This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Best Buy Junk Rating's False Foundation

Updated to include additional data and January Fitch commentary.

NEW YORK ( TheStreet) -- Best Buy (BBY - Get Report)'s junk bond ratings from Standard & Poor's and Fitch appear to have penalized the struggling big box electronics retailer for a takeover deal that never took place.

In the wake of company founder Richard Schulze's failed effort to take Best Buy private, which ended without a bid in late February, many stock analysts are taking the company's declining losses and a commitment to a new pricing strategy as reason to believe the company can survive competition from online retailer Amazon (AMZN - Get Report) and pressure from the likes of Wal-Mart (WMT - Get Report) and Costco (COST - Get Report).

That's not necessarily the case at Standard & Poor's and Fitch Ratings, however.

The credit ratings agencies seem to have moved on from downgrades of Best Buy's bonds to "junk" status in early August when Schulze unveiled a thin proposal to take the company private for up to $8.8 billion, with little explanation.

As it turns out, S&P now says in a few sentences Best Buy's junk rating has nothing to do with Schulze's buyout plan, meaning the lack of a formal offer is immaterial to the company's current rating.

But the agency's August cut explicitly focused on Best Buy's debt-fueled takeover proposal as cause for the company's move from investment grade to junk.

"The rating action is a result of founder and largest shareholder, Richard Schulze's proposal to acquire the company for a purchase price in the range of $24.00 to $26.00 per share," wrote S&P in its Aug. 6 downgrade of Best Buy from investment grade.

Fitch also referenced Schulze's proposal as a part of its Aug. 6 downgrade of Best Buy to a sub investment grade rating. The ratings agency's analysts cited "the possibility of a leveraging transaction" following Schulze's proposal.

Still, Fitch noted the takeover deal was a secondary factor to its "assessment that Best Buy's business profile, including its weakening [comparable] store sales, recent margin pressure that Fitch believes will continue, and heightened event risk, is no longer consistent with an investment grade rating."

Both agencies also wrote that if a takeover were to occur, it would trigger further downgrades.

However, when the agencies moved lockstep once more on Nov. 21 in cutting Best Buy further into junk territory, they scarcely made reference to Schulze's outstanding takeover proposal, despite ongoing reports that he was arranging a deal with large private equity firms.

Instead, S&P and Fitch focused almost exclusively on disastrous third quarter earnings report and weak holiday season guidance.

Since the Nov. 21 cuts, which put Best Buy ratings at BB and BB- at S&P and Fitch, respectively, neither agency sees reason to reassess the company's financial picture.

Best Buy's ratings remain on 'negative' watch at both agencies, indicating that a lot has to be done for the company to pull itself from junk territory.

But a lot has changed for the Minnesota based big box-electronics retailer.

Most notably, a formal takeover offer from Schulze never materialized.

Meanwhile the company beat fourth quarter earnings expectations and its own guidance on declining losses. Further, tight management of working capital led to an improving cash flow profile.

The genesis of Best Buy's junk rating raises the question of whether S&P and Fitch used Schulze's takeover proposal as cause to rejigger their opinions of the company's finances.

Such a scenario might have been unfair to Best Buy given that no formal offer takeover was ever proposed and Schulze never made a bid.

Consider how S&P and Fitch responded to a comparably risky takeover offer that Carl Icahn proposed for household products giant Clorox (CLX) in July of 2011. While Icahn came to the table with a formal offer and a near $8 billion financing commitment from investment bank Jefferies (JEF), neither agency saw reason to cut Clorox's bond ratings. Instead, they simply put the company on review for a downgrade.

In a March 4 ratings bulletin, S&P indicated that its November downgrade of Best Buy superseded the August ratings cut to junk, meaning that its most recent rating did not reflect any of the debt or financial strains from a prospective buyout offer from Schulze.

The lack of a takeover offer "does not affect the 'BB' corporate credit rating and negative outlook on the company," said S&P, in what appears to be a major, if little explained, change in opinion.

A January ratings report by Fitch highlights sales and gross margin declines as risks for a further downgrade, while noting a bottoming could lead to a stabilization of Best Buy's ratings. The company's proposed takeover wasn't referenced as a factor for ratings actions.

Moody's, on the other hand, may be the most consistent of the big three agencies in its rating of Best Buy's debt during a tumultuous six months of takeover reports and seesaw earnings.

After Schulze's proposal was first announced, Moody's maintained a low-investment grade rating for Best Buy -- Baa2 -- while characterizing what turned out to be a phantom takeover as a developing situation given a lack of firm financial commitments.

"The stable rating outlook reflects Moody's expectation that Best Buy will continue to profitably defend its market share, and as a result credit metrics will not change materially despite the still-difficult consumer environment," Moody's analysts wrote.
1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
DELL $0.00 0.00%
AMZN $671.32 -1.83%
BBY $31.74 -1.64%
COST $151.41 0.32%
MSFT $49.78 -1.64%


Chart of I:DJI
DOW 17,750.91 -140.25 -0.78%
S&P 500 2,063.37 -18.06 -0.87%
NASDAQ 4,763.2240 -54.37 -1.13%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs