Best Buy Research Report

Best Buy Analysis

Prepared by: John R. Pangere

November 2011

Copyright ©2011 by John R. Pangere. All rights reserved. Sources: Best Buy Company filings and

presentations, ETrade Research Center, Google Finance, Yahoo Finance, Wal-Mart Company Filings,

Amazon Company Filings, Radio Shack Company Filings, HH Gregg Company Filings, Conn’s Company

Filings

Best Buy Corporation (NYSE: BBY)

Date of Report: 11/6/2011 Shares Outstanding (Millions): 362.3 Current Price: $27.31 Institutional Holdings: 65.3% 52-week range: $21.79 - $45.63 Fiscal Year Ends: 26-Feb Average Volume (3-Months): 7,150,730 FY 2011 Net Income (Millions): $1,277 FY 2011 EPS (Reported): $3.08 Book Value, as reported (Millions): $6,087 FY 2011 P/E: 8.87 Market Cap. (Millions): $9,900 Dividend Yield: 2.4% Price/Book Value: 1.71x Index Membership: NYSE Industry: Retail

Business Description: Best Buy Co., Inc. is a multinational retailer of consumer electronics, home office products, entertainment products, appliances and related services. The Company operates retail stores and call centers, and conducts online retail operations under a variety of brand names, such as Best Buy (BestBuy.com, BestBuy.ca, BestBuy.co.uk), Best Buy Mobile (BestBuyMobile.com), The Carphone Warehouse (CarphoneWarehouse.com), Five Star (Five-Star.cn), Future Shop (FutureShop.ca), Geek Squad, Magnolia Audio Video, Napster (Napster.com), Pacific Sales and The Phone House (PhoneHouse.com). The Company operates in two segments: Domestic and International. The company was founded in 1966 in Minnesota. Investment Thesis With the stock currently selling at a price near its 52-week low, the company is selling at a compelling valuation. Since reaching its all-time high of $59.50 per share during the first quarter of its Fiscal Year 2007 (upon releasing FY 2006 annual report), the stock has twice fallen to its current level, or lower. At its current price, this represents a decrease of 54% from its all-time high. In the time since the common stock reached its all-time high, sales of Best Buy have increased approximately 63%, while net income has increased approximately 12% and the number of shares outstanding (at time of FY 2011 annual report) has decreased 17%. At the time of reaching its all-time high, Best Buy was selling at a price/earnings (P/E) ratio of just over 26x. On average, Best Buy’s stock sells at a P/E ratio of approximately 15x over the last five years. Taking into account the last twelve months’ earnings (LTM), a return to the

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historic P/E ratio would value Best Buy’s shares at $44.55 per share, a return of approximately 63% from its current price. The company has a solid balance sheet. Best Buy’s balance sheet has been, in my opinion, prudently managed over the last 5 years, allowing the company to better weather current market conditions and any future economic slowdowns.

FY 2012 Q2 2011 2010 2009 2008 2007

Cash 2,120 1,125 1,916 509 1,502 3,793

Debt 2,140 1,152 1,139 1,180 660 609

Net Debt 20 27 (777) 671 (842) (3,184)

Equity 6,087 6,602 6,320 4,643 4,484 6,201

Debt/Debt+Equity 0.26 0.15 0.15 0.20 0.13 0.09

Net Debt/Debt+Equity 0.00 0.00 - 0.13 - - *Numbers in millions, except Debt-to-Debt-Plus-Equity ratios

As evidenced above, Best Buy’s current Debt-to-Debt-Plus-Equity ratio stands at just 0.26x, and taking into account its current cash and securities position, the ratio is negligible. This allows Best Buy greater flexibility in its operations. The company has produced solid cash flows over the past several years. As a true measure of profitability, Best Buy’s free cash flow has been solid and increasing:

2011 2010 2009 2008 2007

EBIT 2,249 2,193 1,920 2,099 1,999

Depreciation 896 838 730 580 509

Capital Expenditures 744 615 1303 797 733

Income Taxes 714 802 674 815 752

Free Cash Flow 1,687 1,614 673 1,067 1,023 *Numbers in millions

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The last-twelve-months (LTM) free cash flow, by quarter, has been as follows: Q3 2011 Q4 2011 Q1 2012 Q2 2012

Operating Earnings (EBIT) 385 1,227 284 289

Capital Expenditures 187 215 202 209

Depreciation 230 228 221 224

Income Taxes 133 314 99 99

Free Cash Flow 295 926 204 205 *Numbers in millions

Overall, over the last twelve months, Best Buy has created $1,630 million in free cash flow. On a LTM price-to-free-cash-flow basis (P/FCF), Best Buy is currently selling at 6.39x FCF. Typically, Best Buy trades at a P/FCF multiple of approximately 14x over the past three years. On a LTM basis, this would value Best Buy’s shares at approximately $59.83 per share, a 119% increase over its current price. The company returns capital to shareholders in the form of dividends and share repurchases. Since the company began issuing dividends to shareholders in FY 2004, the dividend has increased approximately 118%, or 11.5% compounded per year, from $0.27 per share in 2004 (split-adjusted) to $0.58 per share in FY 2011. Over the same time period, Best Buy’s issuance of dividends to shareholders has risen 82%, from $130 million in 2004 to $237 million in FY 2011. In essence, Best Buy has been able to increase its dividend payments per share at a greater rate than money actually paid to increase said dividends. This has been done through Best Buy’s share repurchase program, allowing the company to increase its dividend payments per share due to a declining share count, all while not having to pay out more cash as a percentage of cash flow than the increased per share amount dictates. Best Buy’s payments of dividends, as a percentage of gross profit and free cash flow, over the last three years has been as follows:

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2011 2010 2009

Dividends paid 237 234 223

Gross Profit 12,661 12,160 10,998

Free Cash Flow 1,687 1,614 673

Dividends as a % of gross profit 1.87% 1.92% 2.03%

Dividends as a % of FCF 14.05% 14.50% 33.14% *Numbers in millions

On the subject of share repurchases, Best Buy has spent $1,396 million in net stock repurchases (stock repurchases net of issued shares) over the last six fiscal years. Including the first two quarters of FY 2012, Best Buy has repurchased $2,242 million of common stock. In June of 2011, the company announced a new stock repurchase program of $5 billion, with no expiration date. Currently, Best Buy is yielding approximately 2.4%. On average, Best Buy has traded at a yield of 1.27% over the last 5 years, while the current Sector average yield is 1.47%. A return to the average yield of the Sector values shares at approximately $39 per share, while a return to Best Buy’s average yield values the shares at approximately $47 per share, providing gains of 43% and 72%, respectively, from its current price. Investment Risks Continued weakness in same-store-sales. Since FY 2009, Best Buy’s same store sales have either been declining or relatively flat. According to Best Buy’s most recent annual results (FY 2011 Form 10-K), same store sales are defined as “revenue from stores operating for at least 14 full months as well as revenue related to call centers, Web sites and other comparable sales channels1.” Fiscal Year Q1 Q2 Q3 Q4 Full Year

2012 -1.7% -2.8%

2011 2.8% -10.0% -3.3% -4.6% -1.8%

2010 -6.2% -3.9% 1.7% 7.0% 0.6%

2009 3.7% 4.2% -5.3% 4.9% -1.3%

2008 3.0% 3.6% 6.7% 0.2% 2.9%

2007 4.9% 3.7% 4.8% 5.9% 5.0%

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2006 4.4% 3.5% 3.3% 7.3% 4.9%

2005 8.3% 4.3% 3.2% 2.8% 4.3%

2004 1.3% 6.7% 8.6% 9.7% 7.1%

2003 6.5% 2.6% 0.7% 1.2% 2.4%

2002 -3.1% 2.8% 1.6% 4.5% 1.9% *Figures are based on a consolidated same store sales basis

Per the table above, Best Buy typically has seen same store sales growth between 2% and 3%, on average. While Best Buy’s sales have grown over the last three fiscal years, from $45,015 million to $50,272 million, or approximately 12% over the time period, the increased sales have been mainly due to expansion rather than existing operations. A continuation of this same-store sales decline on a yearly basis may hamper Best Buy’s ability to overcome current market conditions, especially should discretionary consumer expenditures rise to pre-2009 levels without any follow-through of same-store sales increasing. Declining profit margins. Over the long-term, Best Buy has produced average profit margins as follows: Profitability Averages 3-year 5-year 10-year

Gross Margin 24.70% 24.47% 24.13%

Operating Margin 4.57% 4.94% 5.05%

Net Margin 2.47% 2.95% 2.86%

While gross margins have increased slightly, operating and net margins have been in decline over the last five years, on average. There are several reasons for this, among them the weakness in the US and European economies. Over the last ten years, Best Buy’s gross and operating margins have been as follows:

Sales Gross Profit Gross Margin Operating Profit Operating Margin

2012 (First 6-months) 22,287 5,640 25.31% 573 2.57%

2010 50,272 12,661 25.18% 2,336 4.65%

2009 49,694 12,160 24.47% 2,287 4.60%

2008 45,015 10,998 24.43% 2,014 4.47%

2007 40,023 9,546 23.85% 2,161 5.40%

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2006 35,934 8,769 24.40% 1,999 5.56%

2005 30,848 7,726 25.05% 1,644 5.33%

2004 27,433 6,495 23.68% 1,442 5.26%

2003 24,548 5,871 23.92% 1,304 5.31%

2002 20,946 5,236 25.00% 1,010 4.82%

2001 17,711 3,770 21.29% 908 5.13% *Numbers in millions

While it seems that Best Buy has been effective in controlling its costs-of-goods-sold (COGS), since 2008, it also seems to have been ineffective in controlling a rise in its overall operating expenses through increases to Selling, General and Administrative expenses (SG&A).

Year SG&A (as a % of sales)

2011 20.54%

2010 19.87%

2009 19.96%

2008 18.45%

2007 18.84%

While the current operating environment may get the blame for this trend, a closer look at Best Buy’s operating segments may unlock a different picture: Domestic Segment:

Sales Operating Profit Operating Margin

2012 (First 6-months) 16,170 537 3.32%

2011 37,186 2,031 5.46%

2010 37,314 2,071 5.55%

2009 35,070 1,758 5.01%

2008 33,328 1,999 6.00%

2007 31,031 1,900 6.12%

2006 27,380 1,588 5.80%

2005 24,616 1,393 5.66%

2004 22,225 1,267 5.70%

2003 19,303 1,002 5.19%

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2002 17,115 886 5.18% *Numbers in millions. The Domestic segment consists of only those stores located in the US

International Segment:

Sales Operating Profit Operating Margin

2012 (First 6-months) 6,117 32 0.52%

2011 13,086 83 0.63%

2010 12,380 164 1.32%

2009 9,945 112 1.13%

2008 6,695 162 2.42%

2007 4,903 99 2.02%

2006 3,468 56 1.61%

2005 2,817 49 1.74%

2004 2,323 37 1.59%

2003 1,643 8 0.49%

2002 596 22 3.69% *Numbers in millions. The International segment includes stores located in Canada, Europe, China, Mexico and Turkey. Operations in Turkey have been discontinued as of Q2 of FY2012.

As shown above, operating margins in the International segment have been inconsistent and notoriously thinner when compared to those of the Domestic segment. While the first six months of FY 2012 operating margins seem to be lower than normal, on a consolidated basis and in the Domestic segment, Best Buy typically sees a mix of sales and profit margins, on average over the last five years, by quarter, as follows:

% Sales Gross Margin Operating Margin

Q1 20.18% 24.84% 3.53%

Q2 21.91% 24.77% 3.71%

Q3 24.36% 24.30% 2.92%

Q4 33.56% 24.16% 7.98% *Figures based on consolidated performance from FY 2007 to FY 2011

As you can see, Best Buy typically sees the bulk of its sales and operating profit in its fiscal fourth quarter. While its operating margins for the first six months of FY 2012 may seem

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alarming, they are closer to, rather than further from, those of normal operations on a quarterly basis. In my opinion, the issue regarding the current trend in Best Buy’s operating margins, in their current state, has more to do with the effect of International operations, rather than Domestic operations, as has been shown above. Continued weakness in controlling its SG&A expenses may hamper Best Buy’s prospects going forward. Ineffectiveness of international expansion. Best Buy’s venture into the International landscape began in FY 2002 with its acquisition of Future Shop in Canada. Since then, the company has expanded to Europe, with its acquisition of a stake in The Carphone Warehouse and The Phone House in a number of European locations, expansion of Best Buy stores in Mexico, and in China, with its acquisition of the Five-Star electronics retail chain. As has been shown previously, Best Buy’s profits in its International operations have been inconsistent and very thin. Since expanding internationally, Best Buy’s international operations have produced the following cash flow:

Sales Operating Profit Capital Expenditures Depreciation Cash Flow

2012 (First 6-months) 6,117 32 185 200 47

2011 13,086 83 263 273 93

2010 12,380 164 230 253 187

2009 9,945 112 332 180 -40

2008 6,695 162 124 80 118

2007 4,903 99 85 71 85

2006 3,468 56 107 59 8

2005 2,817 49 104 46 -9

2004 2,323 37 93 40 -16

2003 1,643 8 58 26 -24

2002 596 22 18 8 12 *Numbers in millions. Contains figures from the International segment only.

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Over the same time period, the Domestic segment has produced the following:

Sales Operating Profit Capital Expenditures Depreciation Cash Flow

2012 (First 6-months) 16,170 537 226 245 556

2011 37,186 2,031 481 623 2,173

2010 37,314 2,071 385 585 2,271

2009 35,070 1,758 971 550 1,337

2008 33,328 1,999 673 500 1,826

2007 31,031 1,900 648 438 1,690

2006 27,380 1,588 541 397 1,444

2005 24,616 1,393 398 397 1,392

2004 22,225 1,267 452 413 1,228

2003 19,303 1,002 667 284 619

2002 17,115 886 563 237 560 *Numbers in millions. Contains figures from the Domestic segment only.

While sales in the Domestic segment have remained relatively flat over the last three years, and the increase in consolidated sales has come from the International segment, it is the Domestic segment that has consistently provided the bulk of cash flow for Best Buy. In addition, the exit from the Turkey market has shown the difficulty Best Buy has faced in expanding to new international locations. If other expansion plans fail to materially produce a return on investment, it may hamper Best Buy’s ability to grow outside of the US, thereby stalling the company’s overall growth prospects in the future. Increased competition from other low-cost and online retailers. Best Buy operates in the highly competitive Retail industry, in the Electronics and Appliances sub-sector. Compared to its closest competitors (Radio Shack, HH Gregg, Conn’s), Best Buy is the largest with a market cap of $9.9 billion. Relative to its competitors, on an Enterprise Value to Earnings-Before-Interest-Taxes-Depreciation-and-Amortization (EV/EBITDA) basis, Best Buy is trading at the lowest multiple of EV at 3.08x (LTM). Best Buy is also trading at the lowest P/E multiple, relative to its competitors, at 9.2x (LTM). (See Appendix for more details.)

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The issue with Best Buy is not so much competing with its peer group competitors (as evidenced by the demise of Circuit City), but with other low-cost and online retailers, such as Wal-Mart and Amazon. Compared with Wal-Mart and Amazon, Best Buy may not be able to compete on an apples-to-apples price basis for the same products every time. With Wal-Mart’s purchasing power (due to its immense size) and Amazon’s online, low-cost operating model, I believe these are the biggest threats to competition for Best Buy. The trends in what types of products consumers are buying from Best Buy over the last several years may show just how this competition is affecting Best Buy: Revenue Mix Category 2011 2010 2009 2008 2007

Consumer Electronics 37% 39% 39% 41% 42%

Home Office 37% 34% 31% 28% 27%

Entertainment 14% 16% 19% 20% 19%

Appliances 5% 4% 5% 5% 6%

Services 6% 6% 6% 6% 5%

Other 1% 1% <1 <1 1% *Figures are based only on the revenue mix in the Domestic segment.

I feel this threat to Best Buy from Amazon and Wal-Mart is mainly in the Domestic space, and some key developments in the trends of each revenue category can be deduced from the data presented above. For instance, Best Buy has seen a decline in the Consumer Electronics and Entertainment categories as a percentage of overall sales over the past several years. While losing market share in those categories (especially the Consumer Electronics category) may hurt Best Buy in the short-term, its ability to increase sales in the Home Office and Appliance categories may help to mitigate those effects. In order to see the effects more clearly on each segment, the revenue produced by each category in the Domestic segment over the last five years has been as follows:

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Revenue Category 2011 2010 2009 2008 2007

Consumer Electronics 13,759 14,552 13,677 13,664 13,033

Home Office 13,759 12,687 10,872 9,332 8,378

Entertainment 5,206 5,970 6,663 6,666 5,896

Appliances 1,859 1,493 1,754 1,666 1,862

Services 2,231 2,239 2,104 2,000 1,552 *Numbers in millions. Figures represent sales for the Domestic segment only, by category, excluding the Other revenue category, as it represents <1% to 1% of sales.

With the revenues of the Home Office category continuing to show improvement and become a larger part of Best Buy’s Domestic segment sales, as is that of the Appliances category (albeit on a smaller scale), the competition Best Buy faces in the Consumer Electronics and Entertainment categories may partially be offset as Best Buy diversifies its product mix. Potential Catalysts:

1. An increase in same-store sales. Best Buy has faced a difficult operating environment over the last several years, which has been one of the main factors in same-store-sales declines since 2009. With the unemployment rate at just over 9% and consumer retail spending in the Electronics and Appliances category having declined from its peak in 2007, it may be difficult for Best Buy to overcome same-store-sales declines until the overall economic picture improves.

Currently, according to the US Census Bureau’s Monthly Retail Trade Report2, sales in the Electronics and Appliance Store category through August of 2011 are relatively flat compared with sales through August of 2010 ($62,587 million in 2011 vs. $62,652 million in 2010), and still below the all-time high mark of sales through August of $69,409 million that was set in 2008, a year in which sales for the Electronics and Appliance Store category were nearly $109 billion. (See appendix for further spending statistics.) Should spending in the Electronics and Appliances category increase in the coming quarters and years, Best Buy should see a boost in same store sales.

2. Profitable international expansion. Since the acquisition of Future Shop in Canada in

2002, Best Buy has seen its fair share of struggles in the International landscape. As evidenced by its exit from the Turkey market, not all expansion plans are created equal.

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Best Buy’s future growth is predicated upon International expansion, as it is becoming more and more limited in its opportunities to expand Domestically with its large-format stores. Domestically, Best Buy’s operations are as follows:

Store Type Total Stores at

Beginning of Q2 2012 Stores

Opened Stores Closed

Total Stores at End of Q2 2012

Best Buy 1,102 3 - 1,105

Best Buy Mobile Stand Alone 198 24 - 222

Pacific Sales 35 - - 35

Magnolia Audio Video 5 - - 5

Clearly, expansion plans in the Domestic segment are focused on increasing the smaller-size Mobile Stand-Alone footprint, rather than the larger traditional Best Buy store. According to its most recent 10-K, Best Buy plans to open 150 of these small-format stores in the US in FY 2012, while opening only 6 to 8 traditional Best Buy stores. However, Internationally, Best Buy’s expansion shows a somewhat different picture:

Store Type Total Stores at

Beginning of Q2 2012 Stores

Opened Stores Closed

Total Stores End of Q2 2012

Best Buy Europe - small box 2,429 38 29 2,438

Best Buy Europe - big box 6 4 - 10

Canada Future Shop 146 2 - 148

Best Buy 71 5 - 76

Best Buy Mobile stand-alone 15 7 - 22

China Five Star 171 7 - 178

Mexico Best Buy 6 - - 6

Turkey Best buy 2 - 2 0

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My main concern regarding the Best Buy Europe stores is possible over-saturation of the small-box format stores, which comprises of The Carphone Warehouse and The Phone House stores. Yet, in Best Buy’s most recent quarterly report, the Computing and Mobile Phones revenue category, in which the small-box format stores operate, continues to see increases in comparable store sales. As long as sales at these stores continue to increase, my concern regarding over-saturation should be mitigated. Taking a look at the International segment’s revenue mix, by category, shows the following:

Revenue Mix Category 2011 2010 2009 2008 2007

Consumer Electronics 21% 20% 26% 39% 41%

Computing and Mobile Phones 55% 53% 45% 30% 32%

Entertainment 6% 7% 9% 13% 12%

Appliances 9% 8% 10% 13% 10%

Services 9% 12% 10% 5% 5%

Other <1 <1 <1 <1 <1 *Includes data from the International segment only. The Computing and Mobile Phones category was previously referred to as the Home Office category.

Obviously, the Computing and Mobile Phones category is, by far, Best Buy Europe’s largest operating category contributing the bulk of revenues from the International segment. Yet, it is not necessarily the only segment producing growth for Best Buy, as the amount of revenues collected from each category can attest: Revenue Category 2011 2010 2009 2008 2007

Consumer Electronics 2,748 2,476 2,586 2,611 2,010

Computing and Mobile Phones 7,197 6,561 4,475 2,009 1,569

Entertainment 785 867 895 870 588

Appliances 1,178 990 995 870 490

Services 1,178 1,486 995 335 245 *Numbers in millions. Figures represent sales for the International segment only, by category, excluding

the Other revenue category, as it represents <1% of sales.

In addition to the Computing and Mobile Phones category, the International segment’s Consumer Electronics and Appliances categories saw record revenues in FY 2011. This

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bodes well for sales in the International segment, provided Best Buy is able to more effectively control its SG&A expenses internationally. What I find interesting in the International segment, going forward, is the possibilities that Best Buy’s operations in China, through its Five Star chain, may provide to the company overall. Since 2009, when Best Buy completed its acquisition of China’s Five Star stores, revenues per store have increased from $9 million per store to $11 million per store in FY 2011 as the number of stores has increased from 165 to its current 178. With 178 total Five Star stores, or roughly one store for every 5.6 million people in China, compared with one store for roughly every 250,000 people in the US, I feel China should be the main focus for Best Buy’s current international expansion plans. According to the CIA World Fact Book3, China’s urban population, in which Best Buy’s stores mainly cater to, is approximately 47% of the nation’s total population. This places approximately 630 million Chinese living in an urban setting, or approximately twice the total population of the US. Furthermore, it is estimated that the rate of urbanization in China is currently 2.3%, or approximately 31 million Chinese moving to urban locations every year. In addition, per capita income is estimated to be on the rise, from $6,400 in 2008 to $7,600 in 2010. While this may be an unconventional way of a viewing China’s growth prospects, with the country’s population becoming more and more urbanized, income per capita on the rise, and sales per store having increased every year since Best Buy entered the China market, I believe Best Buy should capitalize on this growth over the long-term provided it can grow effectively by closely monitoring its costs, as well as produce operating margins in a more consistent manner. (See Appendix for more details.) Focusing on expansion in China has been the norm of other retailers, such as Wal-Mart. Since 2007, Wal-Mart has increased its footprint in China by 350%, from 73 stores to 328, as of Wal-Mart’s most recent Annual Report. Best Buy has stated it is planning to increase its presence in China by opening 40-50 Five Star stores over the course of the current fiscal year.

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3. More effective cost-control measures. As has been previously stated, Best Buy has faced pressures controlling its SG&A costs in both segments, but more so in the International segment. If Best Buy is to produce better results in the coming quarters and years, it must rein in these costs.

If, in the coming quarters and years, Best Buy is able to improve its operating margins, especially in the International segment, it may provide a boost to the price of shares and confidence among investors.

Recommendation: Upon reviewing Best Buy’s financial results and company filings, it is my contention that Best Buy is currently undervalued at today’s price of $27.31 per share. As I have previously shown, there are several metrics in which to value Best Buy under a more normalized environment (P/E, P/FCF, Dividend Yield, etc.). The basis I have used to value the company’s shares is through an estimation of the Earnings Power Value (EPV) of the company. Using the EPV estimation of the company, my calculation, assuming a cost of capital rate of 8% (based on Best Buy’s current financial position and average cost of capital, adjusted to reflect the current yield of the 30-year Bond4), is as follows:

EBIT Adjusted 2,336

Less: Maintenance Capex Adjustment 224

Tax Rate 38%

EBIT After Tax, Net of Maintenance Capex Adjustment 1,533

Plus: Depreciation & Amortization 896

Income As Adjusted 2,429 *Numbers in millions

Using the adjusted income in conjunction with the cost of capital rate, and then further adjusting for cash and debt, my estimated price for Best Buy comes out to the following:

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Income as Adjusted 2,429

Cost of Capital 8%

EPV 30,368

Less: Cash-Debt Adjustment 9,868

Final EPV, as Adjusted 20,500

Per Share 49.22 *Numbers in millions, except per share data

Incidentally, using the EPV model provides an estimated price in-line with the price deduced from Best Buy’s typical yield of 1.27%. Taking into consideration my estimates above, I feel Best Buy’s intrinsic value is $49 per share and is safe to buy up to $30 per share. As I have stated before, my main concerns with Best Buy are operations issues: controlling SG&A costs and effective expansion into International locations. Best Buy has done a good job of controlling its product costs as evidenced by its increasing gross margins both domestically and abroad, but must find a way to reduce its SG&A costs, especially in the International segment. Regardless, in its current state, I feel Best Buy is undervalued with minimal downside risk as overall sales are increasing despite a troubled worldwide economy. My recommendation is mainly a way to buy Best Buy’s Domestic operations at a significant discount, with the opportunity to obtain Best Buy’s international growth prospects basically for free (based on the company’s cash flows from its Domestic and International segments, as previously shown above). Should the International segment’s operating cash flows improve from their current levels, I would expect an investment in Best Buy at current levels to outperform even that of my estimate of intrinsic value. To show how Best Buy may outperform my estimation of intrinsic value, based on extrapolating sales and profits for the 3rd and 4th quarters of the current fiscal year (as shown in the Appendix), I have estimated Best Buy’s sales for the full year to be $54,204 million, with an operating profit (EBIT) of $2,676 million. After deducting interest expense (estimated at $130 million) as well as a reduction for Other Expense (estimated at $250 million), Pretax Income comes to $2,296 million. Using a tax rate of 38% brings net income to approximately $1,424 million. Earnings per share (EPS) would then come to (using an estimated 400 million diluted

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shares outstanding for FY 2012) $3.56 per share, implying a forward P/E ratio for FY 2012 of 7.7x. Based on these estimations, the implied value of Best Buy stock, if it were to return to a P/E ratio of 15x, would be $54 per share. While this estimation is purely hypothetical and may or may not come to fruition, it may provide a basis with which to show Best Buy’s prospects going forward.

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Appendix: Estimated Revenues and Cash Flow for FY 2012:

Sales

% of Sales

Gross Profit

Gross Margin

Operating Profit

Operating Margin

Capital Expenditures Depreciation Cash Flow

FY 2012 Estimated 54,204 13,263 24.47% 2,676 4.94% 914 935 2,698

Q1 (As Reported) 10,940 20.18% 2,768 25.30% 284 2.60% 202 221 303

Q2 (As Reported) 11,347 20.93% 2,872 25.31% 289 2.55% 209 224 304

Q3 (Estimated) 13,202 24.36% 3,209 24.30% 385 2.92% 234 246 398

Q4 (Estimated) 18,188 33.56% 4,395 24.16% 1,452 7.98% 269 244 1,427

*Numbers is millions. Data for Q3 and Q4 was extrapolated based on averages of sales and operating margins as has been shown under the Investment Risks: Declining Margins section of this report.

Net Sales by Geographic Region: Geographic Region FY 2011 FY 2010 FY 2009 FY 2008 FY 2007

United States 37,186 37,315 35,070 33,328 31,031

Europe 5,511 5,591 3,205 - -

Canada 5,468 5,065 5,174 5,386 4,340

China 1,952 1,677 1,558 1,309 563

Other 155 46 8 - - *Numbers in millions. Other includes the Mexico and Turkey markets.

Average Revenue per Store: Geographic Region FY 2011 FY 2010 FY 2009 FY 2008 FY 2007

United States 28 31 32 34 36

Europe 2 2 1

Canada 24 24 26 30 26

China 11 10 9 8 4

Other 19 8 8 *Numbers in millions. Per store revenue is calculated from fiscal year-end revenue from each geographic region divided by the total number of stores in that region. Revenue per store in each region includes all store format types in that region. Trends in sales per store in the US and Canada are not necessarily indicative of overall sales trends as smaller format and specialized stores are included in the figures.

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Valuation Comparison with Peer Group Competitors

Name Symbol Current Price

Market Cap P/E P/S P/B ROE ROA EV/EBITDA

EV/EBITDA-Capex

Debt- to-debt-plus-equity

Best Buy BBY 27.30 9.9B 9.20 0.2 1.71 19.5% 6.9% 3.08 4.37 0.26

Radio Shack RSH 13.22 1.3B 13.29 0.3 1.65 12.7% 4.9% 4.36 6.44 0.45

HH Gregg HGG 14.52 537.9M 12.07 0.2 1.8 16.8% 7.4% 5.09 10.94 0.10

Conn's CONN 9.32 297.1M - 0.4 0.82 -2.17% -0.9% 11.17 11.78 0.45

*Figures are based on a LTM basis. Current prices are as of November 6, 2011

Valuation Comparison with Amazon and Wal-Mart

Name Symbol Current Price

Market Cap P/E P/S P/B ROE ROA EV/EBITDA

EV/EBITDA-Capex

Debt-to-debt-plus-equity

Best Buy BBY 27.30 9.9B 9.2 0.2 1.71 19.52% 6.9% 3.08 4.37 0.26

Amazon AMZN 216.48 98.4B 114 2.28 12.79 12.3% 5.3% 46.74 241.66 -

Wal-Mart WMT 57.50 197B 13 0.46 2.93 23.66% 8.8% 7.01 11.29 0.41

*Figures based on a LTM basis. Current Prices are as of November 6, 2011

Electronics and Appliance Store Retail Sales

Year Thru August Total

2011 62,587

2010 62,652 100,471

2009 61,430 98,384

2008 69,409 108,869

2007 67,946 110,849

2006 66,017 107,826

2005 61,985 101,449

2004 57,773 94,524

2003 52,243 86,796

2002 52,080 83,897

2001 49,196 80,395 *Obtained from census.gov. Numbers in millions of dollars and are based on data obtained from the Monthly Retail Trade Survey, Annual Retail Trade Survey, and administrative records.

Best Buy Analysis


November 2011




Filings

Sources noted above: 1: Obtained from page 129 of FY 2011 10-K: http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDI0NDcyfENoaWxkSUQ9NDM5MjU1fFR5cGU9MQ==&t=1 2: http://www.census.gov/retail/#arts 3: https://www.cia.gov/library/publications/the-world-factbook/geos/ch.html#top 4: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/ (Please note: figures are updated daily)

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDI0NDcyfENoaWxkSUQ9NDM5MjU1fFR5cGU9MQ==&t=1



http://www.census.gov/retail/#arts

https://www.cia.gov/library/publications/the-world-factbook/geos/ch.html#top

http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

Documents

Best Buy Research Report