Schulze Said to Envision More Debt Than Norm for Best Buy
Best Buy Co. (BBY) founder Richard Schulze is considering a takeover structure for the electronics retailer that would leave the company with more debt than a typical buyout, said people with knowledge of the matter.
Credit Suisse Group AG (CSGN), Schulze’s financial adviser, has told Schulze that he can raise $6.5 billion to $7 billion in debt for a deal, and $2.5 billion to $3 billion in equity, said the people, who asked not to be identified because the talks aren’t public. Schulze last week offered to buy the company for $24 to $26 a share, or as much as $9.5 billion, including net debt.
A transaction using 70 percent to 75 percent debt would be higher than leveraged buyouts since the financial crisis and more reminiscent of the 2007 boom in LBOs. In the past four years, deals on average have been financed using 54 percent debt, according to Seattle-based researcher PitchBook Data Inc. Best Buy’s credit rating was already cut to junk this month by Standard & Poor’s, which cited the prospect of additional borrowings. The chain had about $1.7 billion in long-term debt as of May 5.
Disappointing earnings next week may put further pressure on Best Buy’s bonds and shares, which are trading below Schulze’s offer. The retailer will probably miss analysts’ average estimate for adjusted earnings of 31 cents a share when it reports fiscal second-quarter results on Aug. 21, according to a person familiar with the matter. A drop in customer traffic and comparable-store sales are to blame, the person said.
“If sales are below estimates and margins really deteriorate, it could cause added pressure on the stock price and make Schulze’s offer more attractive to shareholders,” John Tomlinson, an analyst at ITG Investment Research in New York, said by telephone this week. “It would put additional pressure on the board, saying what it’s doing is not working.”
Anne Swift, a spokeswoman for Richfield, Minnesota-based Best Buy, declined to comment, as did a spokeswoman for Schulze.
Schulze in a letter yesterday asked Best Buy’s board to allow him to form a group to support his buyout proposal. He is also asking for access to confidential financial data, which private-equity firms want to see before they commit to backing a bid, said the people. The firms would then plug the information into Schulze’s models to evaluate how much debt Best Buy can tolerate, the people said. Some firms are willing to put more debt on Best Buy than others, said the people.
KKR & Co. (KKR), TPG Capital, Leonard Green & Partners LP and Apollo Global Management LLC (APO) are among private-equity firms that have met with Schulze and expressed interest in being part of a takeover, said two people. The Wall Street Journal last week reported the names of the firms, and Schulze’s strategy for cutting prices on some products.
Officials for the private-equity firms declined to comment.
A deal would be the largest leveraged buyout on record for the retail industry, data compiled by Bloomberg show. Sales of junk bonds in the U.S. have already set a record for August as the fourth year of near-zero short-term interest rates prompts investors to put their money in higher-yielding assets. High- yield, high-risk, or junk bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P.
Credit Suisse, which has told Schulze it is highly confident it can arrange debt financing, is holding off on lining up other banks, said one person. At least two other lenders that have contacted private-equity funds to gauge their interest say many firms are reluctant to get involved because of Best Buy’s unwillingness so far to negotiate with Schulze, said the people. Best Buy’s board has said it is evaluating his offer and will consider it “in due course.”
Schulze, 71, resigned as chairman in June after an internal probe by Best Buy found he acted inappropriately in handling former Chief Executive Officer Brian Dunn’s relationship with a female employee. Schulze still holds more than 20 percent of the company and said in his letter yesterday he would put at least $1 billion of the equity into a deal.
Some private-equity funds have told Schulze they may not want him to put in his entire stake, valued at about $1.7 billion based on the $25 midpoint of his offering range, because it would give him too much ownership and control in the deal, two people said.
A firm offer with committed financing is unlikely unless Best Buy’s board permits Schulze to conduct due diligence and form a group with private-equity firms and former executives, the people said. Best Buy says Schulze isn’t limited by Minnesota law from exploring and engaging in discussions with private-equity partners and doesn’t need the consent of the board to name them.
Best Buy advisers and lawyers are telling investors and analysts that Schulze is using Minnesota takeover law as an excuse to justify the lack of a private-equity partner or committed financing, said the people.
Schulze could also call for a special meeting with 25 percent support from shareholders if the board won’t back his efforts, according to Best Buy’s amended by-laws. Schulze may be willing to pursue that option at a later date, one person said.
Schulze and his advisers are instead trying to rally support from investors and equity analysts to pressure Best Buy’s board to open up the company’s books, said people familiar with the matter. They have spoken to Putnam Investments LLC and Fidelity Investments, said these people. Funds managed by Putnam hold about 4.1 percent of Best Buy, while Fidelity funds have about 7.1 percent, according to June 30 filings.
A spokeswoman for Fidelity declined to comment. A Putnam spokeswoman didn’t return a call seeking comment.
Back to $25?
Best Buy and its advisers at Goldman Sachs Group Inc. (GS) and JPMorgan Chase & Co. (JPM) have also been talking with shareholders to see what kind of support Schulze has, said people familiar with the matter. Some shareholders have told Best Buy they think the company can get back to $25 a share on its own, said one person, citing new products such as the Windows 8 operating system that should bring customers into stores.
Best Buy shares slipped 0.7 percent to $20.27 at the close in New York, after reaching a high of $27.51 for the year on March 23.
As part of a broader restructuring, Best Buy interim CEO Mike Mikan is preparing to announce a reduction of more than 1 million square feet in retail space beyond what has been disclosed, with most of the cuts coming from existing stores, said a person with knowledge of the plans. The retailer has so far said it is closing 50 U.S. big-box stores this year.
Schulze is recruiting former Best Buy executives who share his view that the chain can’t cut its way to growth and needs to find ways to compete against companies such as Amazon.com Inc., said people familiar with the matter. He is betting U.S. lawmakers will pass legislation requiring Internet retailers to collect sales tax, removing another factor that draws customers toward online purchases over physical stores, one person said.
Schulze is reluctant to close stores because it reduces the number of interactions with consumers, according to a former executive asked by Schulze to join his management team. When it comes to reducing costs, he is arguing the company can be nimble closing down stores if and when necessary because Best Buy stores have short-dated leases, another person said.
Asset sales may be required if Schulze raises his offer for the company, a move that may encourage investors to press Best Buy’s board to allow Schulze to proceed, said Colin McGranahan, an analyst at Sanford C. Bernstein & Co. in New York, who rates the shares market perform, or the equivalent of a hold. He said he’s skeptical directors will allow Schulze to proceed.
“If Schulze & Co. are forced to increase their bid, the deal structure becomes more complicated and returns suffer dramatically given limited room to expand financial leverage,” he said.
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