By Chad Sandstedt of Value Investing Lab
Best Buy has been hanging around with the wrong crowd. Most people are frequently comparing Best Buy to other big-box retailers as well as its online nemesis Amazon. I believe they are looking at Best Buy in the wrong light. Best Buy is really a service company that uses the sale of electronics as its delivery mechanism. Consider the following table from Best Buy’s fiscal 2011 10-K:
| 2011 | 2010 | 2009 | |
| Revenue | |||
| Domestic | $37,186 | $37,314 | $35,070 |
| International | 13,086 | 12,380 | 9,945 |
| Total | $50,272 | $49,694 | $45,015 |
| Percentage of revenue, by revenue category | |||
| Domestic: | |||
| Consumer electronics | 37% | 39% | 39% |
| Home office | 37% | 34% | 31% |
| Entertainment | 14% | 16% | 19% |
| Appliances | 5% | 4% | 5% |
| Services | 6% | 6% | 6% |
| Other | 1% | 1% | 1% |
| Total | 100% | 100% | 100% |
| International: | |||
| Consumer electronics | 21% | 20% | 26% |
| Home office | 55% | 53% | 45% |
| Entertainment | 6% | 7% | 9% |
| Appliances | 9% | 8% | 10% |
| Services | 9% | 12% | 10% |
| Other | <1% | <1% | <1% |
| Total | 100% | 100% | 100% |
If we apply the services revenue percentages to the domestic and international revenue it gives us the following:
| 2011 | 2010 | 2009 | |
| Services revenue | |||
| Domestic | $2,231 | $2,239 | $2,104 |
| International | 1,178 | 1,114 | 895 |
| Total | $3,409 | $3,353 | $2,999 |
| As a % of total revenue | 7% | 7% | 7% |
| EBITDA | $3,290 | $3,213 | $2,807 |
| As a % of service revenue | 97% | 96% | 94% |
The interesting aspect here is that services revenue comprises virtually all of Best Buy’s EBITDA. This is not completely accurate because this revenue is not pure profit. There is some cost associated with providing these services. What exactly are these services?
Also from the 2011 10-K:
“The services revenue category consists primarily of service contracts, extended warranties, computer-related services, product repair, and delivery and installation for home theater, mobile audio and appliances.”
This is the honey list. Every item on this list is high-margin revenue. This is what you are purchasing when you buy shares of Best Buy. Every time I buy something at Best Buy the associate asks me if I want to add a protection plan for X dollars. While these are items I usually do not buy, other people do. I recently caved in and bought my wife a new iPhone at the local Best Buy store in their mobile department. There was a younger guy buying a new phone at the next desk over. They pitched him on the protection plan and he agreed to pay around $30 per month for the protection plan on a recurring charge to his debit card. Ka Ching!
Note: Right after I declined the protection plan on her phone the associate handed it to my wife and she dropped it. Maybe I should have bought the protection plan.
Since services represent a large share of the past and future profits for Best Buy, comparisons to Amazon and the big-box retailers are not that applicable.
Where’s the Growth?
The lack of growth at Best Buy is undeniable. They have simply saturated the market with stores and their same-store sales have actually been declining. Some of this is caused by online competition such as Amazon and some of this is from a weak product cycle. Some of it is from an incredible run by Apple which now generates $10 billion of revenue in its retail stores driven by undeniably innovative products and great marketing. That’s $10 billion of revenue that Best Buy lost out on. It may come back to Best Buy someday if the next hot thing is not from Apple. Amazon is not going away but states like California will eventually figure out a way to tax online retailers which will level the playing field for Best Buy. The product cycle will also ebb and flow. New tablets and mobile devices targeting the iPhone and iPad will be good for Best Buy.
What if this growth doesn’t happen? At the current share price it really does not matter. Mr. Market is selling his shares of Best Buy so cheap that the company does not need to grow to generate solid returns for its shareholders. This is why Best Buy has been buying back a ton of its stock, more than $5 billion over the last five years and $846 million through the first two quarters of this fiscal year. Without any real growth (and the corresponding capital expenditures) I estimate the company is worth $18 billion which equates to $47/share. If and when the company does grow due to online sales taxation or an improving product cycle the company is probably worth $20 billion, or $50/share. At the current market price of $25/share there is a lot of upside in this retailer service company.
Here are the screen shots of my valuation models:
Inflationary Growth DCF Model
Normal Growth DCF Model
Disclosure: I own shares in Best Buy.
