Buyout Savior for Circuit City?

CHARLOTTE, N.C. (AP) – Circuit City's recent profit warning and concerns about competition have pulled the plug on the consumer electronics retailer's shares.

Trading around their lowest level in more than two years, shares are below the $17 buyout offer Circuit City Stores Inc. rejected from a Boston hedge fund in 2005. At $15.77 Wednesday, a share of Circuit City is cheaper than a DVD copy of the recent “Borat” movie the retailer sells on its Internet site.

But the near-term outlook is so cloudy that some company watchers believe it will take either a buyout offer, a major management change or both to spark shares in the months ahead.

A price war on flat-screen televisions that erupted late last year as Wal-Mart Stores Inc. and others made a big push into the product category has vexed Circuit City's latest turnaround efforts. The pricing prompted Circuit City to replace 3,400 retail employees with lower-cost workers in a move analysts now believe has hurt sales. Meanwhile, larger rival Richfield, Minn.-based Best Buy Co. appears to be weathering the tough industry environment much better and continues to expand rapidly.

“There's a lot of questions in the marketplace in regard to Circuit City's (market) share losses and consumer spending in general,” said Chris Kagaoan, a retail analyst with investment firm J. & W. Seligman. The firm doesn't own shares of Circuit City but does manage close to 1 million shares of Best Buy.

Circuit City's chief executive, former Best Buy executive Phil Schoonover, has financial flexibility — his company has more than $4 a share in cash on the balance sheet, and a potential sale of its Canadian business could add an estimated $1 a share. But shares are so cheap by some measures that the Richmond, Va.-based retailer has landed on numerous takeout-candidate screens on Wall Street.

Several firms, including UBS AG and Bear Stearns, consider Circuit City one of the most attractive candidates for a private equity buyout among hardline retailers.

“It's a really inexpensive stock,” said Bear Stearns analyst Christopher Horvers, whose financial models indicate a buyout price in the range of $22 to $24 a share still would generate attractive returns for a buyer. “Structurally, there are a lot of things they can do to improve profitability.”

Besides rejecting the offer in 2005 from hedge fund Highfields Capital, Circuit City's board also rebuffed a 2003 takeover offer of $8 a share from Mexican billionaire Carlos Slim Helu. There's no sign board sentiment has changed.

Company spokesman Bill Cimino declined to comment for this story, other than to say “management and the board are laser-focused on building and delivering shareholder value.” Highfields, through a spokesman, declined to comment, and Slim could not be reached for comment.

At least 10 retail chains have been sold over the past couple of years, and Circuit City has the kind of sector leadership, strong cash flow prospects and potential for operating margin expansion a buyer might like, said UBS analyst Brian Nagel in a recent note.

Consider this: Fiscal 2007 earnings before interest and taxes were 1.1 percent of sales, compared with 5.6 percent at Best Buy.

Circuit City has about 650 U.S. stores, or about three-fourths as many as Best Buy, but it generates roughly a third of the sales. Circuit City's biggest structural issue is that it has way more warehouse and non-selling space in its stores than does Best Buy, hurting sales productivity, according to JP Morgan. Circuit City last year generated an average $593 in sales per square foot, compared with $942 at Best Buy. Meanwhile, the companies' expenses per selling square foot are nearly equal.

Consumer electronics retailing is complex, with so many vendors and cyclicality of products, but most company watchers see opportunity for a strong No. 2 player.

Analysts and investors expect a buyer would be able to speed up store renovations or relocations and shut down at least 100 less productive stores. Other electronics retailers, including CompUSA Inc. and Tweeter Home Entertainment Group Inc., have announced hundreds of store closings.

Circuit City's profit warning on April 30, however, has thrown some cold water on buyout buzz. It blamed “substantially below-plan sales” for withdrawing its financial guidance for a pretax loss of $40 million to $50 million in the first half of fiscal 2008. Now it expects a pretax loss of about twice that in the first quarter alone.

At least eight brokerage firms followed the news by downgrading their investment ratings, citing the uncertain sales outlook and impact on profitability.

Circuit City has been a client of Bear Stearns in the last 12 months.