Best Buy Is Smarter Than You Think

By Rich Smith, Motley Fool

Will history sweep Best Buy (BBY) into the proverbial dustbin? Or has this blue-chip stock been mistakenly filed in Mr. Market's bargain bin, offering sharp-eyed shoppers a true steal of a deal?

Fellow Fool Alyce Lomax posed the question to investors earlier this week, wondering aloud whether the era of big-box stocks such as Best Buy has ended. And it's a fair question. Everyone knows how Wal-Mart (WMT) and Target (TGT) are struggling with low-single-digit sales growth of late, while boxless (and sales tax-less) Amazon.com (AMZN) keeps growing like a weed -- or, more specifically, a chokevine. Best Buy has responded by moving to cut its megastores' footprints and open more "mobile kiosks." If even Best Buy doesn't believe in its old business strategy, why should investors keep the faith?

In fact, they aren't keeping the faith. Shares of the electronics retailer have shed 35% of their value over the past 12 months and have underperformed the S&P 500 by a staggering 4,500 basis points. Perhaps it really is time to throw in the towel on this one

...Or Perhaps Not
There are several reasons I disagree with that assessment, though. First and foremost is Best Buy itself. You see, Wall Street has lost faith in the company. Sanford Bernstein recently noted that "while the stock is very cheap and expectations are very low," it sees nothing happening at Best Buy that might "change sentiment significantly" on the Street, But I haven't lost faith, and management is the reason. As CEO Brian Dunn averred last week: "We are adaptive learners. ... We are aware of those competitive and other issues."

More importantly, Best Buy is taking steps to address those issues. Faced with an aggressive all-on-line, all-the-time threat from Amazon, Best Buy is refusing to play its rival's game and is instead shifting its focus to a battleground where it has the advantage -- namely, the ground itself.

Boots on the Ground
Amazon has an advantage in the ether, but one thing it lacks is boots on the ground -- a physical presence, right next door to potential customers. To date, Amazon's been able to leverage its low-fixed-costs, no-sales-tax advantages to steal market share from Best Buy and the other big-boxers. (Home Depot (HD) and Sears Holdings (SHLD) are also feeling the pinch.). Amazon has used its ability to offer the best prices on the Internet to transform its bricks-and-mortar rivals into virtual (by which I mean "physical") sales floors for itself -- places, in other words, where consumers can go and try out their gadgets before logging online to make their actual purchases ... from Amazon.

But in an exercise of business judo, Best Buy is acting to turn Amazon's strategy against it. Customers have been trained to head to Best Buy first for trying out new electronic doodads. That's a good first start. What Best Buy wants to do now is take steps to make its stores more sticky, to ensure that customers who enter its doors spend their money there as well.

It's tromped into GameStop's (GME) turf, by initiating an aggressive used-game trade-in business. Taking the idea one step further, it's instituted trade-in policies that allow customers to unload their obsolete gadgets on site and upgrade to new-and-improved electronic wares. And when customers do buy their gadgets at Best Buy, the company now tries to sign them up for "mobile phone, home broadband, mobile broadband, and video service" as well -- businesses that, as Best Buy confides, offer sales opportunities more than twice as large as "the traditional consumer electronics hardware market."

Heads, We Win; Tails, We Win Bigger
On their own, these initiatives offer every possibility of reversing Best Buy's slide -- but they're not the only tricks up the Geek Squad's starched short sleeves. The company's also leading a legislative counterattack against Amazon's sales-tax-free business plan, by plying state legislators with sugar-plum dreams of fixing their tax-revenue gaps while leveling the playing field for their in-state constituent retailers. As I described last month, a win on this front would basically eliminate Amazon's pricing advantage by presenting customers with a choice between in-person service from Best Buy and deliver-it-to-your-doorstop convenience from Amazon.

I think that's a battle Best Buy can win. But honestly, even if the status quo prevails in tax law, I think Best Buy's stock has been sufficiently punished to present investors with a bargain today. Management told us last week that it will in all likelihood generate between $2 billion and $2.5 billion in free cash flow in fiscal 2012. At today's price, that means the stock could be selling for as little as 5 times this year's free cash flow.

How much do you want to bet that Best Buy can't grow quickly enough to justify that price? Think carefully, Fool. At this price, gambling on anything other than Best Buy's success is a sucker's bet.

Fool contributor Rich Smith does not own shares of Best Buy ... yet. Best Buy, Home Depot, and Wal-Mart are Motley Fool Inside Value picks. Amazon.com and Best Buy are Motley Fool Stock Advisor recommendations. Wal-Mart is a recommendation of Motley Fool Global Gains and Motley Fool Income Investor selection. Motley Fool Options has recommended writing covered calls on GameStop. Motley Fool Options has recommended a diagonal call position on Wal-Mart. The Fool owns shares of Best Buy, GameStop, and Wal-Mart. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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