LBO Tutorial Best Buy Co. September 16, 2012 Michael Karp TMT Portfolio Manager Jawwad Siddiqui TMT Analyst Jan Iyengar TMT Analyst Alexander Banh Chief Strategy Officer This presentation is for informational purposes only, and is not an offer to buy or sell or a solicitation to buy or sell any securities, investment products or other financial product or service, an official confirmation of any transaction, or an official statement of Limestone Capital Investment Club. Any views or opinions presented are solely those of the author and do not necessarily represent those of Limestone Capital.
What is a Leveraged Buyout? Overview An LBO (leveraged buyout) is when a firm (usually a Private Equity firm) uses a higher than normal amount of debt (known as leverage) to finance the purchase of a company. 1) Pay for company with a combination of existing cash and leverage 2) Burden of leverage is placed on target company s balance sheet 3) Annual cash flows of target company used to pay off debt 4) P/E firm holds target for a set amount of years, helping it grow organically, through acquisitions, or by installing new management 5) P/E firm sells target for a profit at the end of holding period Without Leverage With Leverage Initial Value $100,000.00 $100,000.00 Cash Paid/Down Payment $100,000.00 $10,000.00 Debt Used $0.00 $90,000.00 Y1 Rent Income $10,000.00 $10,000.00 Y2 Rent Income $10,000.00 $10,000.00 Y3 Rent Income $10,000.00 $10,000.00 Y4 Rent Income $10,000.00 $10,000.00 Y5 Rent Income $10,000.00 $10,000.00 Ending Debt $0.00 $40,000.00 Ending Value $200,000.00 $200,000.00 Total Profit $150,000.00 $150,000.00 Returns 150% 1500% * Due to leverage, returns for the P/E firm are a lot larger than they would be without leverage 2
What is a Leveraged Buyout? The Ideal Target Stable cash flows, lots of tangible assets, strong management team Tax savings from interest expense and depreciation from writing up assets enable LBO investors to offer targets substantial premiums over current market value Strategic buyers will still pay more Leverage makes LBO vulnerable to business cycle fluctuations 3
Investment Thesis Event-driven upside, with viable business model amidst underperforming peers, supports intrinsic valuation to limit downside. Business Model: Tangible, in-person electronic sales, still viable. Competitors are failing, BBY has survived while Circuit City have liquidated & Radio Shack has begun losing money Industry: Growing mobile segment of Best Buy s Business Event Driven Upside Thesis: Tentative bid from Richard Schulze at $24-26 to take Best Buy private, large upside if deal goes through Argument: Limited downside. Intrinsic valuation close to current share price. 4
Overview Profile Current Stock Price: $18.58 52 Week: $16.25 - $28.52 Industry: Retail Headquarter: Richfield, Minnesota Founder: Richard Schulze Employees: 167,000 (2012) Locations: 1,103 domestic stores and 85 international stores Operations: U.S., Canada, Mexico, Puerto Rico and China Management, Subsidiaries CEO: Hubert Joly Interim CEO: Mike Mikan Chairman: Hatim Tiyabi Best Buy Mobile, The Carphone Warehouse Five Star, Future Shop, Geek Squad Magnolia Audio Video, Pacific Sales The Phone House 2012 Revenue by Region 2012 Revenue by Segment 5
Overview Business Model Acts as an intermediary between manufacturers and consumers Sells a wide selection of products and accessories Also offers a vast range of service offerings, such as extended warranties, installation and repair; knowledgeable sales staff Operates in 2 segments: Domestic (w/in U.S.) and International Seasonal business with majority of sales coming in Q4 during the holiday season Q2 2012 Financial Highlights Sales dropped to $10.55 billion, down 3% from a year earlier Net income fell to $12MM, or 4 cents a share, in Q2, from $150MM, (39 cents/share), a year earlier. Industry Outlook Growth will be driven by ongoing trends, such as, digitalization, mobility, and portability Growth opportunities to stem from the expanding consumer base in Asia, Latin America and Middle East markets Intensifying price competition will continue to benefit online retailers Semiconductor industry will continue to fuel innovation in consumer electronics 6
Recent Developments March 29, 2012 Posts $1.7 billion quarterly loss, says will close 50 large U.S. stores April 10, 2012 CEO Brain Dunn resigns after alleged relationship with employee Aug 6, 2012 Schulze offers to take Best Buy private for $24- $26 a share 7
SWOT Analysis Strengths Service and support offerings (e.g. sales representatives, geek squad, repair services, etc.) Integrated and distinct store formats Economies of scale Weaknesses Competitors operate low cost operating structures and seek to compete for sales purely on price Economic downturn continues to hurt sales Risks With Going Private: Risk of in insider self-dealing Competition and Technology: Amazon? ebay? Mobile Stores? s liquidity and accounting policies Poison Pill Borrowed 1.5B through three bond offerings with maturity dates in 2013, 2016 and 2021. 8
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IMPLIED SHARE PRICE $16.78 10