Dueling Fools
August 18, 1999
Borne in the CompUSA
Bull Argument
By
Louis Corrigan (TMF Seymor)
Woah, did I really agree to be the bull on CompUSA? What was I thinking! This puppy should be taken out and shot.
OK, CompUSA has obviously suffered through tough times of late. The stock has howled from a high of $38 in December 1997 to the $5 range this week. There are four main reasons for the company's troubles, and all relate fundamentally to its core business of selling increasingly commoditized computers through its 208 retail stores:
- First, average selling prices (ASPs) for the beige boxes have been in steady decline as the "under $1,000" computer led quickly to the "under $500" computer. Preliminary results for Q4 ended June 30 show that the company's desktop ASPs declined 20% year-over-year and 7% sequentially. Deflation like that pressures gross margins since there just ain't as much profit built into a $500 box as there is in the $1,500 boxes of yesteryear.
- Second, Internet e-tailers have stolen market share from CompUSA by offering rock-bottom prices -- think of Onsale's <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ONSL)") else Response.Write("(Nasdaq: ONSL)") end if %> atCost -- or the can't-miss combination of brand, price, and service offered by direct sellers such as Dell <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %>. Moreover, folks buying their second or third PC feel comfortable purchasing this commodity product on the Web.
- Third, the company's customer service has sucked, plain and simple. Like millions of Americans, I think of CompUSA whenever I hear Beyond.com's <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BYND)") else Response.Write("(Nasdaq: BYND)") end if %> radio ads mocking the lame service at your local computer superstore. My last trip to CompUSA entailed a hefty restocking fee for an item I had opened but realized I didn't need. Let me tell you how happy that made me.
- Fourth, consumer electronics stores like Best Buy <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BBY)") else Response.Write("(NYSE: BBY)") end if %> and Circuit City <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CC)") else Response.Write("(Nasdaq: CC)") end if %> have been pulling customers away from CompUSA because they offer not just some basic PC models but everything else the digital consumer wants. They get the store traffic so they get the sales.
The good news is that CompUSA has the makings of an answer for each of these problems. At the same time, the stock market has already discounted almost complete disaster.
- First, Internet Service Providers (ISPs) have started subsidizing PC purchases for U.S. consumers, 46% of whom still don't own a computer. America Online's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %> CompuServe unit, for example, is now offering a $400 rebate to CompUSA customers who sign up for 3 years of CompuServe when they buy a PC. In a sense, ISPs have decided that their marketing costs may be best spent at the point of purchase and that locking customers into long-term Internet access deals is the best way to prevent customer churn.
The "Free PC" model also works for CompUSA for three reasons eloquently laid out by Piper Jaffray's Rebecca Yarchover. First, each ISP will pay retailers to promote its access package rather than a rival's. Second, customers appear to be using the $400 rebates not so much to get bargain basement PCs for free but to get good deals on more expensive models. So falling ASPs could actually begin to rise. Third, consumers spend an average of $500 on peripherals and accessories (monitor, printer, scanner, digital camera, etc.) with each PC purchase. That stuff carries higher profit margins than a beige box.
CompUSA is the volume leader among PC retailers. Indeed, Q4 desktop unit sales soared 60% year-over-year. Under the new subsidized PC regime, the volume leader has the most to gain. Plus, CompUSA is Apple's <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AAPL)") else Response.Write("(Nasdaq: AAPL)") end if %> largest reseller, and sales of the new iBook consumer notebook, which will make getting online even easier, should be huge. So the Internet may actually be CompUSA's friend.
- Second, the company's direct sales division, renamed CompUSA Net.com, became a separate subsidiary in March, and the company is planning a major website relaunch this fall. Market willing, this subsidiary will eventually go public. The firm has also outsourced its direct sales product fulfillment to Ingram Micro <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IM)") else Response.Write("(NYSE: IM)") end if %>, which will reduce inventory risks and capital costs.
- Third, CompUSA is addressing the customer service problem directly by adding more employees to the sales floor while doubling employees' initial training and adding ongoing training so they'll be able to tell the difference between Quicken and Riven. The company has also brought in-house the handling of its extended warranty service contracts. (No word on the restocking fee, but note to CEO James Halpin: Does Amazon.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %> charge a restocking fee? Then, you know what to do.)
- Fourth and most dramatically, CompUSA is diversifying its product offerings to look more like its main consumer electronics competitors. It plans to focus on new areas such as gaming (Sony, Nintendo, Sega); entertainment products such as DVD movies and MP3 Internet music technology; imaging products such as digital camcorders and cameras; mobile computing gear such as personal digital assistants; and products for small business customers.
Management seems to understand it needs to fundamentally refocus the business. The company could even reduce its computer department to a kind of Gateway <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GTW)") else Response.Write("(NYSE: GTW)") end if %> Country Store format. Customers could get lots of special attention on purchase decisions, but the bulk of PCs might be sold build-to-order. That would reduce CompUSA's inventories, alleviate the need for major markdowns, and reduce working capital needs.
No question, CompUSA is in the early stages of a turnaround that's dependent on a fairly drastic change of direction that may end up making the CompUSA name obsolete. Turnarounds take time and involve lots of risk.
But the market has already discounted a lot of ugliness. CompUSA rang up a 20% gain in FY99 sales to $6.32 billion, yet it now trades for just $541 million. Cash and debt, as of March 27, roughly canceled each other out. So the retailer sports a price-to-sales ratio around 0.08 at a time when the well-managed Best Buy trades for about 1.0x sales. The last time Best Buy traded for less than 0.08x sales was in mid-1997, when it was beginning to rebound from a bankruptcy scare.
Or, let's consider CompUSA's book value of $439.8 million, or roughly $4.68 per share, as of March. OK, some of this is about to disappear. CompUSA will take a $50 million after-tax charge between Q4 FY99 and Q2 FY2000 to close at least four stores and one distribution center, lay off up to 1,500 of its 21,000 employees, and write down assets and inventories. The charges could easily climb higher. Also, goodwill related to its acquisition of Computer City accounts for $105 million of the company's assets. So let's reduce book value to about $285 million, or $3 a share.
That's a rough downside liquidation value that basically figures CompUSA Net.com as an Internet business is worth nothing. But we're a long way from liquidation. CompUSA just redeemed its $110 million in 9 1/2% senior notes thanks to a new $500 million revolving credit facility announced July 1. And the company still had $242 million in cash as of March. So it appears CompUSA has the financing in place to roll out the new strategy.
Would I buy the stock now? No. CompUSA will report its full FY99 results on August 30, along with more details about its new plans. I would expect more store closings and restructuring charges, so the bad news probably isn't all out yet. I'd also like to see an updated balance sheet.
CompUSA faces major challenges. But the stock has gotten cheaper in the last six months even as the story has unexpectedly improved. Those comfortable with the risky business of turnaround investing might soon find CompUSA exhibiting an attractive risk/reward profile.
Next: The Bear Argument