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Best Buy Is No Circuit City

Closing of 50 Big Box Stores Still Troubles Retail Industry
April 4, 2012
Best Buy Co. Inc. sent a shock through the retail real estate industry last week after it reported a $1.7 billion loss for its most recent quarter, which included 2011 holiday shopping sales, and announced plans to close 50 big box stores in the coming year and lay off 400 workers.

Media and industry analysts were quick to speculate that Best Buy might befall the same fate as former rival Circuit City chain, which filed for bankruptcy in November 2008. At the time, many analysts were caught off guard by Circuit City's abrupt departure. Five months before its bankruptcy filing, Circuit City reported that it planned to continue rolling out more superstores. Then one month before the filing, it put the brakes on expansion and skidded into bankruptcy operating 712 superstores; now all closed.

While there are parallels, Best Buy's competitive situation appears far different from the one Circuit City faced, according to several analysts.

While Best Buy was expected to have abetter time of it with Circuit City out of the way, things have not turned out as expected for the electronics retailer.

What changed and what's different?

According to The Wharton School, University of Pennsylvania marketing professors Best Buy's troubles are, in part, a sign of the weak economy.

Most of the products Best Buy sells are not necessities, and Best Buy has been facing fierce competition from other large retailers, such as Staples, Costco, Walmart and Target.

In addition, like Best Buy several other big chains are also trimming back their number of larger stores: Sears and Kmart, Gap and Abercrombie & Fitch.

Wharton marketing professor Stephen Hoch "I have admired the way that they [Best Buy] have survived when others have failed, such as Circuit City and that they have adapted to an unpredictable high tech market better than anyone else. They just don't need as many stores right now and don't need as much space in the stores that they keep - probably at least as difficult a problem as completely closing 50 stores."

Garrick Brown, director of research for Terranomics and the ChainLinks Retail Advisors Group, said Best Buy's announced plans also prompted many pundits to reflect on the "death of big box retail."

"To that, we would have to point out the fact that Best Buy is now selling almost as many iPhones as Apple itself… so that gloomy outlook may be jumping the gun," Brown said.

Unlike Circuit City, which was losing sales as consumers started switching from tangible movie and music disks to cloud-based downloads, the growing mobile technology field is all about gadgets, and Best Buy is aligning its store growth in that direction.

Best Buy's transformation strategy also consists of a series of actions to increase points of presence, while decreasing overall square footage. The company intends to remodel key stores and to continue to build out the successful Best Buy Mobile small format stores throughout the U.S. by opening as many as 100 smaller format stores.

Best Buy is testing the closing and expansion initiatives in the Minneapolis/St. Paul and San Antonio metro areas. The company expects total big box square footage in these combined test markets to be reduced by almost 20% through store downsizing and closures, while points of presence will increase by more than 20%.

The results in other markets won't necessarily match those in the Twin Cities and San Antonio, Best Buy's Jim Muehlbauer, CFO said.

"Our density of stores is much higher in the Twin Cities than it is in San Antonio that's part of the reason purposely we picked two different types of markets to focus on," Muehlbauer said. "We have many, many, many stores that provide well above our investment returns in the portfolio today. As a matter of the fact, of the - even of the stores that we're announcing from a closure standpoint they are just a handful of them that don't make money on NOP basis and even fewer that don't make money from a cash flow basis."

R. J. Hottovy, a director of equity analysis with Morningstar, likes the strategy.

"As we've advocated for some time, these decisions should help to lower the company's overall cost structure, which can be invested in more aggressive pricing to better compete with rivals like Amazon, Wal-Mart and Costco and improve the overall customer experience," Hottovy noted. "Some of the cost savings have also been earmarked to fund key growth initiatives, such as building out more productive small-box formats, expanding digital capabilities, and further penetrating the Chinese market--each of which strikes us as prudent sources of capital."

"Taken together, we view these initiatives as a step in the right direction for the beleaguered retailer, though it remains unclear whether they are sufficient enough to curtail and reverse recent market share losses, or whether the company needs to evaluate even more aggressive cost-cutting measures to stay competitive," Hottovy said.

However, the strategy going forward is no guarantee of success. Wharton marketing professor John Zhang noted this week: "I believe that Best Buy's struggle is just beginning."

Consumers looking to buy more expensive electronics are no longer subject to sales tactics at individual stores, because they are armed with mobile phones and can compare products and prices at will, he said.

"In the end, smart customers trick Best Buy into providing them free consulting services" on electronics they may ultimately purchase elsewhere, Zhang noted.

David Tobin, principal of Mission Capital Advisors, a financial advisory firm in New York that specializes in sale of CRE debt, said the Best Buy news is worrisome.

"We are concerned about the structural implications of the Best Buy store closure announcement," Tobin said. "This signifies continued erosion in the retail sector and we are challenged to think of who the replacement tenant is for these stores."

Using Trepp LoanAdvisor, CoStar Group found 269 CMBS loans backed by collateral with exposure to Best Buy as a tenant. The loans have an unpaid principal balance of about $6.26 billion. Of the loans, 18 are currently delinquent on their loan repayment and 10 of those loans are in special servicing. In addition, CoStar Group found 52 locations backing CMBS loans at which Best Buys lease was scheduled to expire in the next 12 months.

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