Best Buy’s Big Bet on a Recovery

Best Buy Co., Inc. (NYSE: BBY) shares began the week on a positive note after rival Circuit City (NYSE: CC) announced the closure of 155 of its stores. The move may allow Best Buy to make some smart acquisitions and increase its market share during a key time in the industry. The result could prove to be a smart move to leverage up if the economy turns around or a move that could cost Best Buy a fortune if it is unable to weather the economic downturn.

Distressed sales on the part of Circuit City could mean an opportunity to acquire buildings on the cheap while the distressed real estate market means that leases on the ground will also be available on attractive terms as they could be renegotiated. In the event of an economic recovery, Best Buy would have (1) a greater market share, (2) higher sales as a result of more stores, and (3) a higher profit margin per store due to lower real estate costs. All of these are positives for shareholders.

The risk is that the economy will not turn around and this expansion will only compound losses. The purchase of these properties means more expenditures in the near-term as Best Buy will be paying more in rent without increasing its sales enough to compensate. After all, Circuit City isn’t closing because it’s too profitable! Best Buy is essentially betting that it will be able to weather the storm for longer and better than its rival Circuit City. However, it is a bet that could pay off in the long run!

So, how can investors make a prudent bet on Best Buy’s play? Well, the first option is to buy a block of stock at $28 per share for roughly $2,800. However, a better risk/reward play may be to purchase long-term options known as LEAPS - or long-term equity anticipation securities. These LEAPS enable investors to realize a leveraged upside (like an option) while being limited to the premium paid on the downside.

Best Buy January ‘10 LEAPS enable investors to acquire the rights to the same block of shares at a fraction of the price. Investors confident in a Best Buy recovery to above $30 per share can purchase the rights to 100 shares at $30 per share for only $600 right now. This means that if shares hit $40 before Janaury 2010, investors will make $1,000 profit on their $600 investment. This compares to a 42% profit buying the underlying stock. However, if the stock drops to $10, LEAPS investors only lose $600 compared to a $1,000+ loss for investors in the stock. Leveraged upside and limited downside make LEAPS a good play on Best Buys bet!

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