Best Buy: The Europe Cash Flow Will Hurt

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

Best Buy (NYSE:BBY) announced the sale of Best Buy Europe to its JV partner, Carphone Warehouse, for ≈ $775 million ($650 cash and $125 million CPW stock).

As Best Buy Europe represented all of Best Buy’s international profits, we expect the sale will result in greater international losses and reduced operating cash flow. Best Buy’s FY:13 international operating profits were $(859) million, while Best Buy Europe contributed ≈ $160 million of pretax profit. The sale will bring in much needed cash, but will place pressure on future cash flow. Best Buy will recognize ≈ $200 million in impairment charges. The transaction, subject to CPW shareholders’ approval, is expected to close in June.

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The cash from the transaction will provide Best Buy some breathing room as it attempts its turnaround, but the Best Buy Europe experiment drained cash by a net $2.4 billion. Since inception, Best Buy’s proceeds have been ≈ $1.1 billion, consisting of the $775 million sale price and cumulative net income of ≈ $325 million through Q1:13E. Best Buy paid $2.2 billion in May 2008 and bought the JV’s profit sharing interest in Best Buy mobile for $1.3 billion in FY12.

We are lowering EPS estimates for FY:14 to $1.73 from $1.95 to reflect the sale of Best Buy Europe.

We continue to expect Best Buy’s cash flow to decline. The company’s price match will likely stem the comp declines experienced in 10 of the last 11 quarters. However, we believe that continued margin erosion from the price match will result in lower profits, and do not expect these lower profits to be fully offset by cost cutting. The sale of Best Buy Europe reduces cash flow by an estimated $75-100 million per year, suggesting that free cash flow in 2014 could dip below $500 million, even with further cost cuts.

Best Buy management is making a solid effort, but we expect that continued migration to online retail will pressure cash flow further. Until we see comp and margin decline trends reverse, we expect to maintain our negative stance.

We reiterate our UNDERPERFORM rating and are maintaining our 12-month price target of $9; our target reflects further operating margin erosion, low visibility, lack of FY:14 guidance, the lack of a credible buyout opportunity, and our doubts about the company’s turnaround plan. Best Buy has been able to stem sustained comps declines only through price promotion, and we believe that continued price matching will erode margins further.

Michael Pachter is an analyst at Wedbush Securities.

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