Best Buy: It's All Downhill From Here

The prodigal founder returns.

Best Buy's (NYSE: BBY  ) Richard Schulze is back as chairman emeritus at the company he rebranded as Best Buy 30 years ago after failing to complete a leveraged buyout of the consumer electronics retailer.

He's not coming back alone. Brad Anderson -- who replaced Schulze as CEO in 2002 and led the company through 2009 -- and former longtime Best Buy exec Al Lenzmeier have been provisionally added to the chain's board of directors. Shareholders will have to vote them in at the next annual meeting.

The market's digging the news. The stock opened higher, and Barclays Capital analyst Alan Rifkin boosted his price target on the shares from $20 to $28. Rifkin also inched his profit estimates slightly higher, but more on the premise that Best Buy will continue to cut costs than actually grow its top line again.

The stock hit an 11-month high this morning.

Hooray!

Now it's time to look out below.

A prodigal bear returns
I closed my bearish CAPS call on Best Buy last month.

It was the right thing to do. Best Buy's stock has gone on to move 35% higher in those five weeks, and the stock has nearly doubled this young year.

"Barring a privatization, there will probably be another great time to bet against the company," I wrote at the time.

Well, the privatization plan is toast.

Schulze wasn't able to round up the private equity firms needed to transform his 20% stake in the retailer he created into a leveraged buyout.

It's easy to see why it didn't happen. Schulze was originally hoping to take the company private last summer, cashing out investors at a share price between $24 and $26. Best Buy is less of a company now than it was a year ago, yet the stock is nearly at that original proposed buyout premium.

If there was ever a time to short Best Buy, it would probably be now. The activist founder has buried the hatchet, ready to see Best Buy's fate play out in public. Analysts are boosting their targets. Shorts are at their lowest level since mid-November, off nearly 40% over the past year.

This is a contrarian's dream, and I went ahead and initiated my Motley Fool CAPS underperform rating on Best Buy this afternoon.

It's still hard to fathom this ending well for Best Buy, and the stock has moved too high, too soon.

It's a new world of retailing out there
If you think the worst is behind Best Buy, pull up some earnings estimates.

Wall Street's betting on sales and earnings sliding 2% and 17%, respectively, this year.

How can this be? Analysts were cheering Android's victory over Apple as a catalyst for Best Buy. The shift from Apple iPhone and iPad products to cheaper Android gadgets would result in thicker margins for Best Buy. Winning traffic over the iconic Apple Store empire also wouldn't hurt.

Well, margins are still expected to take a hit this year.

Analysts have been cheering Best Buy's move to match prices with Amazon.com as a way to end the showrooming trend, but the projections don't bear that out, either. Even as the economy improves -- and Amazon is expected to widen margins as net sales surge 24% this year -- Best Buy is going the wrong way.

Best Buy still doesn't have a cure for the biggest stumbling block. It's not showrooming, though it's fair to say that a physical retailer will never be able to realize the cost savings necessary to compete against a bare-bones e-tailer on price.

Best Buy's biggest problem is that media is going digital. This may not seem like such a big deal, but Best Buy relies on CDs, DVDs, software, and video games to keep customers coming back on a regular basis. You may only need a new dryer once every dozen years, but there are always weekly media releases. As that traffic dries up, Best Buy will have no choice but to shrink in size.

Hope always springs eternal -- until spring springs eternal
It seems as if every year kicks off with investors of retailer stocks warming up to a laggard.

Last year it was J.C. Penney (NYSE: JCP  ) and Sears Holdings (NASDAQ: SHLD  ) rallying through the first three months of the year.

J.C. Penney had taken on a new CEO with plans to radically reinvent the department store chain. Sears had suffered through years of same-store sales declines at Kmart and Sears, but investors felt that -- once again -- there was a real estate play there that was being undervalued.

Well, we know how that played out. J.C. Penney came undone after CEO Ron Johnson's ambitious makeover alienated loyal customers. Sears didn't disappoint as badly, but it did post another year of declining comps and sales. Sears has seen its stock lose 40% of its value since peaking last March.

Best Buy's "Renew Blue" turnaround strategy under new CEO Hubert Joly isn't as radical or as alienating as what Johnson did at J.C. Penney. Best Buy's comps have been negative for just two years. It has a long way to go to match Sears. However, the unsustainable surge for a company that is now unlikely to be acquired yet equally as unlikely to regain relevance doesn't fit today's buoyant share price.

Enjoy the rally, Best Buy investors. Celebrate, but stay close to the exits.

More motley perspectives on Best Buy
The brick-and-mortar versus e-commerce battle wages on, with Best Buy caught in the middle. After what might have been its most tumultuous year in history, there are now even more unanswered questions about the future for the big-box electronics retailer. How will new leadership perform? Will old leadership take the company private? Will a smaller store format work out for both the company and its brave investors? Should you be one such brave investor? To help answer all these questions, The Motley Fool has released a premium research report detailing the opportunities -- and the risks -- in store for Best Buy. Simply click here now to claim your comprehensive report today.


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