A Hard Look At Best Buy

Best Buy Co., Inc. is a multinational retailer of consumer electronics, computing and mobile phone products, entertainment products, appliances and related services.

With BBY diving again off of earnings and the mysterious potential buyout looming from the former Chairman at $26, I though it was a good time for another update.

The first post I published regarding his wild ride was on 7-2-2012; sort of a pre-cursor to the bigger news. You can read that post here:

Best Buy (BBY) - Stock and Vol Up on LBO "No" News
Back then, the stock was trading just under $22. Here's that Symbol Summary:

Then, on 8-29-2012, I wrote this: Best Buy Co. (BBY) - Options Reflect Upside Potential in Near-term; Vol Diff Gaps Open to Upside

At the time of the 8-29-2012 post, BBY was trading above $18. I have included the Symbol Summary from that day, below:

Here's the news that started this story and a bunch of headlines / snippets to catch you up if you're not already familiar:

(Reuters) - Best Buy Co Inc's (BBY.N) former Chairman Richard Schulze is not expected to present a buyout or other proposal to the company's board anytime soon, a person familiar with the situation said.

Media reports said Schulze was close to presenting an offer for the consumer electronics chain. Discussions around a leveraged buyout of the company are still in the early stages, the person said.

Source: Reuters via Yahoo! Finance; No bid by Best Buy ex-chairman to come soon: source, reporting By Nadia Damouni; editing by Gerald E. McCormick.

So that was sort of no news with news expected soon, but denied. But here are some headlines from Briefing.com in chronological order (Provided by Briefing.com (www.briefing.com)):

06-Jul-12 15:23 ET: Best Buy to layoff 2400 employees - CNBC

11-Jul-12 09:33 ET: HHGregg at a 3.5 year low following Q1 warning and FY13 guidance cut, now off ~32% (7.80 -3.74) -Update BBY -6%

13-Jul-12 09:42 ET: Best Buy trading lower off the open; Hearing cautious comments at Cleveland Research

30-Jul-12 08:44 ET: Best Buy spikes to $20 then comes back to ~$19 following renewed takeover reports;

30-Jul-12 08:43 ET: Best Buy founder Schulze recruting executive team for buyout - Bloomberg

06-Aug-12 08:35 ET: Best Buy Founder Richard Schulze confirms proposal to acquire BBY for $24.00 to $26.00 per share

Richard Schulze, Founder and former Chairman of BBY, submitted a written proposal to the Best Buy Board of Directors to acquire all of the outstanding shares of the company that he does not already own for a price of $24.00 to $26.00 per share in cash. The purchase price, which is based on current public information and is subject to due diligence, represents a premium of 36% to 47% to Best Buy's closing stock price of $17.64 on August 3, 2012. Schulze is Best Buy's largest shareholder, controlling 20.1% of Best Buy shares.

And finally, the news on 8-29-2012:

29-Aug-12 07:08 ET: Best Buy: Buyout feasible albeit unlikely - Oppenheimer

OpCo notes clients continue to ask whether the firm believes former BBY chairman Richard Schulze will prove successful in his attempt to take the Co private. The BBY situation is clearly fluid. Shares are likely to remain susceptible to an ongoing deluge of data from BBY and its potential suitors. In the end, firm views a deal to purchase Best Buy as unlikely. Ample cash flow and a still healthy balance sheet suggest that BBY could support the added leverage associated with a leveraged buyout (LBO). OpCo believes, however, that potential private equity buyers will ultimately balk at a deteriorating business model that is increasingly falling victim to the inroads of new non-traditional CE competitors and a weak product cycle.

Provided by Briefing.com

Back then, $26 seemed like a reasonable premium to take the company over. Now... well... How about this news today:

Best Buy Co. founder Richard Schulze faces a looming deadline to review the firm’s financials as a part of his proposed takeover and he is now collaborating with three private-equity firms, including Cerberus Capital Management, in conducting due diligence. According to inside sources who wish to remain anonymous, Schulze has requested an additional 30 days for the procedure, even though he and the advisor firms have been evaluating the data since September. The company granted him 60 days for a proposal upon his announcement that he would bid as much as $26 a share on August 6.

Source: Wall st. Cheat Sheet via Yahoo! Finance Best Buy Founder Wants More Time, written by Mark Lawson.

All I can say to that is, you're damn right he wants more time, the stock is cratering and $26 seems almost ridiculous at this point.

Let's turn to the Charts Tab (two-years) is below. The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).

On the stock side we can see the cataclysm that has been the last two years. On 11-22-2010 BBY closed at $44.86. As of this writing the stock has had a two-year return of -73%. The chart makes it quite apparent that the levels reached today are multi-year lows.

I have included a two-year vol chart (IV30™ only), to better examine that trend.

As the stock has been falling to new lows, the implied has been rising to new highs. The dip today is off of the earnings release, but watch it climb again if the news flow stays the same... That is bad and with a lot of uncertainty.

Looking to the Skew Tab, we can see some interesting risk reflected by the option market.

Note how the Dec options show a decidedly upside skew though the ATM vol is almost identical to Jan'13 (look at the $12 strike). That is, the option market reflects greater upside risk (potential) than downside risk. The Jan'13 options show a rather flat skew and the Mar'13 options show a "normal" skew, with the OTM puts priced to higher vol the ATM options and OTM calls.

In English, the upside potential -- with breath held, is reflected in the Dec expiry. That Schulze due diligence completion and the result could be gigantic for BBY as a going concern.

Finally, let's turn to the Options Tab.

We can see the monthly vols are priced to 79.15%, 79.24% and 71.80% for Dec, Jan'13 and Mar'13, respectively. But, again, look at the skew difference between the Dec options and Jan'13 to the upside. While Dec and Jan'13 ATM vol are essentially the same, the Dec/Jan 17 call spread (for example) shows a 13 vol point difference (Dec elevated to Jan'13). On the other side, the Dec/Jan'13 9 put spread shows a ~4 vol point diff in favor of Jan'13 -- so totally backwards from the calls.

Dec may be make or break time for BBY and I'm guessing the board in retrospect would liked to have jumped to accept the $26 bid made by Schulze a few months ago. Now the business may find itself trying to stay above zero.

This is trade analysis, not a recommendation.

Disclosure: Images provided by Livevol®