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Will Best Buy’s Big Buy Fly?

MINNEAPOLIS -Best Buy’s bold-stroke buyout of Music-land and Magnolia Hi-Fi for nearly three quarters of a billion dollars in cash, as well as its planned conquest of Canada, received mixed reviews from competitors and industry analysts in the wake of the dramatic announcement.

On one hand, observers lauded the No. 1 CE chain for acknowledging the limitations of its big-box format. Its purchase of Musicland’s 1,300 Sam Goody, Suncoast, Media Play and On Cue stores puts it into malls and rural markets where the Best Buy footprint doesn’t fit, and gives it greater access to female and teenage shoppers.

Meanwhile, with mass merchants and wholesale clubs nipping at its heels, the addition of high-end CE specialist Magnolia provides a margin-rich antidote to the plague of deeply discounted DVD players and other mainstream products.

Moreover, with Best Buy’s stores approaching the saturation point (another 250 units will be added over the next four years, mainly to fill out existing markets), the acquisitions and new Canadian outposts will be key to the company’s continued growth.

Best Buy already envisions 150 markets with “affluent early adopters” where the Magnolia franchise could thrive and plans to transform the Musicland locations into full-price digital entertainment destinations akin to RadioShack.

Indeed, in a conference call with analysts, Best Buy executive VP/marketing Wade Fenn acknowledged that mall-based stores provide a “convenience premium that RadioShack has been able to afford from customers.” Rather than taint Best Buy’s low-price image, the company decided to “approach these unapproachable customers with different brands.”

To that end, Best Buy will maintain the Musicland and Magnolia nameplates and will operate the chains as autonomous, wholly owned subsidiaries. (For the management plan, see TWICE PEOPLE, p. 8.)

Magnolia president Jim Tweten, who will remain with the chain, will step down as president of the PRO buying group, a normal occurrence when a member retailer has a change of control, explained PRO executive director Roger Heuberger. While Magnolia is welcome to maintain its membership, he said, its group status will likely be determined before CES.

Despite the talent it’s bringing on board, analysts and retail adversaries wondered whether Best Buy could pull off its planned hat trick, citing the premium it’s paying, its inexperience in those channels, and the timing of the expansion given the economic slowdown and sluggish retail scene.

“Just a few weeks ago Best Buy signaled that it was looking at slowing down its growth in order to deal with a weakening environment,” reminded Aram Rubinson, a managing director at UBS Warburg. “To have an acceleration in investment of this magnitude is somewhat incongruous.”

Rubinson also questioned its investment in a music chain in an age of digital downloads, and suggested that Best Buy has bitten off more than it can chew.

“Tackling a 1,300-store, mall-based acquisition, a new endeavor into the high end, and its first international expansion all in one swoop is a daunting task for any retailer, let alone one that has not attempted any such moves in the past,” he observed.

Apparently, others on Wall Street agreed. Within hours of the announcement, Best Buy’s share price was sheared by 20 percent, although chairman/CEO Dick Schulze managed to allay investor fears in a subsequent conference call in which he predicted accretive earnings by fiscal 2002.

Still, the retailer faces a steep learning curve, as RadioShack was quick to point out in a hastily convened conference call of its own. Argued executive VP/chief operating officer David Edmondson, “It’s not easy to replicate our model. There are a lot of idiosyncrasies about managing a multi-thousand-store chain. It’s difficult to shift new systems and retrofit them to a small store format, and replenishment logistics to keep 7,000 locations in stock isn’t something you learn overnight. A different skill-set is required which takes focus and a great deal of time to develop.”

Tweeter Home Entertainment Group, which had also been in negotiations to acquire Magnolia, said the ultimate purchase price was too rich for its blood. “Magnolia got a nice premium for themselves,” observed Joe McGuire, the chain’s chief financial officer. “We would have loved to buy them, but not at that price. Our previous acquisitions were four-and-a-half to five-and-a-half times cash flow. Best Buy paid eight.”

McGuire wasn’t surprised by the move, as Best Buy had previously expressed interest in the specialty store format, and believes that privately held Magnolia will benefit from the deep pockets of its new parent. “They can provide Jim [Tweten] with some capital so he can flush out the Northwest. It doesn’t bode well for Good Guys.”While McGuire thinks it’s “nice that Best Buy has validated our strategy,” he warns that Magnolia has a “completely different business model from what they do.” His advice to Schulze and company? “Stay out of Jim’s hair.”- Additional reporting by Steve Smith and Doug Olenick