No Rout at Circuit City

The shares ease but most saw its Highfields rejection coming.
By Nat Worden ,

Shares of

Circuit City

(CC) - Get Report

eased Tuesday, but no rout ensued, after the board rejected a hedge fund's $3.4 billion buyout offer and said the company isn't for sale.

The shares were recently down 47 cents, or 2.9%, to $15.78.

Responding to a Feb. 11 bid by Highfields Capital Management, Circuit City late Monday said its board "unanimously determined that further exploring the transaction proposed by Highfields or other sale alternatives would not be in the best interests of the Company's shareholders."

Highfields, with a reported 6.8% stake in Circuit City, tendered its $17-a-share offer early last month in hopes of taking the company private, where the buyout shop felt it could be more effective in turning the business around.

Instead, the Richmond, Va., electronics retailer said it believes it "can best maximize shareholder value by continuing to aggressively implement the strategic, operational and financial initiatives currently under way and contemplated for the future." Circuit City doubled its share-buyback program and said $455 million remains available to repurchase stock.

The news comes as Circuit City shares have run up an impressive 259% over the last two years, in large measure as investors have speculated that a buyout bid might be brewing. Certainly the company's competitive fundamentals haven't improved nearly that much, judging by Circuit City's loss of market share to rivals

Best Buy

(BBY) - Get Report

and

Wal-Mart

(WMT) - Get Report

.

After the bid was announced last month, Circuit City shares jumped up near the $17 mark, but they soon backed down on speculation that the company would spurn the bid. Harris Nesbitt analyst Richard Weinhart said most of the disappointment from Monday's official rejection was already priced into the stock.

"We had speculated $17 would not be enough to complete the deal, but it appears that a higher price could not be negotiated and that Circuit did not want to put itself on the auction block," Weinhart said. "As Circuit City has traded well below the $17 bid, we believe this outcome is at least partially priced into the shares. Further, we suspect

its surprisingly better-than-expected

fourth-quarter sales results reported last week should help support the stock."

The shares jumped Friday after Circuit City reported a smaller decline in fourth-quarter sales than expected. The retailer said its same-store sales, or sales at stores open at least a year, dropped 1.8% for the quarter, compared to the year-ago period, while net sales grew 5.3% to $3.47 billion. Still, the declining comps reflect a loss of market share for the company at the hands of its dominant competitors.

Indeed, Morningstar analyst Joseph Beaulieu, who values Circuit City at $10 a share using a discounted cash-flow analysis, said in a research note last month on the heels of the Highfields bid that Circuit City "remains an inefficient operator that is destroying shareholder value." He strongly recommended accepting the offer.

To be sure, Circuit City is a better company than it was on Feb. 15, 2003, when it traded for $4.69 a share and was losing money. Now, profits are expected to rise by an average 33% over the next two years, according to consensus estimates reported by Thomson First Call. Sales have also reversed a downward trend and are set to gain an average 6% in the next two years.

Still, Circuit City has regularly reported weakening profit margins and soft sales growth, while Best Buy, the industry leader, has reported strong same-store sales and improving gross margins.

But Circuit City expressed hope that the run-up in its shares would continue even as Best Buy and Wal-Mart continue to loom at its doorstep.

"The Board of Directors, with the help of outside advisors, carefully evaluated all relevant aspects of the Highfields proposal and of a possible sale process, including the significant risks and uncertainties associated with such a process," CEO W. Alan McCollough said. "Among factors the board considered were the company's existing strengths, business opportunities and financial prospects, including the many strategic, operational and financial initiatives already under way to improve the business."

"Less than two years ago, the Board received and rejected an offer of $8.00 per share for the company," McCollough added. "Since that time, the Company has made significant progress in positioning itself strategically, operationally and financially for long-term strength and success."

In 2003, the Mexican billionaire Carlos Slim offered to buy Circuit City for $8 a share. The company rebuffed his offer, a move that many analysts saw as a bid to encourage a higher offer. The stock has doubled since then.

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