Discount retail chain Big Lots (NYSE:BIG) never ceases to amaze me... when it comes to underwhelming around earnings time, that is! Last year, I made the mistake of assuming that Big Lots had placed many of its previous inventory issues in the rearview mirror, only to have my CAPScall of outperform break down in the fast lane on more than one occasion.
However, a Bloomberg report this weekend may change shareholders' fortunes for the better. It pointed out that at just 5.3 times EBITDA, Big Lots is cheaper than any of its retail rivals. According to research firm Wedbush Securities, Big Lots is cheap enough that it may attract interest from private equity firms and assigned a price of $40 per share, a 28% premium to its closing price on Friday, as a reasonable buyout expectation. The move may be even more feasible given that current CEO Steven Fishman is on his way out after announcing his retirement (and a probe of his trading activities).
But is a private equity buyout in the best interests of Big Lots' shareholders? Believe it or not, I'm saying "Yes!"
Begging for a buyout
Although buyouts almost always involve some sort of price premium for shareholders, they aren't always in shareholders' best long-term interests (i.e., the company could do more for shareholders over the long term by remaining independent). In the case of Big Lots, I feel that shareholders would be thanking their lucky stars if they could find a buyer for this inconsistent retail chain.
The no. 1 problem for Big Lots is that it can't compete with the likes of Dollar Tree (NASDAQ:DLTR), or Dollar General (NYSE:DG) when it comes to consumables inventory. Sure, Big Lots carries food and other household items, but its focus tends to be oriented more toward seasonal decor, which rarely provides earnings consistency from one year to the next. Dollar General and Dollar Tree focus on luring customers into their stores with promotional food pricing and then reap the benefits when those consumers make higher-margin discretionary non-food purchases.
Another problem for Big Lots is that it can't expand quickly or advertise effectively enough to put itself in the same category as Target (NYSE:TGT) or Wal-Mart (NYSE:WMT). Big Lots, for example, purchased Canada's Liquidation World in 2011, but the venture has produced nothing but losses thus far as growth in the country has been tepid. Part of the problem can be traced back to brand image, but an even bigger one is its advertising budget. Wal-Mart and Target spent $2.4 billion and $1.4 billion, respectively, on advertising in 2010, or 0.6% and 2.15%, respectively, of total sales. Even if Big Lots spent on the upper end of what Target did, it would have spent just $102 million on marketing its business in 2010. Big Lots simply can't compete with bigger chains such as Wal-Mart and Target that can undercut it on price, considerably outdo it from an inventory perspective, and already have a global brand name.
If Big Lots wanted to turn its business around, it probably could by following the example of dollar store Dollar General and megachains Wal-Mart and Target by greatly expanding its food offerings and using that to drive traffic into its stores. Big Lots also recently instituted new retail inventory systems, which could go a long way to improving its past inventory issues.
Still, I have a hard time believing that Big Lots will come to terms with the fact that it lacks the right mix of consumables to get customers into its stores. With that, I feel the company would be wise to pursue a future buyout and look forward to what good may come from the departure of Steven Fishman.
Is a buyout in Big Lots' shareholders best interests? State your case in the comments section below.
Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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