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Best Buy not a good buy to value investors

Tags: Best Buy, Retail
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In an ideal world, Best Buy (BBY-N) would be a value investor's dream come true. But in the real world of transparency and retailing twists and turns, it just isn't.

The retailer's stock has lost one-third of its value since touching a 52-week high of $32.85 US in June. It has a healthy cash flow, and its shares trade at about six times forward earnings while the larger electronics sector trades at a multiple of 10 -- all traits that would normally attract value investors.

Instead, Best Buy's inability to fend off online rivals such as Amazon.com (AMZN-Q), lack of strong leadership, and conflicts of interest in the boardroom are scaring investors away.

"I kind of view it as a value trap right now. I think most of my peers view it the same way," said Harry Rady, senior portfolio manager of San Diego-based Rady Asset Management. Rady said he would not buy Best Buy shares even if they fell further.

"I don't care how cheap it gets. Their business model is obsolete," Rady said, referring to how Best Buy has been reduced to a mere showroom for online retailers, with consumers going to Best Buy stores to check out electronics like high-definition televisions, then buying them elsewhere for less.

Other investors agreed.

"In a risk-off environment, I'd be scared to own Best Buy," private investor Daniel Yu said, adding that the current state of affairs at Best Buy made him compare it to Hewlett Packard (HPQ-N) and Research In Motion (RIM-T). Risk-off is the notion that when markets are down, stocks like Best Buy come under deeper selling pressure because it is seen as riskier.

HP's stock spiraled downward after CEO Mark Hurd departed over accusations of an improper relationship with a female contractor, and Research In Motion's deteriorating business pulled down its stock, Yu pointed out.

ISSUES APLENTY

The world's largest consumer electronics chain is also reeling from its own CEO scandal. Last week, CEO Brian Dunn resigned abruptly during a board of directors probe into allegations of personal misconduct.

The Minneapolis Star Tribune and other media have reported that the probe involves allegations of misuse of company assets in relation to an inappropriate relationship with a female employee. A spokesman has declined to comment on the scope of the investigation and Dunn has not responded to repeated requests for a comment.

Dunn's departure has also renewed concerns about potential conflicts of interest in the retailer's boardroom.

Almost two years ago, research company Management CV Inc. raised issues about favoritism granted to Best Buy founder Richard Schulze's relatives, and transactions connected to Schulze's immediate family and some board members.

Those include jobs with big paychecks for Schulze family members, vast sums of money spent on products from a company owned by Schulze's brother, real estate and aviation agreements with businesses owned by Schulze, and spending on services from companies that have connections with Best Buy board members.

"These ethical problems may reflect deeper-rooted issues, during a time when the company could not afford to be distracted," Yu said.

Schulze, who still is Best Buy's chairman and its largest shareholder with about 20 percent of the company's stock, was not available to comment. Greg Hitt, a spokesman for Best Buy's board, said the company "fully complies with all legal requirements, including public disclosure, regarding related-party transactions."

In fact, the company's annual proxy statements with the U.S. Securities and Exchange Commissions disclose several potential conflicts.

Best Buy paid Schulze $1 million US in rent for two of its U.S.-based stores last year. These leases date back to 1990 and run through 2011 and 2018, respectively.

Susan Hoff, Schulze's daughter, is founder, chairwoman and CEO of the Best Buy Children's Foundation. Her base salary for fiscal 2011 was $242,000 and she was eligible for a cash bonus with a target payout of close to half that amount.

Since joining Best Buy in 1983, Hoff has served in various roles. Her husband, Duane Hoff, also worked for Best Buy in the early 2000s.

Best Buy also leases its airplanes from a company owned by the Schulze Trust and paid about $3.6 million for leases and chartered aircraft services over the past five years.

"Our senior management generally use the airplanes when it is more economical or practical than flying commercial airlines," the company said in the proxy filing.

Best Buy also did business with Phoenix Fixtures, owned by Schulze's brother. It spent at least $70.7 million for store fixtures over a period of five years.

BEST BUDDIES

Best Buy paid about $12 million in fiscal 2011 to law firm Robins, Kaplan, Miller & Ciresi, which serves as its primary external general counsel and where former Best Buy board Director Elliot Kaplan is a partner.

Kaplan's stepson, Michael Stillman, served as a vice president of Best Buy Connect, a Best Buy-owned mobile broadband service, before he left the company. Kaplan's daughter, Jane Kirshbaum, is still a senior corporate counsel at Best Buy.

Also, since 2003, Best Buy has had a health benefit services agreement with UnitedHealth. It buys employee medical plans from the insurer, where Best Buy board member and current interim CEO G. Mike Mikan has held senior positions.

The amounts Best Buy paid to UnitedHealth were "an insignificant portion" of the revenue of Best Buy and UnitedHealth for each of the past three fiscal years, the retailer said in a filing, adding "Mikan did not influence or participate in negotiating our agreement with UnitedHealth."

During fiscal 2009, Best Buy paid $175 million to UnitedHealth under the agreement.

"All those conflicts we cited in our report, all those same issues, still exist at this day at Best Buy," Renny Ponvert, CEO of Management CV, said.

Still, while all these conflicts of interest were "examples of very poor fiduciary behavior" and are "egregious" from an ethical standpoint, none of them are illegal, Ponvert said.

Ponvert hoped "the embarrassing circumstance around Dunn's departure gave Dick Schulze a cause to clean up the boardroom."

Corporate governance experts and investors agree.

"The longer the conflict section in the proxy (statement), the more concern people have," said Charles Elson, director of the Weinberg Center for corporate governance at the University of Delaware. "The goal should be to make that conflict section either small or non-existent."

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