I don't believe it surprised anyone when the board at Best Buy (NYSE:BBY) didn't exactly leap for joy at the receipt of a go-private bid from Best Buy's founder (and largest shareholder) Richard Schulze. Likewise, I'm not sure many investors will be surprised that the company once again posted a very disappointing quarterly financial performance. Now the question turns to whether shareholders should give newly hired CEO Hubert Joly a chance to work his turnaround magic, or take Schulze's money and move on to new opportunities.
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Another Rotten Quarter
It's hard to feel good about the numbers Best Buy reported for its fiscal second quarter. Revenue was better than the bottom end of the estimate range, but the company missed expectations on a 3% sales decline. Nobody expected positive comps, but the 3.2% drop was bigger than feared. The closest thing to good news is that domestic revenue did improve 1% on a per-square-foot basis, as the company took out about 4% of its selling space.
Margins were likewise disappointing. Gross margin slid more than one point, while adjusted operating income dropped by half. Consequently, the company posted a large miss at the bottom line - 20 cents per share, adjusted, versus an expected 33 cents per share. Making matters worse, at least from a perception standpoint, is that management pulled guidance for the remainder of the year.
SEE: Can Earnings Guidance Accurately Predict The Future?
Can Joly Fix This?
Best Buy shareholders were not exactly ecstatic that the company named Hubert Joly as the company's next CEO, sending the shares down about 10% on Monday's announcement. Although Joly is an experienced turnaround specialist, he has no experience in retail, and Best Buy is arguably the biggest mess he has tackled so far in his career.
The fact is, there's no way to know yet whether this is the right executive for the job. Investors who've been following the markets for a decade or more have seen plenty of cases where a CEO with no explicit industry experience has done well, and plenty of cases where industry veterans have failed. That said, it's a bold pick for a company that cannot afford to see any missteps as the new CEO gets his bearings in an unfamiliar industry.
SEE: CEO Savvy And Stock's Success Go Hand In Hand
Rebuffing the Bid?
Monday's sell-off wasn't necessarily all about the new CEO, though. News also came from Richard Schulze that the company is not exactly cooperating with his go-private bid. In particular, it appears that management attempted to bargain off enhanced access for due diligence with an 18-month standstill agreement. Eighteen months is an eternity for a company in Best Buy's condition, and it was no surprise that Schulze rejected this condition.
Best Buy is playing a dangerous game. Just as the stock was above $36 some 18 months ago, it would not be hard to imagine it falling below $10 in another 18 months, and Schulze has far too much of his personal wealth at stake to be cavalier about that sort of waiting period. Overdramatic as this might sound, it's not unthinkable that Best Buy could be beyond saving after another 18 months of bad management.
On the other hand, Schulze doesn't have the best bargaining position. Even the high end of his $24 to $26 range presupposes pretty unimpressive future performance, and it's hard to imagine that private equity investors will chip in for such an unimpressive outlook. In other words, if Schulze gets reputable private equity investors to pony up next to him, it may well be a sign that the deal undervalues Best Buy by a meaningful amount. On the flip side, private investors need to be compensated for their risk, and there's no guarantee that Best Buy is salvageable in the face of increased competition from Amazon (Nasdaq:AMZN), Walmart (NYSE:WMT), Costco (Nasdaq:COST) and the like.
SEE: Four Online Shopping Alternatives To Amazon
The Bottom Line
If there's good news for Best Buy, it's that hhgregg's (NYSE:HGG) comps were even worse, due in part to the company's greater reliance on TVs in the sales mix. But "others are doing worse" is hardly a bullish argument. I fully acknowledge that Schulze's bid does not give investors full value, but that has to be weighed against the significant risk that even more value will disappear as Best Buy struggles to turn itself around. Perhaps Joly is the right person for the job, and maybe he can unlock the potential that lies within. But this is definitely not a stock for investors who can't embrace an elevated amount of risk.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.
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