Deep Analysis: RadioShack Cuts Losses with This Huge Partner

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

RadioShack (NYSE:RSH) and Target (NYSE:TGT) will terminate their Target Mobile partnership in April.  On January 14, RadioShack announced that its negotiations with partner Target had come to an end after mutually beneficial terms could not be reached. RadioShack operates Target Mobile centers in 1,500 Target stores, and will begin closing the centers on April 8,  2013. RadioShack reported that it had lost $26.5 million in 2012 through October, not including an impairment charge of $11.7 million, due to its unprofitable Target Mobile centers. The Target Mobile kiosks are unprofitable primarily due to product mix, as RadioShack is unable to sell higher margin pre-paid wireless and accessories along with its post-paid wireless offering. After RadioShack exits Target, we expect some gross margin recovery, but lower overall sales levels may trigger de-leverage of corporate overhead.

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We expect significant losses in 2013. RadioShack had repeatedly stated that it expects the factors that led to the Q4:11 decline to continue to depress earnings, with difficulty easing in Q4:12. However, once Q4 was underway, it was clear that a turnaround was not imminent. As of its last earnings call, company management forecast weakness in sales volumes and expected gross margin compression to continue at least through the end of the year, and commented that the quarter is off to a weak start. We are pessimistic that RadioShack can reverse its deteriorating mobility margins, as the company clearly has no control over smartphone or post-paid plan pricing.

While it is clear that management is hopeful it can sell accessories at a higher attach rate, we think recent problems are traffic driven, and expect traffic to continue to deteriorate. Our holiday channel checks support this view. Should RadioShack attempt to charge higher prices, we expect competitors to capture market share, given the proliferation of smartphone vendors.  iPhone 5 sales were weak at RadioShack stores, as demand exceeded inventory, and customers are content to either delay purchases or simply purchase the iPhone 5 elsewhere. The company’s low price guarantee for mobile phones caused…

margin pressure that was not fully offset by drawing incremental traffic, contributing to further losses.

Wireless competition continues to intensify. We expect increased competition to impact RadioShack’s growth in wireless. Despite fewer physical stores, it is clear that Best Buy gained share over the holidays, as the retailer has a competitive advantage over RadioShack due to more extensive carrier relationships, greater access to high-profile phones, and a larger inventory of non-wireless products. We note that RadioShack also has to compete with 8,000 carrier-owned stores (almost twice as many locations as RadioShack’s), although it is uncertain that wireless carriers will continue to consolidate at retail. Finally, online and mass merchant competitors can offer both superior pricing and comparable selection, and could conceivably become loss leaders to drive market share in a short amount of time. As consumers become increasingly comfortable purchasing large consumer electronics items from online and mass merchants, we expect an increased shift in market share away from traditional CE retail.

Reiterating our UNDERPERFORM rating and 12-month price target of $1 as losses grow from declining CE sales, and continued margin erosion, compounded by an ill-advised strategy to invest in growth. Our price target reflects our best guess at the brand equity and going-concern value for the business (around $300 million), net of the company’s net debt.

Risks to attainment of our share price target include changes to the macroeconomic outlook, variability in new product release timing, the company’s ability to maintain its dividend should earnings continue to decline, the effects of competition from other consumer electronic and big-box retailers and changes in consumer demand for consumer electronics.

Michael Pachter is an analyst at Wedbush Securities.

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