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Is Best Buy Heading for Bankruptcy?

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After a dismal quarter, it's time to take a hard look at Best Buy's chances for survival.

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MINYANVILLE ORIGINAL Last September, I discussed Best Buy's (BBY) potential to turn into the next Circuit City, based upon the company's endless spending of money on share buybacks while fundamentals were declining. (See: Best Buy Must Stop Purchasing Its Own Stock.)

Here was my conclusion on that day:

Amidst these internal and external challenges, Best Buy wants to buy back even more stock, and that's just nuts.

Boosting current earnings through share repurchases seems far less important than the company's long-term financial health.

Now is the time to batten down the hatches and stuff that balance sheet with cold hard cash. If the economy really sinks or the sales of now-hot products like smartphones slow, that free-cash-flow generation could disappear.

What does that mean?

Well, because of fiscal mismanagement, Best Buy will have started down the dark road of the now-bankrupt Blockbuster and Circuit City.

I followed up in December. (See: Best Buy: Weak Sales, Weak Margins, More Buybacks.)

[Best Buy] can't get enough of its own stock, as it sucked down another $320 million worth of shares during the quarter, bringing year-to-date share repurchases to a whopping $1.2 billion, or 60% of free cash flow. The obvious goal is to continue to shrink the share count to help the company hit near-term earnings targets, but it's not even accomplishing that.

So you know Best Buy is in trouble when in conjunction with this morning's lousy second-quarter earnings report, it announced that it suspended its share repurchase program.

How much money has Best Buy spent on buybacks? Well, since fiscal 2011, $2.9 billion. And if we include the $3.5 billion buyback from 2008, the total goes to a whopping $6.4 billion.

Best Buy's market cap this morning? $5.6 billion.

So yes, it's bought back more stock in the past half-decade than it has in market cap today.

Let's take a brief look at the quarterly earnings numbers before we get to the real question: Is Best Buy actually heading down the dark road of bankruptcy à la Circuit City?
  • Earnings came in at $0.20 per share, missing consensus expectations of $0.31 per share.
  • Revenue was $10.55 billion, slightly below Wall Street's $10.61 billion forecast.
  • Revenue fell 3%.
  • Same-store-sales fell 3.2% despite an easy year-over-year comparison.
  • Gross margin fell to 24.3% from 25.4% last year.
  • Operating margin was 1.2% vs. 2.4% last year.
  • Earnings guidance was suspended, but the company said it expects $1.25 billion to $1.5 billion in free cash flow this year.
Best Buy saw weakness in gaming, digital imaging, televisions, and notebook PCs. On the positive side, the company saw strength in tablets, mobile phones, appliances, and eReaders.

Domestic online revenue grew by 14%. However, that pales in comparison to the 800-pound gorilla Amazon (AMZN), which grew by 29% last quarter.

International sales were weak with a same-store-sales decline of 8.2%, driven by weak consumer spending in China and the expiration of government-spending programs. The company also saw poor results in in Canada.

Okay, on to the juicy stuff.

Let's hop in the time machine and look at the four financial metrics that illustrate Circuit City's demise, and compare each to Best Buy's.

1. The Balance Sheet

As you can see, Circuit City went from a peak of $984 million in net cash in fiscal 2005 to a deficit in early 2009:



Best Buy is operating at a net debt position. However, keep in mind that the company is likely to see significant cash inflows during the next two quarters, so we'll have to wait at least until next quarter until we can realistically worry about a cash crunch.



2. Declining Free Cash Flow

Circuit City's free cash flow generation peaked in 2005, but went negative by 2008:



Best Buy has done much better, and if the company can hit its full-year free cash flow target of $1.25 billion to $1.5 billion, it should be okay for the time being. However, I'd assume that this forecast was conservative -- so if Best Buy can't hit it, assume more trouble is on the way.



3. Share Repurchase Activity

Between 2004 and 2008, Circuit City spend $967 million on share repurchases:



Best Buy very smartly suspended its share repurchases, but it has eaten up $6.4 billion buying back stock since 2008:



4. Sales Growth

Circuit City sales fell hard as the economy began caving in:



Best Buy's leaning negative, but isn't doing nearly as badly as Circuit City was doing before bankruptcy.



Conclusion

Best Buy's on what I like to call the "Edge of Gory." The company's clearly not doing well, but things haven't yet gotten so bad that bankruptcy is likely.

For that to happen, we would need to see a major contraction in US economic activity, and some new competitive threat -- perhaps Amazon making a push with physical stores, or actually going through with same-day or next-day delivery (though the company recently said this was not feasible).

Overall, Best Buy still smells like a value trap. I'd happily give it to my worst enemy.

At this point, the prospects of a takeover by co-founder Richard Schulze are looking pretty dim. And in terms of the underlying fundamentals, if the company is panicked enough to pull its buybacks, it has got to be awfully worried about how the holiday season is going to shake out. And the worse the results get, the harder it will be for Schulze to raise money for a deal.

As for new CEO Hubert Joly, I'm not excited. Best Buy's fighting against the inevitable evolution in retail and consumer electronics. I don't think anyone has a plan to fight this tide.

Ultimately, Best Buy's decline in prominence is actually an endorsement of companies like Apple (AAPL), SanDisk (SNDK), and Qualcomm (QCOM), which are much more directly levered to the growth in next-generation mobile devices and have little-to-no exposure to the old stuff that's not growing.

The same mobile devices that are sending Apple's stock to all-time highs are sending Best Buy to all-time lows. Best Buy used to sell a lot of computers, video games, GPS devices, and physical media -- categories that have been eaten up by smartphones and tablets.

That equals stores that are too freaking big, and a stock that's a lot more expensive than it looks.
Position in AAPL,SNDK
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