This May Be Best Buy's Last Hope

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Best Buy StoreBest Buy (BBY) founder Richard Schulze apparently isn't giving up on his dream of taking back his company.

Reuters reported Wednesday that Schulze and a consortium of at least four private equity firms are studying the struggling consumer electronics retailer's books to explore what sources say may be an $11 billion buyout.

Don't hold out for an immediate resolution. A source tells Reuters that the group is unlikely to have a buyout proposal until mid-November at the earliest, and that's if the firms like what they see after diving into the numbers. Schulze understandably has an emotional attachment to the company that he got off the ground decades ago, but private equity firms will only invest in something that they feel will be worth more down the road.

Best Buy will prove to be a perplexing decision for even seasoned bean counters.

Singing the Best Buy Blues

Schulze owns a 20% stake in the company, so the 71-year-old founder will be an important player in any potential deal.

He had a falling out with the company's board earlier this year when now-former CEO Brian Dunn was dismissed under allegations of having an inappropriate relationship -- according to Best Buy's corporate policy -- with an employee. Dunn had confided in Schulze, who was then taken to task for not getting back to the board with the information.

Schulze approached the board in June to discuss plans to take the company private but was rebuffed. He went public with his battle to wrestle back control two months later, exciting battered shareholders with the notion of buying back the company at a price between $24 and $26 a share.

Best Buy's shares were in the high teens at the time.


Taking the Easy Way Out

A lot has happened at Best Buy since Schulze's summertime offer, and most of it hasn't been good for its shareholders.

The retailer's board went ahead and hired a new CEO, and that's a move that will make it more expensive for a potential buyer given the new helmsman's lavish pay package. Best Buy also had another disappointing quarter.

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Schulze may still be willing to buy the company in the mid-$20s, but his potential private equity partners may not see it that way. They don't have the sentimental attachment to Best Buy, and there's little reason for them to get excited about the chain's future prospects.

Few things seem to be trending Best Buy's way these days. Amazon.com (AMZN) is eating its lunch. Much of its space is devoted to selling CDs, DVDs, e-books, and video games, but digital delivery is disrupting all four platforms. Rolling out smaller Best Buy Mobile stores as it closes down some of its superstores makes sense on paper, but RadioShack (RSH) -- further along with a similar strategy -- is doing so badly that it had to suspend its dividend and recently lost its CEO.

A Schulze buyout may be the last chance for investors to get out at a reasonable price, but it remains to be seen when -- and at what price -- a deal can get done.

This May Be Best Buy's Last Hope

Showrooming -- the troublesome practice for local store owners that finds potential buyers kicking the tires of products before buying them cheaper online -- isn't going away.

Amazon.com (AMZN) reported a 34% spike in net sales during its first quarter on Thursday. Best Buy doesn't operate on the same fiscal calendar as the leading online retailer, but analysts feel that the company's top line will inch less than 3% higher when it reports next month.

It's not Best Buy's fault. A company with the overhead of manning physical stores can't afford to sell at the prices that nimbler Web-based retailers can offer. The wide availability of the Internet as a research tool also makes the hands-on perspective that local retailers provide less necessary, and in some cases even less desirable.

Some real-world chains are fighting back through exclusivity. Cheap-chic discount department store operator Target (TGT) has been a strong player in stocking up on items that are only available through Target.

Best Buy doesn't have that luxury.

Best Buy confirmed on Thursday that it's killing Best Buy Connect, the retailer's private-label mobile broadband service. It never took off, and the service reportedly had just 11,000 customers. Yes, the company has private labels for home theater and other consumer electronics, but it's not as if the merchandise is considered unique. This isn't Sears (SHLD) with brand equity for its Craftsman tools and Kenmore appliances.

Walk into a Best Buy and check out the racks of CDs, video games, books, and movies. All four of those media platforms are losing physical appeal as those industries go digital.

In Thursday night's quarterly report, Amazon revealed that nine of the 10 best-sellers were digital products. Best Buy may think it's scoring a sale when it sells a tablet or a smartphone, but it's really simply handing over the tools that will result in that shopper relying less on in-store purchases.

Another nugget in Amazon's report is that 130,000 of the books in its virtual marketplace are exclusive to the Kindle Store. Yes, a lot of that is vanity press stuff from authors who couldn't land real publishing deals, but 16 of Amazon's 100 best-selling e-books were exclusive to its store.

Apple (AAPL), on the other hand, is the poster child of the modern ecosystem. The success of iTunes has turned Apple into the country's largest music retailer. There are now hundreds of thousands of apps in the company's iconic App Store.

Best Buy has tried its hand at digital distribution of music and movies -- even to the point of buying Napster and CinemaNow -- but that hasn't panned out. Brick-and-mortar chains just don't have the high-tech appeal to launch cool digital ecosystems.

The worst part about movies, music, books, and games going digital isn't just the empty space that Best Buy will have to fill. The company has enough sharp retail vets to put the space to work with store remodeling plans that are currently in the works.

The worst part of the migration is that these are the items that forced shoppers to come back to Best Buy. You may only need a new washer once every 10 years, but there are always new DVDs hitting the market every Tuesday. New video games, CDs, and books are also always coming out. As more people replace physical media with digital -- and you do realize that Apple and Amazon are selling millions of tablets every passing quarter -- Best Buy will be a less frequent stop for even its most loyal customers.

Best Buy conceded in its most recent report that it will have to get serious about lowering prices in the future. Its aggressive expense-shaving efforts will be partly passed on to shoppers in the form of better pricing.

"We intend to invest some of these cost savings into offering new and improved customer experiences and competitive prices," Best Buy explained last month.

The problem is that it will probably never be able to cut its overhead to the point where it's truly competitive with Amazon and even cheaper e-tailers. This will force Best Buy into sacrificing margins on products, but hoping to make a profit by selling extended warranties, obsolescence insurance, and Geek Squad services. It's a plan that sounds fine on paper, but consumers are already tiring of the hard sell during the checkout process for services that they may never need. If Best Buy sees this as its future, it's underestimating what shoppers do when they're annoyed.

They stop coming back!

hhgregg (HGG) and Conn's (CONN) are some of the rare survivors in this field, and it's because they key in on heavy appliances, furniture, bedding, and even lawn care equipment that's harder to secure cheaper online, given the bulk of the items.

Best Buy naturally sells appliances, but that's just 5% of its business. If Best Buy wants to emphasize big-ticket items that are purchased very infrequently -- thereby taking on the smaller hhgregg and Conn's -- it would probably have to close all but a store or two in each of its major markets. There just isn't enough business for these products to justify Best Buy's existing store base and square footage.

In short, it's not going to happen.

Best Buy may be in the process of closing nearly 50 stores over the next few weeks, but there will be more of that in the future unless trends reverse and positive catalysts emerge.

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Motley Fool contributor Rick Munarriz does not own shares in any of the stocks in this article. The Motley Fool owns shares of Amazon.com and Best Buy. The Motley Fool has sold shares of RadioShack short. Motley Fool newsletter services have recommended buying shares of Amazon.com.

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