Dueling Fools
Buy Buy or Bye Bye
May 12, 1999

The Bear Rebuttal
By Chris Rugaber ([email protected])

Paul did an excellent job anticipating my argument about the Internet, but if he thinks Best Buy's website somehow demonstrates its e-commerce bona fides, he hasn't shopped online enough. I don't think e-commerce will ruin Best Buy, but I certainly stand by my argument that their website stinks, and demonstrates a myopic attitude toward the Net.

Much of the rest of Paul's Bull case is as I expected: he ably demonstrates how well Best Buy has done in the past couple of years, and there's no doubting that. But there are enough screw-ups in Best Buy's past to give any prudent investor pause.

Best Buy has hardly performed flawlessly over the years. In fiscal 1997, which after all was not that long ago (the company is in its first quarter of fiscal 2000 now), operating income was less than it had been in 1994. Same-store sales may have been great in fiscal 1999, but fiscal 1998's paltry 2% was on top of a 5% decline the previous year. And Best Buy's revenue per store went all the way from $28.4 million in 1995 to $29.7 million in fiscal 1998, a scant 4.5% increase over three years. These numbers reflected management's errors in its "no money down, etc." policy and its helplessness in the face of technological change: the introduction of the Pentium II, as mentioned earlier, forced the company to write off $15 million in PC inventory. Consumer electronics retailing is a tough business, and Best Buy has taken its share of knocks. As a result, Paul's confidence in the company's "innovative management" may be misplaced. A good year does not a juggernaut or "category killer" make.

After all, it's not like consumer electronics retailing is a real reliable business. We're not talking Coca-Cola here. As Warren Buffett said, Dairy Queen's "Dilly Bar" will outlast most of what's on Best Buy's shelves. (Buffett was referring to software, specifically, but his general point applies to most of Best Buy's hardware as well).

Technological change is a major question mark in Best Buy's future. What will happen to the company when the software, DVDs, and music that it sells in its stores and on its crappy website is downloadable direct from the Net? There's little reason to believe that Best Buy's "brand name" (I put it in quotes because I don't think it has one) will help it on the Net anymore than Barnes & Noble's did. I've bought stuff at Best Buy before. I thought their service was slow and annoying, and I feel no brand loyalty to them at all. Their bricks-and-mortar stores might lose a chunk of their DVD and CD sales, and there's little reason to believe that people will download movies or music from their website, rather than Amazon.com's or a movie studio's own site.

Another question mark is the economy. Admittedly, making investing decisions based on which way you think the economy will go is pretty Wise, but nevertheless, any company selling nonessential electronic gadgets will be a little more sensitive to an economic downturn than a Costco or Wal-Mart, for example.

Offline, Best Buy will continue to face competition, new and old. CompUSA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPU)") else Response.Write("(NYSE: CPU)") end if %> is considering expanding into consumer electronics, according to its third-quarter conference call. Given CompUSA's recent performance, this probably won't strike fear in anyone's heart at Best Buy, but it's another example of the unpredictability of retail.

With all this in mind, let's look again at the company's valuation. I'm sure Paul will poke fun at my reference to Best Buy's projected growth rates of 26% and 23% over the next couple of years, since those are pretty good numbers. True, but are they worth 45 times trailing earnings? You can get higher-growth and more reliable companies such as Dell for not much more (51 times earnings). Best Buy is not outrageously priced, but after roughly fifteen-fold growth in the past couple of years, there's a lot less upside from here.

On the whole, there's no question that Best Buy is the leading consumer electronics retailer, for now. Potential investors should note that they would pay an appropriately high price for such a company, and should ask whether the company's earlier disasters might repeat themselves.

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