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The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
Best Buy (NYSE:BBY) announces new CEO, Hubert Joly. Today, the board of directors named Hubert Joly as CEO, replacing interim CEO George “Mike” Mikan, who served in the capacity since April 10. Mr. Joly’s biography lists driving the turnaround of EDS in France from 1996 to 1999, leading the restructuring of Vivendi’s video game business from 1999 to 2001, oversight of the integration of Universal and Vivendi’s media assets in the U.S. and membership on the restructuring team at Vivendi from 2002 to 2004, and leading the turnaround at Carlson Wagonlit Travel from 2004 to 2007. Mr. Joly became CEO of CWT’s parent, Carlson in 2008.
We find Mr. Joly’s resume unimpressive, and believe he lacks sufficient experience to engineer a turnaround at Best Buy. Mr. Joly’s experience in U.S. retail is virtually nonexistent, with all of his experience in the media, technology and hospitality sectors. His experience at Carlson is particularly inapplicable, as the company derives the vast majority of its revenues from its hotel and restaurant operations, with only a small percentage derived from its corporate travel agency business. The travel agency business has been disintermediated by competition from Internet agencies, much in the way that Best Buy’s business is in the process of being disintermediated by Internet competition, and it is not clear from Mr. Joly’s resume that he made any progress whatsoever in stemming the decline of Carlson’s travel agency business.
Item #1 on Mr. Joly’s “to do” list is to figure out Best Buy’s business. Once he learns the consumer electronics retail sector, Mr. Joly must be prepared to manage Best Buy’s transition from big box to small box format, and must come up with a strategy to lower overall costs, deliver outstanding service, and attract consumers to Best Buy stores, all while remaining price competitive. We believe that this is a Herculean task even for an accomplished retail executive, and believe that Mr. Joly’s complete lack of retail experience will be an impediment to his success.
Buyout discussions appear to have broken down. On August 6, 2012, Best Buy founder and former Chairman Richard Schulze offered to acquire all of the common stock of the company for $24-26 per share in cash. On August 19, Best Buy announced that its proposal to Schulze had been declined. The board’s proposal to Mr. Schulze included access to the company’s non-public information to perform due diligence on condition that Mr. Schulze provide a fully financed proposal within 60 days. It also appears that within the proposal, there was a provision such that if Mr. Schulze’s proposal was denied, he would be unable to “disrupt the company going forward.” Mr. Schulze today issued a statement that he is surprised and disappointed that the discussions had ended prematurely, and that he believes time is of the essence.
Should the buyout discussions resume, we would continue to view a buyout by Schulze as unlikely. The Best Buy Board has been slow to drive innovation at Best Buy during a crucial time in its history, in our view. Mr. Schulze’s record while chairman of the Best Buy board suggests that he will be unable to implement the “bold and extensive changes” contemplated by his turnaround plan. We are not optimistic that a deal will be completed on the terms described by Mr. Schulze without significant equity participation from a partner, and we do not think he will find such a partner.
We remain cautious on Best Buy shares. We believe Best Buy store traffic is driven by a declining consumer electronics business, and expect the company’s focus on its growth segments (primarily Computing and Mobile Phones) to yield lower-thanexpected results as store traffic continues to slow. Same-store sales and margins are likely to continue their decline, with increased SG&A expected; this is an unhealthy combination.
We think Best Buy’s long-term financial health requires substantially lower store level overhead. We believe that Best Buy’s store level economics place it at approximately 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 are maintaining our NEUTRAL rating and $20 price target. Our price target reflects a P/E multiple of 6x our FY:14 EPS estimate of $3.30, well below Best Buy’s historical 12-15x multiple due to continued comps declines, sluggish revenue growth, and eroding profitability.
Risks to attainment of our share price target include changes to the macroeconomic outlook, variability in new product release timing, the effects of competition from other consumer electronic and big-box retailers and changes in consumer demand for consumer electronics.
Michael Pachter is an analyst at Wedbush Securities.
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