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Whatever anyone says, Best Buy (NYSE: BBY) still has a monopoly--on the fondling of all classes of electronics in one location. With Best Buy's 1,103 domestic stores and its 326 Best Buy Mobile stores, they have a sizable advantage.

With the drama of an ousted CEO, a parting founder, a lousy TV market, a poor video game market, and increased competitive pressure from Amazon (NASDAQ: AMZN) and other retailers, Best Buy shares are selling at a handsome discount: about 5 times free-cash-flow. That represents a return of 20%--if, and only if, Best Buy can maintain or improve its position.
Competitive Position
It is frequently repeated that Best Buy is Amazon's show room, implying that people look at products at Best Buy and purchase them on Amazon. But the relationship also works in the other direction, reading reviews on Amazon and purchasing in Best Buy. Therefore, such statements don't help us investors. That being said, Best Buy is working to end "show-rooming."

A lot has been said regarding Amazon's sales tax advantage (in some states) and the prevalence of price shopping with smart-phones in store. Both of those things may be true (for now), but people do not always buy goods at the lowest price. Many shoppers won't price shop and frequently price differences are immaterial. More importantly, Best Buy price-matches at some locations. Psychologically speaking, Best Buy's advantage rests on the fact that shoppers can be directed by sales staff, fondle a product, and then walk out the door with it without having to wait for its arrival by mail.

Apparently, there is also a misconception that Best Buy is losing market share. Mike Vitelli (President, United States - Enterprise EVP) said the following at the shareholder meeting Thursday morning in response to the question "why are you losing market share?":

We use NPD, a leading company that provides consumer and retail information; we use that, many of our competitors and suppliers use that, and they have told us, and Mike mentioned it earlier, that we have not lost share. We actually gained share last year. We have maintained our number one share in the leading industry categories of computing, of television and cameras; and gained, importantly, in very rapidly growing categories which are very important to our consumer: smart phones, tablets, e-readers, and a category we put some focus on, appliances. We have grown our market share in all those areas and maintained our leading position...We are focused on and we have gained share in the online industry. ( Shareholder Meeting, June 21st, 2012; starting at 31:05)

Best Buy's advantage is its tangible stores, but the value they bring to the analysis is largely intangible. It is the ability of patrons to go into a store and see and feel the technology they wish to purchase.
Is convergence a problem?
Convergence is the idea that fewer gadgets will do more things, and therefore we will need fewer gadgets, to the detriment of Best Buy. Best Buy has long competed in one of the few industries where deflation is typical. Thus far Best Buy has adjusted itself to the changing times. For example, Best Buy started selling mobile phones when they became widespread. Best Buy is an electronics retailer and is not limited in what it specifically sells. In fact, we probably can't accurately predict what it will sell in the future.
Is their weak online presence a problem?
Best Buy's domestic online sales grew by 13% last year, bested only by their sales growth in China (about 15%). While I cannot answer this question myself, if they succeed in making their online sales more effective, in addition to leveraging their stores for pick-up, they could have a large advantage. Other than that, Amazon probably beats the pants off of them. For instance, Amazon's "electronics and general other merchandise" has grown at 60% year-over-year since 2009. The only problem for us analysts is what counts as "general other merchandise"? Hence, getting accurate data on Amazon's success in the electronics market has been difficult, although some data suggests that they have increased market share in some specific electronic markets, such as LCD TVs.
International Presence (25.8% of Revenue)
Best Buy's international sales have been growing at 3.9% since 2009, boosted by their Five Star retailers in China and offset by the European segment (the latter was the catalyst for their latest impairment charge). As noted recently by the Wall Street Journal, China's emerging middle class is entering the electronics market for the first time. This could benefit Best Buy via Five Star.

China's appliance subsidies expired at the end of 2011, which made China same-store comparable sales drop significantly (28%) in Q1 2013. However, Best Buy management expects this to improve as the year progresses. As a long term investor, the end of subsidies means a more sustainable consumer.
Apple (NASDAQ:AAPL) Stores
Apple stores are not a happy sight for a Best Buy retailer, they would much rather have a monopoly on the sale of Apple products. That being said, because many people use Apple products in addition to products of other brands, such as Microsoft's (NASDAQ: MSFT) Windows, Best Buy serves the customers of both groups. To me, this is a win. Some of these people will fall into status-quo bias and continue to use Best Buy more frequently than Apple simply because they go there for their other electronic gadgets. Besides, with Microsoft's Windows 8 and the prospect of a Windows tablet (in addition to new Xbox games this fall), Best Buy stands to gain.

That said, Apple electronics accounted for 19% of all electronics sold in the last holiday season, according to NPD Group. Such a market share helps the retail of both Best Buy and Apple stores, but helps Apple more. Further, the success of Apple stores has driven Microsoft to experiment with the concept itself. Such a move by Microsoft could be a more decisive blow to Best Buy than Apple alone.
Comparable Same Store Sales Declines and Strategy
Yes, this is the headline grabber: Best Buy same store sales down 1.7% (and 5.3% Q1 fiscal 2013 against Q1 fiscal 2012). Actually, it's worse because fiscal 2012 included a 53rd week. The same store sales declines are where we find our quantitative signal that Best Buy's strategy needs revision. Conversely, overall revenue was up 1.9%.

However, part of Best Buy's strategy is their new Mobile stores. To wit, some scuttlebutt research concluded that is "practically" where all their profits arise. According to their fiscal 2012 10-K, sales from their new stores, which are mostly Best Buy Mobiles, directly offset the loss in same-store comparable sales.

For those who do not know:

Revenue from U.S. Best Buy Mobile stand-alone stores is primarily derived from mobile phone hardware, subscription service commissions from mobile phone network operators and associated mobile phone accessories ( Best Buy 10-K Fiscal 2012, p. 6).

And further:

In our Domestic segment, our current store development strategy is focused on increasing our retail points of presence, while decreasing our overall store square footage, for increased flexibility in a multi-channel environment. This includes our plans to remodel existing key stores in test markets with our new "Connected Store" format in fiscal 2013, as well as increasing the number of small-format Best Buy Mobile stand-alone stores. We announced plans to close approximately 50 large-format Best Buy branded stores in the U.S. in fiscal 2013 and explore options for downsizing other stores throughout our portfolio (Best Buy 10-K Fiscal 2012, p. 8; emphasis added).

They increased their Best Buy Mobile count by 128 stores in fiscal 2012 to 305. At the end of Q1, there were 326 Best Buy Mobiles.

Best Buy Mobile is accounted for under Best Buy's "Computer and Mobile Phones" category which had comparable same store sales growth of 6% and represented 40% of sales revenue in fiscal 2012, up from 37% in 2011. The increase was due to tablets and mobile phones, partially off-set by decreased notebook sales. These numbers suggest, superficially, that their new strategy is working.
Conclusion
Are Best Buy shares undervalued below $20 a share? If they maintain their free-cash-flow, yes. Do they have a margin of safety? Yes, I believe that there is a margin of safety at and below $20. If they were valued at only 10 times free-cash-flow they would be still be priced around $40. Around and under $20 leaves a good deal of room for error. Further:

1. it appears they are executing their new strategy successfully;

2. they have no "direct" electronics retail competitors besides Apple stores;

3. Amazon and Wal-Mart will take some market share, sure, but I don't believe they can eliminate traditional electronics-only retail;

4. their average capital expenditures are only slightly greater than half of adjusted net income and are typically less than depreciation--or rather, their free-cash-flow is nearly double their average capital expenditure; and

5. with smaller stores come smaller capital expenditure.

The biggest question marks are: Will Best Buy remain favorable with suppliers? Can the Wal-Marts, Targets, and Costco's (NASDAQ: COST) take more market share without offering sales expertise and more varied product offerings? And, will Best Buy Mobile continue to be successful? How will the global economy develop in the near term?

Their competitors offer an experience different than the one at Best Buy, and further, the experience which is available at Best Buy, I believe, would be missed if it were removed from the American experience overnight. Their increase in sales in China is a bright spot for Best Buy. China has, after all, four times as many people as the domestic United States (and 20% of the LCD TV market last quarter). Even a small capture of this developing market will be a boon to a Best Buy shareholder.

Also, they have been repurchasing shares: about $1.2 billion and $1.5 billion, in fiscal 2011 and fiscal 2012 respectively. Their diluted share count has decreased from 427 million at the end of fiscal 2011 to 342 million on March 5, 2012, a decrease of 20%. In the first quarter they purchased $115 million dollars' worth of shares at $25 a share. Hopefully, they have been purchasing more while their share price is favorable. In theory, if they're able to keep up their present rate of free-cash-flow, they would be getting 20% return on their share repurchases. That would be an effective use of capital.

Hopefully share repurchases are moving forward while their shares languish.

Disclosure: I am long BBY.

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Whatever anyone says, Best Buy (NYSE: BBY) still has a monopoly--on the fondling of all classes of electronics in one location. With Best Buy's 1,103 domestic stores and its 326 Best Buy Mobile stores, they have a sizable advantage.

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Best Buy is spending millions to maintain its sales momentum

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Retailer is planning to spend $650 million to $700 million in the current fiscal year on capital expenditures, up from $550 million last year.

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In the never-ending quest to feed consumers exactly what they crave, Best Buy's messaging during back-to-school was so targeted that some customers may not have been alerted to promotions at all -- on purpose.

The back-to-school season marked the first time Best Buy tested the prowess of its Athena project in digital media campaigns. The database has been publicly touted by execs as key to the company's future since early last year. Now, CMO Greg Revelle says the marketing success surrounding back-to-school foreshadows the retailer's plans for the all-important holiday season.

Mr. Revelle said the company did not send, as it may have historically, a blanket back-to-school sale message promoting discounted laptops or refrigerators to the whole customer database. Instead, Athena helped the firm identify students, those who seemed like students and the parents of potential students based on prior shopping records, among other interactions with the retailer. These select customers then received back-to-school emails that had been cross-referenced with products the company had identified for promotions. As a result, it's the customers who did not fall into those specific categories, Mr. Revelle said, who may have been unaware the retailer even ran a back-to-school sale.

Similarly, via its Best College back-to-school campaign, Mr. Revelle said the retailer did not want to "alienate parents" by its choice of young talent, but knew it had to change tactics from years past. "Previously, the ads weren't connecting with the decision makers, which were the students. So we featured the student above all else," he said.

Knowing that messaging resonates differently with different customer segments is important, said analyst Scott Tilghman of B. Riley & Co. In the case of mobile phones: "The parents want to know what the deals are. Can my child upgrade? What's it mean to my bill? Are there any sales?" he said. By comparison, students want to know what models, colors and cases are available. With Athena, Best Buy "can hit both with what is essentially the same product, but with two different types of messages," said Mr. Tilghman.

In another instance, for Best Buy's Labor Day appliance sale, Athena helped the company create marketing messages that targeted late-stage millennials or Gen Xers, who are typically more likely to be moving at that time of year.

"Instead of running one campaign, we run campaigns in parallel," Mr. Revelle explained. He added, "We're certainly happy with the [recent marketing] results and will do a similar thing with holiday this year."

Athena, which is named after the Greek goddess of wisdom, was formed several years ago with loyalty program data. It connected the company's previously siloed departments under one umbrella to create carefully chosen messages that would hit the right inboxes or platforms at the right time, Mr. Revelle said. Athena's capabilities have slowly ramped up, having started with data from email/CRM, then incorporated a focus on marketing and promotional messaging during last year's holiday season.

"We can take our real customer base and put them into segments based on knowledge of activity with Best Buy -- shopping and purchasing behavior and service consumption behavior. We put it all together to inform segmentation. We use third-party research to [further inform] segmentation and then center marketing campaigns," Mr. Revelle said, adding that Best Buy employs data scientists who work alongside the marketing team. "In that regard, we're somewhat state-of-the-art."

The $40 billion electronics retailer, which saw a 17% jump in online comparable store sales during the second quarter, has also "sacrificed," Mr. Revelle said, by not spending money on TV or print ads it otherwise might have run during back-to-school. "We invested so many dollars into Athena," Mr. Revelle said. "But we're seeing good results."

Best Buy spent more than $59 million on U.S. measured-media during the first six months of 2015, down from nearly $116 million during the same period in 2014, according to Kantar Media. Overall, the retailer spent $635.5 million on domestic advertising last year, according to the Ad Age Datacenter.

The knowledge Athena provides has also created a need for different messages -- and a lot more of them than in years past. This shift helped spur the retailer's move away from an agency-of-record model. Last April, Best Buy parted ways with Crispin Porter & Bogusky and moved to a project-by-project model. Mr. Revelle said Best Buy has "more demand for creative than supply" at this point.

"We're redeploying a lot of the resources we might have put against a major campaign via an AOR to much more tailored creative that can be reused across social networks and email banners," among other platforms, in order to leverage the message over as many channels as possible, said Mr. Revelle. The depth of its database allows the retailer to be nimble and test what types of messages customers connect with, which, he said, produces a wider variety of creative overall.

Best Buy is also using Athena to improve its new wedding registry program. After connecting with third-party data vendors to capture customers that are likely to be getting married soon, Athena learns what assortments are interesting to people in this category, then determines how to time promotions for the right products. It also gathers data on whether or not people who are already registered want to know when an item has been purchased for them, and what messaging makes people engage more with the registry.

Kate McShane of Citibank Global Markets is impressed with Athena's positive impact on marketing efficiency and is not surprised by its payoff, which has been visible for other retailers with similar initiatives. "Like anyone who's making an investment of this kind for technology, it's one of those things that just gets better over time," said Ms. McShane.

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Athena Database Pushes Ad Boundaries for Best Buy

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In the never-ending quest to feed consumers exactly what they crave, Best Buy's messaging during back-to-school was so targeted that some customers may not have been alerted to promotions at all -- on purpose. The back-to-school season marked the first time Best Buy tested the prowess of its Athena project in digital media campaigns.

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Like many people, played into my Thanksgiving weekend. No, I didn't camp out for three nights to get dibs on the Black Friday sales. And, no, I didn't go online to get the favorite people on my holiday gift list the latest, greatest gadget. Rather, I caught up on my reading. And, among the things I read were a couple of news stories about Best Buy's red-hot profits of late.

I've been in the marketing business long enough to remember when Best Buy won Forbes "Company of the Year" in 2004. And, I've been in the business long enough to have seen it, and any number of other electronics retailers, slide off the retail radar screen. So, while it should have come as a surprise to me to see that it was back on top in the category, it didn't. That's because I know what Best Buy knows. I've been in the business long enough to recognize that Best Buy knows the two most important words relative to achieving brand success in this day and age: and execution.

You don't have to have been in this business long enough, or even in this business, at all, to know how fast the marketplace has been changing over the past several years. Brand names and businesses that are here today may very well be gone tomorrow. Competition is so fierce, consumers so savvy, that even the most self-confident brands can find themselves marginalized or dematerialized in an instant. Among the most challenged brand categories has been retail, what with Amazon disrupting and dominating how goods are sold. Given this, no retailer has been more under attack than Best Buy, whose big box stores were quickly becoming nothing more than a showroom where consumers could look over the latest, greatest gadgets and then order them for less, right from their mobile phones, and directly from Amazon.

But, let me go back to those two words: agility and execution. In this rapidly changing marketplace, nothing is more critical for brands than the ability to see the changes taking place, to be agile enough to assess and adapt their strategies on the fly, and to be able to execute these strategies with speed and brilliance. While many of its competitors have become nothing more than memories, from Crazy Eddie to Circuit City, CompUSA to, most recently, J&R Music, Best Buy has been able to stay, not just in the game, but on top of its game, as a result of, yes, agility and execution.

Among the things it has done is taken a page out of the Saks Fifth Avenue and Bloomingdale's branding handbooks and created separate brand "boutiques" within its stores. Much like Clinique or Estee Lauder have unique presences in department stores, each with its own line of products and its own experts demonstrating products, Best Buy has established this "store-within-a-store" concept. Rather than just a mass collection of electronics wares, there's a uniquely designed and individual presence for every major brand name- , Samsung, Beats, and -among them, each staffed by experts from its brand and able to speak with authority about the products. Rather than operating with the one-size-fits-all mentality, Best Buy was able to see what would make the store experience better, and agile enough to execute on this new model.

In addition to this, Best Buy has taken its Geek Squad out of the corner and created its own version of the Apple Genius Bar theme. Sure, these folks will happily and ably help you set up your new computer and answer all the questions you have about which printer to buy. They'll just as happily and ably put that pesky, plastic screen protector on your phone, leaving none of those annoying little bubbles. More than this, Best Buy has acted on the pricing issue, a significant barrier, in the quest to keep Amazon at bay. It will match any advertised price on its products. It has also focused on its delivery system, including how it gets gifts to recipients after a major weather challenge, and how to ship more items from its stores rather than just a few warehouses around the country, all in an effort to speed up the process. It has expanded its ship-from-store option to 1,400 stores from only 400 last year. It has also done quite a bit to improve the in-store pick-up process, not only driving additional traffic to the store, but also making the overall customer experience more convenient.

Numbers talk. And the latest earnings reports for Best Buy speak volumes about its current success. While just a couple of years ago, Best Buy was getting clobbered, this year is an entirely different story. From in-store experience to pricing policy, online experience to delivery systems, Best Buy not only saw what it needed to do, but was agile enough to react to the necessary changes and smart enough to execute in a way that would help it deliver on its promise Expert Service. Unbeatable Price. Agility and execution. Two unbeatable words for any brand that wants to succeed.

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Best Buy Knows The Two Most Important Words For Brand Success

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Like many people, Best Buy played into my Thanksgiving weekend. No, I didn't camp out for three nights to get dibs on the Black Friday sales. And, no, I didn't go online to get the favorite people on my holiday gift list the latest, greatest gadget. Rather, I caught up [...]

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Three years ago, consumer-electronics retailer (( Best Buy NYSE:BBY) was in a tough spot. Former CEO Brian Dunn resigned in early 2012 amid an investigation into his personal conduct, online retailers such as Amazon.com NASDAQ:AMZN) were stealing market share, and the company's e-commerce efforts were at best an afterthought. Best Buy was assumed to be going the way of Circuit City, a former competitor that went under in 2009.

Fast-forward to today, and the story has shifted dramatically. CEO Hubert Joly, who took over about three years ago, has transformed the company into a leaner, more nimble retailer. One only has to look at Best Buy's most recent earnings report to see how far the company has come: Comparable-store sales rose 3.8%, profits soared, and online sales jumped 17% year over year.

Joly and his management team still have plenty of work to do, but the turnaround at Best Buy is one of the most impressive in the history of retail.

Table stakes
When Joly took over, Best Buy's prices simply weren't competitive. The concept of showrooming, where customers browse in-store but then buy online, often getting a better price, was widely seen as an insurmountable challenge in the age of Amazon. Joly had a very simple strategy to counter it: "We believe that price competitiveness is table stakes. The way we want to win is around the advice, convenience, service.

The only way to combat showrooming is by ensuring that a better price can't be found online. Best Buy implemented a price-matching policy, both in-store and online, while also lowering its prices to be more competitive against both online retailers and discount retailers such as Wal-Mart. The result of these moves has been a contraction in the company's gross margin, which fell from 25.1% in 2010 to just 22.4% in 2014.

If this had been the only initiative Best Buy had undertaken, the company's profitability would have collapsed. But another part of Joly's plan, dubbed Renew Blue, was to drastically cut costs. By the end of 2014, Joly had removed a little over $1 billion of costs from the company. Layers of management were removed, processes were streamlined, and the supply chain was made more efficient.

It's important to understand that Best Buy didn't simply cut costs across the board. Circuit City, in the lead-up to its bankruptcy, slashed costs and fired scores of employees in an effort to remain profitable. These cost cuts backfired, as the lack of experienced store employees took a major toll on sales and the customer experience.

Despite the more than $1 billion of costs taken out of the business, Joly stated in Best Buy's most recent conference call that the amount of customer-facing labor has increased. The company's rounds of layoffs have mostly targeted middle managers and staff at the company's headquarters, an approach that ensures that the customer experience doesn't take a hit for the sake of cutting costs.

These cost cuts largely haven't flowed through to the bottom line, as Best Buy has taken the savings and invested them in various initiatives. Cutting prices is one of those initiatives, and increased employee training is another. But e-commerce may be the most important.

Competing with Amazon
Amazon operates a network of online order fulfillment centers that no other retailer can rival. Best Buy runs 23 distribution centers in the United States, but most of them are dedicated to feeding its stores, not fulfilling online orders. This difference created a major problem for Best Buy: An item had to be in stock at a distribution center set up for online fulfillment for a customer to be able to buy it online.

Best Buy's online conversion rate was downright awful in 2013. In that year, 1 billion website visits translated into just $2.3 billion of sales. A website redesign 2013 helped the cause, but product availability was still an issue.

Best Buy's solution was the implementation of a ship-from-store initiative, with which its 1,000-plus retail stores act as mini-distribution centers, with store employees packing and shipping online orders. This approach isn't as efficient as Amazon's giant fulfillment centers filled with robots, but Best Buy's plan used its current assets, turning its network of stores into an advantage.

This program accomplished two things. First, it opened up store inventory to the online channel, vastly increasing product availability on the website, including clearance items and returns that would have previously been stuck at an individual store. Second, it reduced shipping times substantially. According to StellaService, in October 2013, after many of Best Buy's stores had begun shipping online orders, the company's average shipping time was faster than that of Amazon.

One thing working in Best Buy's favor is that Amazon collects sales tax in more states. For years, Amazon had a built-in price advantage over national retail chains, since it didn't collect sales tax in states where it had no physical presence. Joly stated during Best Buy's most recent conference call that 89% of the U.S. population now lives in states where Amazon collects sales tax, up from less than 50% three years ago.

Why Best Buy is succeeding
Best Buy provides a service that an online-only retailer can't match: the ability to see, touch, and try a product in person. That's extremely important for the large swath of the population that isn't particularly tech savvy. Combine this advantage with prices that are competitive with online retailers, and customer service that's superior to discount chains such as Wal-Mart, and you have the recipe for Best Buy's long-term success.

Best Buy has come a long way over the past three years. The company is winning market share, growing sales even as NPD reports industrywide declines in consumer-electronics sales. Its e-commerce efforts are bearing fruit, and a renewed focus on selling appliances is helping to drive in-store sales growth. During the latest quarter, comparable-appliance sales jumped by more than 20%, now accounting for 10% of Best Buy's sales.

There's plenty of work left to do, and plenty of additional costs to wring out of the company. But Best Buy, just three years ago on a path that would have probably led to its demise, is now a force to be reckoned with.

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Best Buy's Turnaround Is One for the Ages

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Three years ago, consumer-electronics retailer (( Best Buy NYSE:BBY) was in a tough spot. Former CEO Brian Dunn resigned in early 2012 amid an investigation into his personal conduct, online retailers such as Amazon.com NASDAQ:AMZN) were stealing market share, and the company's e-commerce efforts were at best an afterthought.