(By Mani) Shares of Best Buy Co. Inc
) were volatile after the consumer electronics retailer agreed to permit its founder Richard Schulze conduct due diligence to help him move forward with his proposal to acquire the company. However, a deal to Best Buy looks feasible, but unlikely.
Best Buy is the leading consumer electronics retailer in the US and an increasingly powerful retail player worldwide. However, waning product cycles and increasingly unproductive categories such as entertainment software in its larger stores could weigh on the chain.
The situation at Best Buy is clearly fluid. Shares are likely to remain susceptible to an ongoing deluge of data from Best Buy and its potential suitors.
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"In the end, we view a deal to purchase Best Buy as unlikely," Oppenheimer analyst Brian Nagel wrote in a note to clients.
Though, the company could support the added leverage associated with a leveraged buyout (LBO) with its ample cash flow and a still healthy balance sheet, the potential private equity buyers will ultimately balk at a deteriorating business model that is increasingly falling victim to the inroads of new, nontraditional consumer electronics competitors and a weak product cycle. The company has access to $2.5 billion in credit facilities.
"We expect BBY to end the year with more than $2B in cash and a roughly equal amount of debt," Nagel added.
The company should generate free cash flow of about $1.1 billion, on average, the next two years, a decline from a $1.4 billion average in fiscal 2010 and 2011. Risks remain to the downside as margin pressures are likely to persist the next few quarters.
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In addition, the debt likely to prove expensive in the case of leveraged buyout as Schulze needs to raise outside debt and equity, which could prove challenging considering the company-specific and sector challenges.
"We would expect interest on the debt to finance an acquisition to be somewhere north of 8-9%. BBY's longer term debt currently trades at a more than 7% YTM, while RSH, which has weaker cash flows, has a >14% YTM," the analyst added.
Meanwhile, challenges are likely to be persist over the next several quarters in key categories including flat-panel TVs, notebooks, CE and entertainment software. These categories still represent more than 50 percent of the company's current sales.
"With price competition from online-only retailers and a dearth of new product introductions, we do not see an easy way to turn around waning store performance. Management has started to close stores, but these efforts alone will not be enough to drive better profitability," Nagel added.
Richfield, Minnesota-based Best Buy is contending with significant structural limitations in its business model and faces intense competition from online retailers. Best Buy has been suffering from the ongoing change in the shopping habits as consumers are avoiding big box stores and are turning online for best deals. They just visit big box stores such as Best Buy and then buy their goods at a cheaper rate from online shopping sites such as Amazon.com, Inc. (NASDAQ:AMZN) and eBay, Inc. (NASDAQ:EBAY).