by Lawrence Meyers | August 21, 2013 1:55 pm
Plugging holes on the Titanic won’t stop the ship from sinking.
I have plenty of points to make regarding a short selling thesis on Best Buy (BBY), and why it isn’t quite time to pull that trigger.
For the moment, however, I don’t care if the company reported better-than-expected earnings. The most basic fundamental problem with Best Buy is that it is a brick-and-mortar cash suck in a digitally driven Amazon (AMZN) world.
There will always be a small contingent of people who must have instant gratification. There will always be a small contingent of people who want to see the item in a store and have the store ship it. But for the most part, people shop in the box stores and then buy their appliances from online retailers. That’s only going to happen more frequently thanks to younger generations who do everything online.
So how bad is it for Best Buy? The founder of the company tried to take the company private with assistance from private equity. But PE firms will only scoop up undervalued companies they can get a bargain on, or that have a long history of stable free cash flow. The key word here is “stable.” Free cash flow since FY06 has been as follows, in millions, backing out net income adjustments greater than $200 million:
|Year||Free Cash Flow (in Millions)||YEAR||Free Cash Flow (in Millions)|
If I were a PE firm, why would I be impressed about any of that, or that six-month free cash flow is negative $282 million? I’d also be looking at a 0.6% decline in overall revenue, a 0.4% decline in same-store sales, and a 10% increase in online sales.
Why would I care about Best Buy’s online sales strategy? Amazon will beat it every time. Amazon can afford to beat it every time, which is why Best Buy’s promise to match online pricing in its stores is crazy — it destroys margins by offering online pricing while paying the same expenses it always did as a brick and mortar operation.
Should I care about the company’s mobile business? No — it is highly competitive and low-margin. I don’t go to Best Buy to get a cell phone.
Margins only improved because the company cut costs, not because Best Buy is driving organic growth. Nor am I thrilled by the store-within-a-store concept. If I want a Microsoft (MSFT) or Samsung (SSNLF) product, I still will buy it online.
Meanwhile, after the PE deal failed, the very same guys who were in charge of the company as it began its death spiral have been added back to the board of directors. That does nothing to shake up the company or make it more likely to survive the next 20 years.
Meanwhile, the company raised $500 million in 5% bonds, which it will use to pay down its 6.75% bonds. That’s like using a pinkie finger to plug a thumb-sized hole.
So amid all that negativity, why shouldn’t investors short BBY?
Because the death spiral hasn’t quite begun.
The company still has a billion in cash on the balance sheet and only $1.6 billion in long-term debt, which it can afford to pay interest on. And a slight bit of positive news (which wasn’t even all that positive) has pushed the stock up 13% this week, proving that investors are still willing to jump in.
I suggest sitting tight. Watch the free cash flow and total cash position. When those start to crumble, then you go short.
As of this writing, Larry Meyers did not hold a position in any of the aforementioned securities.
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