Best Buy Buyout? Why Founder's Bid May Be Retailer's Best Bet

Best Buy BuyoutA private buyout of Best Buy (BBY) may not be such a crazy idea after all.

Sources are telling The Wall Street Journal that founder Richard Schulze -- who stepped down from his roles as company chairman and director earlier this month -- is working with a Wall Street investment banker to take the struggling consumer electronics giant private.

It's not exactly a layup. Schulze only owns 20% of the company. He has to find enough willing investors -- likely among the ranks of private-equity firms -- to bankroll the purchase of the shares that he doesn't already own.

Another sticking point may be a matter of price.

Shares of Best Buy dipped into the high teens for the first time in more than three years last month. You would think that frustrated shareholders would relish a shot at an exit strategy, but the company's board may hold out for too rich of a premium.

Best Buy's battered stock popped nearly 5% higher on Tuesday after the Journal's story broke. The higher the speculative trading goes, the harder it will be for Schulze to raise the money he needs at an agreeable price.

Schulze Makes Sense in Leading the Charge

There isn't any publicly traded company that would be willing to expose itself to the scrutiny that would accompany buying a struggling retailer with what may be a broken model. Private-equity firms have greater leeway in their purchases, but they are typically only interested in buying growing companies or turnaround situations that they can unload for more money in the future.

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Best Buy fails on both counts. It has closed dozens of its superstores in recent weeks, and there's no reason to believe that the showrooming trend that's transforming former customers into online shoppers is going to end anytime soon.

However, Schulze has every reason to believe in the company that he created decades ago.

Schulze can't be happy with the company's board, which chastised him for failing to rat out then-CEO Brian Dunn after he learned that the executive was having an inappropriate relationship with an employee that violated the retailer's policy.

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Best Buy Buyout? Why Founder's Bid May Be Retailer's Best Bet

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. (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.

Schulze was supposed to simply step down as the chairman after completing his term, but he left the board abruptly earlier this month.

Investors initially feared that he would dump his 20% stake in the company -- creating the potential for the stock to head even lower as supply drowned out demand -- but now it seems as if he may be more interested in finding a way to get the other 80% of the company back.

Given the many challenges that await Best Buy, the board better not get too cocky if Schulze is able to pull together an offer to take the company private. Circuit City's board rebuffed a couple of buyout offers, too -- and as we're all aware, that ended badly.

Longtime Motley Fool contributor Rick Munarriz does not own shares in any of the stocks in this article. The Motley Fool owns shares of Best Buy.

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