Fitch Ratings has downgraded Best Buy Co., Inc.'s (Best Buy) Issuer Default Rating (IDR) to 'BB+' from 'BBB-', and has placed the company's ratings on Rating Watch Negative. As of May 5, 2012, Best Buy had $2.0 billion of debt outstanding. A full list of rating actions follows at the end of this press release.
The downgrade reflects Fitch's assessment that Best Buy's business profile, including its weakening comparable (comp) store sales, recent margin pressure that Fitch believes will continue, and heightened event risk, is no longer consistent with an investment grade rating.
The Rating Watch reflects the possibility of a leveraging transaction following the report today that Best Buy's Founder, Richard Schulze, has offered to take the company private at $24 - $26 per share, or up to $8.8 billion. Fitch understands that under Minnesota law he may need permission from Best Buy's board of directors to form a buyout group.
Assuming he receives this permission and succeeds in acquiring the company, Fitch projects that Best Buy's leverage (adjusted debt/EBITDAR) would increase from 2.6x currently to at least 3.7x, and possibly the mid to high 4x, depending on the actual purchase price and the amount of equity in the transaction.
The high end of the range of Mr. Schulze's offer equates to only 3.3x LTM EV/EBITDA. Potential buyers could also consider major cost cutting and accelerating the downsizing of the company's retail foot print versus current management plans.
However, as with any potential leveraged buyout, value and risk must be weighed. Fitch believes the company faces significant competitive hurdles, with the potential for an accelerating shift in consumer electronics sales to the online channel as price-conscious consumers gravitate toward the lowest prices, making it difficult for the company to maintain market share. Best Buy could become more promotional to protect market share, at the expense of margins.
On top of this, macro headwinds such as high unemployment and a soft housing market are likely to continue to hamper consumers, particularly with respect to large ticket discretionary purchases.
Best Buy's restructuring efforts - including accelerated store closings and a reengineering of its operations to take excess costs out of the system - as a public entity or as a private firm - will be beneficial but may be insufficient to offset the pressures facing its business.
In the event a buyout occurred, Best Buy's bondholders would be protected by change of control language and limitations on liens covenants. Each of Best Buy's three bond issues allows bondholders to put their notes back to the company at a price of 101 in the event an entity acquires more than 50% of the company's voting shares and the bonds are downgraded to below investment grade by each of the rating agencies (as defined). In addition, liens are limited to the greater of 15% of consolidated net tangible assets or 10% of consolidated capitalization.
Best Buy's financial performance weakened in the first quarter ended May 5, 2012, when comp store sales fell 5.3%, following a 1.7% decline in fiscal 2012 (ending March 3, 2012). Best Buy's comp sales have not been materially positive since calendar 2007, even after incorporating strong growth (18% in fiscal 2012) in domestic online revenues, implying further erosion in the productivity of Best Buy's retail stores.
Operating EBIT margins narrowed by nearly 80bp year over year in the first quarter, after being flat in fiscal 2012. Given Fitch's expectation that comp store sales will likely remain negative in the low to mid-single digit range, and the promotional nature of the consumer electronics sector, full-year EBIT margins will likely narrow meaningfully even after taking into account expected cost reductions.
The company's plan to take $800 million out of its cost structure over the next three years (including $250 million in the current year) will provide some support to margins, though much of the savings are expected to be invested in improved customer service and sharper prices as Best Buy seeks to improve its competitive position vis-a-vis pure online retailers.
Financial leverage (adjusted debt/EBITDAR) was 2.6 times (x) in the twelve months ending May 5, 2012, compared with 2.4x at end-fiscal 2011, and Fitch believes that, in the absence of a buyout, it could move up modestly from these levels as margins gradually contract while debt levels remain flat.
Best Buy repurchased $1.5 billion of its shares in fiscal 2012 and $1.2 billion in fiscal 2011, and has indicated that it will repurchase $750 million to $1 billion in fiscal 2013. This compares with Fitch's expectation for FCF after dividends of about $1 billion in fiscal 2013.
Best Buy has ample liquidity with $1.4 billion in cash, short-term investments and zero draw under its $2.5 billion revolving credit facility as of May 5, 2012. Upcoming debt maturities include $500 million of unsecured notes in 2013, which Fitch expects the company could refinance or pay down with cash on hand.
WHAT COULD TRIGGER A RATING ACTION
Positive: Given the trends in Best Buy's business, there is little potential for an upgrade over the medium-term.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--Further evidence of erosion in Best Buy's ability to defend its market share in the face of significant and growing competition.
--Ongoing weakness in comp store sales in the negative mid-single digit range.
--Further EBIT margin compression toward the low 4.0% range.
Fitch has taken the following rating actions:
--Long-term IDR to 'BB+' from 'BBB-';
--Bank credit facility to 'BB+' from 'BBB-';
--Senior unsecured to 'BB+' from 'BBB-';
The ratings are on Rating Watch Negative.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011);
--'Evaluating Corporate Governance'(Dec. 13, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Evaluating Corporate Governance
Philip M. Zahn, CFA, +1-312-606-2336
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Monica Aggarwal, CFA, +1-212-908-0282
Michael Simonton, +1-312-368-3138
Brian Bertsch, +1-212-908-0549 (New York)