Aug 6 - 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
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
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
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
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