Best Buy to sell Musicland following unharmonious marriage

DSN Retailing Today, April 21, 2003 by Laura Heller

MINNEAPOLIS -- It raised a few eyebrows at the time, but Best Buy insisted its acquisition of Musicland stores made sense. Two-and-a-half years later, it's singing a different tune and looking to unload the division to refocus attention on its core concept.

The chain initially bought Musicland in December of 1999 to expand its presence with younger shoppers, mall customers and into rural markets. The plan was to re-merchandise the mall-based Sam Goody stores to include digital electronics, DVDs and gaming products and expand the On Cue concept in rural areas too small to support a Best Buy store.

"Several assumptions we made in purchasing Musicland proved to be incorrect," said Best Buy ceo Brad Anderson. "First, we were not successful in selling digital products." Even at prices comparable to Best Buy stores, consumers were ,still suffering from a misperception that Sam Goody was more expensive.

"Second, we did not expect such steep declines in CD sales and mall traffic," continued Anderson. Sales of prerecorded music fell 10% in 2002 according to Nielsen Soundscan and have continued to decline throughout this year. Best Buy experienced double-digit declines in this category for its fiscal year, according to president and coo, Allen Lenzmeier, who doesn't see the trend slowing any time soon.

An attempt to streamline the CD assortment at Musicland stores failed to yield profitability increases and inventory turns, even as the identical program had succeeded at Best Buy stores. "When we deployed that same process [at Musicland], we lost some of our core customers," said Anderson. And although the company did successfully increase the selection of DVDs and gaming products, the lower gross margin of those products was not enough to make up for lost sales from CDs, he said.

But the question remains, who will buy Musicland? With CD sales sinking across all retail channels thanks to new digital formats, piracy and the bad economy, finding a suitor may prove difficult. Discount department stores increasingly sell the lion's share of newly released music while Best Buy itself is a formidable player in this market. Consolidation has left few specialty chains and Wherehouse Entertainment filed for Chapter 11. bankruptcy protection in January.

"We don't think Best Buy will be able to sell most of the Musicland businesses, particularly the troublesome Sam Goody chain," said Morgan analyst Danielle Fox. "Given that Best Buy, which has a leading market share in music could not make it work, we are hard pressed to identify any potential acquirers."

Rather, Best Buy may be forced to simply discontinue operations, an expensive proposition given the restrictive nature of mail leases, according to Fox. Excluding the lease issue, Michael Baker of Deutsche Bank Securities estimates that the remaining asset value of Musicland is approximately $208 million, compared with the purchase price of nearly $700 million (Best Buy also assumed nearly $260 million in debt at the purchase).

Anderson said the company intends to maximize Musicland's value until the company can be sold and has promoted Connie Fuhrman to president of Musicland to guide the company through the transition period. Fuhrman recently served as evp of the unit while former president Kevin Freeland resigned in January.

For the fiscal year ended March 1, 2002, Musicland posted a loss of $421 million, now reported as discontinued operations for the Best Buy Enterprise.

It's the continuing operations of Best Buy's core business that the company hopes to focus on. Musicland was originally acquired in part, to address the company's need for growth once the Best Buy format reaches saturation.

"Last year, we shifted our long term strategic plan for growth," said Anderson. "We've moved from trying to find new customer segments in different places, to looking at the customer in our core stores and harvesting more from those customers." The retailer began a series of tests this month to determine new ways to capture a higher percentage of discretionary dollars.

"And we still have approximately another three years of growth in the United States and Canada," said Lenzmeier. "Our current market share in the United States is approximately 14%, so there's a significant opportunity to increase market share out of the core stores we currently operate."

Anderson declined to offer contingencies if Best Buy did not find a buyer. for Musicland, calling it speculation. The company is presumably in talks with interested parties for. all or parts of the business, Goldman Sachs is handling the sale and Best Buy will update investors on the matter in June.

"I'm anxious to return our attention to a more profitable endeavor--our core business," he said. "That's the energy here."

MUSICLAND


736  Sam Goody stores
     (approximately 500 mall stores
     and the remainder former
     On Cue rural locations)

383  Suncoast Video

76   Media Play