By Brian Lund (TMF Tardior)
April 6, 2000

Will someone tell me why Circuit City (NYSE: CC), a consumer electronics retailer, retains its equity stake in CarMax Group (NYSE: KMX), a no-haggle used car pusher? What's the point? There's no synergy, CarMax has been nothing but a drag on Circuit City's financials for years, and it makes it much more difficult to figure out what's going on at the company. Today's fourth-quarter results from Circuit City turned up at $0.78 per share, a penny short of analysts' expectations. Net of the inter-group interest in CarMax, however, Circuit City would have hit $0.79.

Of course, you can't just ignore the CarMax stake -- analysts include it in their estimates -- just as you can't ignore the huge charges Circuit City took this year from its ill-advised Divx venture. Those self-imposed liabilities are two of the reasons Circuit City relentlessly fails to live up to its potential.

Things aren't that bad at Circuit City. The company registered sales of $4.0 billion in the quarter, 17% ahead of the year-ago quarter, and realized $327.8 million in net income from continuing operations, a 55% improvement. Sales increased 17% to $12.6 billion in fiscal year (FY) 2000, and net income from continuing operations rose 37% to $159.7 million.

The situation would look a lot better, however, without any used-car salesmen on the lot. Circuit City, the company that you get when you buy the "CC" ticker, owns a 77% equity stake in CarMax. Because Circuit City owns such a large percentage of CarMax, Generally Accepted Accounting Principles (GAAP) require that Circuit City combine the financial statements of the two entities. Circuit City also provides separate financials for its superstores alone, and another set for CarMax alone. To get a true sense of Circuit City's operations, one has to use the GAAP-required combined statements, minus 23% of the CarMax statements for each line item (to account for the 23% of CarMax that Circuit City doesn't own).

But, for simplicity's sake, I'm not going to do that. Let's see instead how CarMax affected the GAAP-required combined FY 2000 results.

CarMax contributed 16% to total revenues, but just 0.6% to net income, which comes out to one red cent per share. CarMax's gross margins this year were a crummy 12%, compared to Circuit City's 25%. And this was a good year at CarMax! In FY 1999, CarMax sucked $0.24 out of every share's earnings, while Circuit City contributed $0.74, even after the Divx debacle. On the balance sheet, CarMax adds only about 2% to the company's cash, yet it accounts for 49% of the long-term debt weight.

If we don't factor CarMax into Circuit City's operations, but treat it purely as an equity investment, things don't look any better. Since CarMax was spun off on February 7, 1997, its stock price has dropped 83% -- and it's in an up cycle right now. The drop has been as much as 90%. Investments don't come much worse than that. And it's not like CarMax is a start-up waiting to take off; this dog has been around since 1993.

Even without CarMax, Circuit City is no Best Buy (NYSE: BBY). Its revenue growth has been slower over the last two years. Its same-store sales growth has trailed Best Buy's by an average of 4.9% over the last eight quarters. Most importantly, Circuit City -- net of CarMax -- turns its inventory six times per year compared to nine turns at Best Buy.

With CarMax, Circuit City will be hard-pressed to ever measure up. Dump it already.

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