Best Buy
I.
Corporate Governance Analysis
A. Management and Stockholders
Balance of Power
Best Buy is run by its management which is led by the CEO, Hubert Joly. The power on the
board comes from their position and not their ownership of stock. The board members
themselves own very little stock. In fact, the CEO sold $17 Million worth of stock to help settle a
divorce. (See Huffington Post Article)
A large majority of the power comes from the owner and founder of Best Buy, Richard Schulze.
Richard Schulze owns 62,920,813 shares or 18.1% of outstanding shares. (See Bust Buy
Ownership Summary) He also helped hand –pick the board. (See Fortune article)This makes him
the top holder of shares at best Buy. Moreover, Richard attempted to take over Best Buy in
August 2012. However, he was unable to secure the private funding in order buy the board seats.
Richard lost power in the company in May 2012 because he was forced to step down as Best Buy
chairman when an investigation found out he knew the CEO was having a relationship with an
employee. However, in March 25, 2013 Richard was reinstated with a new title chairman
emeritus. This allowed him to hold a non advisor position on the board. He was also allowed to
add two former executives, Brad Anderson and Al Lenzmerier, to the board on his behalf. This
along with his share ownership gives him a great amount of power at Best Buy. Both Hubert Joly
and Richard Schulze have many relationships with the board. Hubert has 23 relationships while
Richard has 28 relationships. (See Businessweek Profile).
Manifestations
Best Buy has compensated very well this past year for the boars performance. In 2013 executives
were compensated 63.66 million which is almost three times the 2012 compensations of 23.33
million. In 2013 Hubert Joly was compensated $19,550,692 million dollars. (See MorningStar
profile)
Source:
http://www.huffingtonpost.com/2013/09/11/best-buy-ceo-divorce_n_3907685.html
http://phx.corporate-ir.net/phoenix.zhtml?c=83192&p=irol-ownershipsummary
http://investing.businessweek.com/research/stocks/people/board.asp?ticker=BBY
http://insiders.morningstar.com/trading/executive-compensation.action?t=BBY
http://finance.fortune.cnn.com/2012/08/22/best-buy-shareholders-caught-in-the-crossfire/
Managerial Performance
Under Hubert Joly’s new strategy management was able to increase gains on Best Buy stock
by237% in 2013. This made Best Buy one of the top performing stocks in the S&P 500 in 2013.
(See Fool) However, in the beginning of 2014 the stock dropped 29 percent because of a decline
in holiday sales. Hubert Joly’s price math strategy failed to boost holiday sales and revenue fell
.9%. Profits fell by 1.85% and revenue declined by 2.6%. Currently the entire retail industry is
suffering and Best Buy seems to have taken a considerable hit by the slow winter retail sales.
(See Bloomberg article)
Source:
http://www.bloomberg.com/news/2014-01-16/best-buy-u-s-holiday-sales-fall-as-shoppers-spurnprices.html
http://www.fool.com/investing/general/2014/01/07/todays-3-worst-stocks-in-the-sp-500.aspx
Stockholder Reaction
Stockholder reaction was a large issue in 2012 when Richard Schulze attempted to buy back the
company. He issued a public letter and a price to buy the company when he felt that the board
refused to allow due diligence for earnings. The entire process ended with both parties being
disappointed and with Best Buy appointing an outsider as the new CEO. Stockholders suffered
since the stock price decreased significantly and talks of Schulze buying the company were
halted by the board. The board refusing to hear Schulze’s demands during the holiday season
hurt both the company and the stockholder’s chance of seeing the company be acquired. (See
Fortune article)
Source:
http://finance.fortune.cnn.com/2012/08/22/best-buy-shareholders-caught-in-the-crossfire/
B. Firm and Financial Markets
Best buy is a widely followed firm and one of the largest electronic retailers. The
company is used to distinguish performance between online retailers such as Amazon and
box retailers like Best Buy. Best Buy provides information about its strategies and
financial information in their earnings reports. A large amount of information is also
available from external sources such as equity research analysts. This reduces the amount
of bias in information. (See Reuters)
Source:
http://www.reuters.com/finance/stocks/analyst?symbol=BBY.N
C. Firms and Society
Best Buy was forced to make some difficult decisions because of a scandal between CEO
Brian Dunn and founder Richard Schulze. Best Buy handled the situation poorly and
caused the entire situation to blow out of control. Richard confronted Dunn about the
affair but did not report it to anyone. When an audit committee was formed Dunn left but
Best Buy made the poor decision to not explain why. This lack of transparency resulted
in a media frenzy that caused Best Buy to create its own PR crisis. (See Business
Indsider)
Best Buy is doing an excellent job with social responsibility. The company has won
awards for recycling and helping reduce energy consumption. (See Best Buy CSR
Report)
Source: http://www.businessinsider.com/best-buys-pr-crisis-turned-into-a-bloodletting2012-5
http://www.bby.com/category/sustainability/
Financial Information
Best Buy wants to transition into appealing more customers to the box retailer
experience. In the past year Best Buy has done that by providing price matching against
its competitors. Although this has made 2013 a successful year for Best Buy it has also
reduced profit margins. Best Buy is currently struggling with competing with companies
like Amazon who make it difficult to match prices when they have no overhead. The
industry is currently wondering if Best Buy will simply just be a Amazon showroom.
II.
Stockholder Composition
In order to analyze stockholder compensation we looked at which types of groups owned
sotck in Best Buy. This information was broken down into a table shown below.
Breakdown
Percent
% of Shares Held by All
Insider and 5% Owners:
21%
% of Shares Held by
Institutional & Mutual
Fund Owners:
75%
% of Float Held by
Institutional & Mutual
Fund Owners:
94%
Number of Institutions
Holding Shares:
418
We then looked at how the stocks were broken down by individual shareholders. The
major shareholders are listed below.
Major Holders
Shares
Richard Schulze
1,735,500
Allen Lenzmeier
6,327
Joly Hubert
476,629
Stephen Gillett
344,840
James Muehlbauer
205,697
Finally we looked at the institutions and mutual funds with the largest shareholders.
They are listed below.
Largest Stockholders
Shares
FMR LLC
42,499,249
Fidelity Low-Priced Stock Fund
23,670,000
Vanguard Group
19,270,786
Wellignton Management Company LLC
12,804,683
State Street Corporation
11,756,849
(See Yahoo finance)
Best Buy is owned by mainly well diversified funds. The company has a large
number of insider holdings because of the shares from the owner Richard Schulze.
Approximately 21% of shares are owned by insiders at Best Buy. However, in the
electronics industry 23.34% of shares are owned by Insiders. The average investor is
either an insider or a large institution. (See Macroaxis)
Source: http://finance.yahoo.com/q/mh?s=BBY+Major+Holders
http://www.macroaxis.com/invest/ratio/BBY--Shares_Owned_by_Insiders
III.
Risk Profile
An analysis of Best buy’s stock prices for the past 5 years shows that the price had a
downward until the end of 2012. However, in 2013 the price rebounded back to its original
price of $40. IN 2014 the price plunged more than $10 because of the slow winter retail
sales.
A. Market Analysis of Risk and Return
To analyze the volatility from market forces we ran a regression of Best Buy’s stock
prices against the S&P 500.
. reg var1 var2, beta
Source
SS
df
MS
Model
Residual
9721.48435
87011.2703
1
1257
9721.48435
69.2213765
Total
96732.7546
1258
76.8940816
var1
Coef.
var2
_cons
-.0110323
45.19707
Std. Err.
.0009309
1.265193
t
-11.85
35.72
Number of obs
F( 1, 1257)
Prob > F
R-squared
Adj R-squared
Root MSE
=
=
=
=
=
=
1259
140.44
0.0000
0.1005
0.0998
8.3199
P>|t|
Beta
0.000
0.000
-.3170148
.
We interpreted the following from the regression:
A. Slope of the regression: -.32. This is Best buy’s beta.
B. Intercept of the regression: -.01% This shows Best Buy’s performance. When compared
with the Rf (1-b) we can see the estimated performance.
Rf (1-b) = 0.6% (1--.32) = .08%
Intercept - Rf (1-b) =-0.01% - (0.08%) = -.09%
This shows the Best Buy performed -.09% worse than expected based on the CAPM for the past
5 years.
C. R squared of the regression: 10.05%. This shows that 10.05% of the risk for Best Buy
comes from the market and the remaining 89.95% of the risk comes from the firm.
This means that Best Buy is a risky investment in the market
(Source: Google Finance and Yahoo Finance Historical Stock Prices)
Levered beta
In order to find the levered beta we first estimated the market value of equity and debt.
Market Value of Equity= Share price * Number of Shares = $24.48 * 341.5 million = 8359.2
Million
To find the market value of the debt we used the book value of debt $ 1612 million, the interest
expense of $100 million and the face-value weighted average maturity of 4 years with the cost of
borrowing at 5% (See Best Buy 10k Long Term Debt) to find an estimated value of debt to be
$2224 Million.
Estimated Market value of debt= 100 [(1-1/(1.05)^4 / .067] + 1612/(1.05)^4 = $2,224
So the levered Beta for Best buy = -0.32(1+(1-0.367*(2224/8359.2)) = -.374
Beta to Cost of Equity
In order to find the cost of equity we used a long term treasury bond rate for the risk free rate and
for the risk premium we used the historical risk premium for stocks of 5.5%.
Expected Return = 7% + -.374 (5.5%) = 4.94%
Best Buy’s Cost of Debt
Based on Best Buy’s long term treasury rate , default spread , and pre-tax borrowing to find the
after-tax cost of debt.
After-tax Cost of debt = 7.5% (1-.367) = 4.74%
Best Buy Weights for Debt and Equity
Equity Ratio= 79%
Debt Ratio = 21%
Best Buy’s Cost of Capital
Using the cost of equity and the after-tax cost of debt to cost of capital is as follows:
Cost of Capital = 4.94%(.79) + 4.74%(.21) = 4.90%
(See Best Buy’s 10k)
Currently Best Buy’s debt to equity ratio is .4157. This shows that Best Buy has a considerable
amount of debt on the books which is not good.
(See Standard and Poor’s Capital IQ Net Advantage)
IV.
Investment Return Analysis
A Typical Project
Typical projects at best Buy depend on management and the direction and strategy the CEO
has planned for the company. Projects at Best Buy are long term projects planned out for the
entire year and have a large impact on the company’s financial. Projects are likely to cost a
lot of money and follow the industry’s forecasts. Projects mainly deal with increasing
revenue and enhancing the consumer experience.
Other projects deal with shifting real estate needs in order to align with customer interest. So
for example Best Buy has begun to close large big box stores and Best Buy Mobile Stores.
(See Standard and Poor’s Capital IQ Net Advantage Best Buy Business Strategy)
A. Measuring Past Returns
In order to determine the returns on Best Buy’s past projects we need to assume that the
earnings after the project can be attributed to the project. Since Best Buy focuses on high
budget financial projects we can assume this assumption will allow us to determine the
success of the project. The project we will be focusing on is the new price matching strategy
introduced early 2013.
Return on Equity= Net Income 2014/ Average BV of Equity for 2013 and 2014 = $532
million/$3852 million = 13.81%
(Average BV of equity =Feb 2013 BV of equity $3715 + Feb 2014 BV of Equity $3989 /2=
$3852)
Net Income February 2013: -441 Million
Net Income February 2014: 532 Million
Return on Capital= EBIT2014(1-t) / Average BV of Capital from 2013 to 2014 = 1087(1.37)/(5234.5) = 13.08%
(2014 BVE 3989+ BVD1612 = 5601
2013 BVE3715+BVD 1153= 4868
Average = 5234.5)
(See Best Buy’s 10k)
B. Evaluation of Past Returns
In order to determine if the returns have an impact on Best Buy’s financials we must look
at the return on equity and cost of equity.
Return on Equity = 13.81%
Cost of Equity = 4.94%
Equity Return Spread= 13.81%-4.94%= 8.87%
The spread is used to determine the value of the project after it is multiplied by the book
value of equity.
Equity EVA= (Return on Equity – Cost of Equity) (BV of Equity) = (.1381-.0494)(3852)
= $341.7 million
In addition, looking at the return on capital shows the following:
Return on Capital= 13.08%
Cost of Capital = 4.90%
EVA= (.1308 -.0490)( 5234.5)=428.18 Million
This shows that Best Buy created 428.18 Million dollars because of the projects.
(See Best Buy’s 10k)
C. Assessments for the Future
We believe that Best Buy’s new projects will continue to create value for the company year by
year. The price matching strategy reduces profits but helps them generate enough revenue to
compete with online competitors like Amazon. In addition, the shift of reducing the amount of
Big box stores and focusing on smaller mobile stores has allowed them to cut operating
expenses. These projects have generated significant value for Best Buy throughout 2013.
(See Standard and Poor’s Capital IQ Net Advantage Best Buy Business Strategy)
V.
Capital Structure Choices
Current Financing Mix
Best Buy currently has the following debt.
Amount
$349 Million
$500 Million
$649 Million
$1 Million
(See Best Buy’s 10k)
Maturity
2
4
7
3
Percent
5.5%
5.0%
5.5%
6.7%
This shows that Best Buy has a large amount of debt on their balance sheet. The debt all
matures at different years and have appropriate interest rates.
Trade Off on debt versus Equity
When we look at Best Buy’s debt we see the following.
Added Discipline of Debt
Bankruptcy Risk
When we look at Best Buy’s institutional stockholders we
see that the owner owns a large amount of the firm.
Because he has a large say in what goes on for
management Best Buy should be cautious with their debt.
This is why Best Buy’s debt was recently rated as junk by
Standard and Poor recently. The risk involved and the poor
company performance made the debt a risky investment
(See Standard and Poor’s Capital IQ Net Advantage)
A large amount of the cash flow is volatile because the
company depends on day to day retail sales. They are at the
point where the company needs to price match to lure in
customers so the company is a risk for bankruptcy.
However, this risk is low because of the large amount of
assets Best Buy can sell to pay off debt.
We believe that Best buy has a significant debt capacity. The only benefit from the debt is the
slight tax benefit but the cash flows help sustain the amount of debt they have. Best Buy should
focus on lowering their debt to equity ratio.
VI.
Optimal Capital Structure
Current Cost of Capital/ Financing Mix
To determine the cost of capital we used the market value equity and debt from the previous
sections.
Cost of Capital = 4.94%(.79) + 4.74%(.21) = 4.90%
An optimal debt ratio would be An AAA to A- rating which means the debt ratio needs to be
under 30%. Because Best buy has a debt ratio of 21% it is optimal.
VII.
Mechanics of Moving to the Optimal
A. Path to the Optimal
Intuitive Analysis
Business
Retail Stores
Project Cash Flow
Characteristics
Projects are short term.
Type of Financing
The cash flows are in dollars.
Short term.
New cash flows are driven by
electronics sales
Primarily dollar
Debt should be
Tied to strategies.
Real Estate
Projects are likely to be
Debt should be long term
Long term.
Primarily in dollars.
Rely on market value
VIII.
Dividend Policy
Best Buy uses dividends in order to payback shareholders. In the past they five years they have
bought back very little stock.
The dividends in the past year are shown below.
2013: 17 cents per quarter
2012: 16 cents per quarter
2011: 15 cents per quarter
2010: 14 cents per quarter
2009: 14 cents per quarter
(See Google Finance)
Based on the stock price of $24.48 today the dividend yield is .17/2.78. It is interesting to note
that Best Buy has been increasing the dividends even though the stock price has been really
volatile. This shows that under new leadership the company believes they should send a strong
message to stockholders to keep paying out dividends.
IX.
Dividend Policy: A Framework
How much should Best Buy have paid as dividends from 2009 to 2013.
To analyze this we need the estimate the free cash flows to equity at Best Buy each year. The
table below summarizes the results.
Year
2014
2013
2012
2011
Net income
$42410
$45085
$46064
$49747
Dividends
.68
.64
.60
.56
This shows that regardless of the net income Best Buy continues to increase the amount of
dividends giving out every year. This is concerning because the dividends should reflect the
financials and not what management see fit.
X.
Valuation