Monday’s announcement that Best Buy (NYSE:BBY) founder Richard Schultze was putting together a bid to take the company private got everyone, and in particular shareholders, all hot and bothered.
The proposed acquisition price of between $24 to $26 per share represents about a $9.5 billion deal, which includes the company’s net debt position, or roughly 40% higher than BBY’s 20-day moving average price, according to Bloomberg. That’s one hell of a premium for a company deemed to be in deep trouble.
OK. Time to take a step back and draw a deep breath. There. That’s better.
Let’s talk about what’s really going on, and what might happen.
First things first. Let’s set the stage as it stands today:
- Schulze sent an unsolicited letter to the company board indicating he’s been in discussions with private equity firms and former management executives about taking the company private. No formal proposal has been proffered to the board to this point.
- Schulze’s letter did not name any potential private equity partners that might be persuaded to invest in the deal, and he did not indicate nor name any committed financing partners. This is important because Minnesota law requires he get the board’s permission to form a bidding group that includes both buyout firm names and executives associated with a buyout. I suspect that permissions will be granted, but you never know, and timing may be important.
- Schulze will include his 20.1% share ownership of BBY as part of the equity in the deal. Schulze’s stake is worth around $1 billion, so the man is certainly putting his money where his mouth and pen are.
- Schulze named Credit Suisse (NYSE:CS) as his financial adviser, and CS has indicated it’s “highly confident” the necessary debt financing can be arranged.
The last two pieces of the puzzle are perhaps the most critical: equity and debt financing. Schulze and company will certainly need both, and the two biggest questions are 1) where will it come from, and 2) can it get paid back?
Schulze’s initial $1 billion is certainly a nice start for an equity piece, but he’ll need to come up with some other players or people for perhaps as much as another $2 billion according to most estimates. That works out to roughly 1/3 of the total price, at least to this point.
According to an article by Fortune‘s Stephen Gandel “the leverage well for private equity deals, which dried up in the financial crises, appears ready to draw from again.”
I’m not going to argue the point because everyone is indeed looking for places to put money and make a couple of bucks, but I don’t think this is the type of deal private equity is looking for right now.
Why? Because at the end of the day these players need an exit strategy that gets them big-time returns, and Best Buy doesn’t offer one. I just don’t see BBY coming out of such a difficult situation in three to five years with a valuation that puts a new IPO stock price at, say, $40 per share. Equity folks don’t like uncertainty any more than the markets, and this one is a little more than uncertain.
Even if LBO money comes to the table, who’s going to lend nearly $6 billion to a company already $1.7 billion in debt with a sagging cash flow? All of a sudden, the debt burden gets more than a little cumbersome. And things actually just got worse, as Standard & Poor’s and Fitch Ratings both cut Best Buy’s credit ratings to junk status, while Moody’s (NYSE:MCO) rates the credit at Baa2, just a few notches above junk.
I’ve been out of banking for a little while, but a quick look at similarly rated corporate bonds suggests a coupon of, oh, roughly 7%. That’s about $420 million per year in debt service. On top of all other borrowing. And a dividend … well never mind that, it’s gone if Best Buy becomes a private company.
If BBY never opens another store, a big possibility, capital spending might get down to $250 million annually, or more than half of what it is today. So, while not an impossibility (mom always told me “never say never”), it’s a long shot to suggest the company can service the debt.
Look, I hope it all works. I’d hate to see Best Buy become Circuit City or Tower Records. But I suspect two things will occur: 1) Best Buy management will call the offer price(s) “inadequate” and demand a higher bid, and 2) Schulze will have trouble paying the higher price.
At which point, the only losers are the shareholders.
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing he does not hold a position in any of the aforementioned securities.