow in FY:12, and we expect it to generate around $1.6 billion in FY:13. We expect to adjust our current $1.45 billion free cash flow estimate after we better understand new management’s turnaround plans.
At the analyst event, Best Buy must focus on how it will keep profitability from deteriorating further; we believe that requires the company to formulate and execute a plan to substantially reduce its high store level overhead, which has placed it at a key competitive disadvantage to its online peers. We believe that Best Buy’s store level economics place it at a ≈ 10% price disadvantage to online retailers, and we believe that increasingly sophisticated consumers with mobile Internet access will value lower prices over service, ultimately making Best Buy’s big boxes obsolete.
We reiterate our UNDERPERFORM rating and 12-month price target of $14.50, which reflects low visibility, lack of FY:13 guidance, our view that a takeover is unlikely, and our doubts about the company’s new CEO. We believe Best Buy has been unable to stem sustained comp declines and eroding margins, and remains at a significant disadvantage to its lower-priced and lower-cost peers. Our price target reflects a P/E multiple of ≈ 5x our FY:14 EPS estimate of $2.90, and is well below Best Buy’s historical 12 – 15x multiple.
Michael Pachter is an analyst at Wedbush Securities.
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