Description

Circuit City (CC) will be spinning-off its CarMax (KMX) tracking stock into a separately traded asset based stock. KMX is currently trading at around $26 per share. Circuit City owns 65% of KMX. That accounts for $8 of value per Circuit City share. Backing that out leaves a “stub” value of $8 for the core Circuit City business. The stub will earn about $0.70 a share this calendar year, which implies a P/E of 13x for the CC stub while Best Buy trades at 29x and Radio Shack at 16x. Earnings may be artificially low due to the fact that CC will also spend about $0.18 per share on capex for upgrades in its stores this year. Given the current economic environment, significant safety lies in CC’s balance sheet. From the latest Q, the company had approximately $3.50 in cash per share (cash at $710M and debt at $120M); debt/cap is at 3% compared to 15% fro Best Buy (BBY) and 46% fro Radio Shack (RSH). Interest coverage is at 85x for the CC. To complete the spin-off, CC will redeem its KMX tracking stock in exchange for shares of KMX stock. Simultaneously, shares of KMX stock would be distributed as a tax-free dividend to the holders of Circuit City Group stock in proportion to the retained interest in the auto superstore business. In the spin-off, the current holders of KMX tracking stock will receive one share of KMX stock for each share of stock redeemed by the company. Management presently anticipates that the holders of Circuit City Group stock would receive a fraction of a share of KMX stock for each share of Circuit City Group stock they hold. The fraction would be approximately .316, based on the current number of shares of Circuit City stock outstanding and the current number of shares of KMX stock reserved for the Circuit City. Circuit City expects that the spin-off could be consummated by late summer.


The Stub:

Circuit City is a national retailer of brand-name consumer electronics, personal computers and entertainment software. The Company sells video equipment, including televisions, digital satellite systems, video cassette recorders, camcorders, cameras and DVD players; audio equipment, including home stereo systems and compact disc players; mobile electronics, including car stereo systems and security systems; home office products, including personal computers, printers, peripherals, software and facsimile machines; other consumer electronic products, including cellular phones, telephones and portable audio and video products; and entertainment software and accessories. As of May 31, 2001, the Company operated 594 Circuit City Superstores in 161 markets throughout the United States and 32 Circuit City Express mall stores. Circuit City, the nation’s second largest consumer electronics retailer, said it expects sales at stores open at least one year to grow in the mid-single digits for the fourth quarter and in the next fiscal year. The company cut its fiscal fourth quarter estimate to a range of $0.68 to $0.71 a share, from a range of $0.72 to $0.76. Like the others in the group, ales were weak in January and February. The company also said it would spend about $130 million to remodel 300 of its 623 stores by September. Over the last three quarters, revenues fell 15% to $6.2 billion. Net income declined 21% to $38.1 million. Revenues reflect the Company's decision to cease sales of major appliances and lower demand for personal computers. Net income suffered from higher S/G/A expenses as a percentage of sales.

Stub Value: Stub value of the stub is $9. The book value of the stub is $11, implying a current valuation of a valuation of 80% of book. The spin-off piece is CarMax KMX, a tracking stock that is trading at $26 per share. Distribution is slated for the summer of 2002; with a distribution ratio 0.316

CC BBY RSH
Gross margin 24% 22% 48%
EBITDA margin 3% 5% N/A
Net margin 1% 2% 4%
P/E (forward) 11x 29x 16x
EV/EBITDA 4x 15x N/A
P/Book 0.8x 6.8x 6.7x
P/S 0.2x 0.8x 1.1x


The Spin-off:

The used-car market looks interesting of cars and light trucks in the United States with 40 retail units, operated from 37 locations, including 33 used-car superstores and satellite stores, two co-located new-car stores and five stand-alone new-car franchises. The Company operates 21 new-car franchises, most of which are co-located or integrated with its used-car superstores. Used-car sales, which are the major part of the Company's business, represented approximately 81% of the group's total vehicle sales in dollars in fiscal 2001. KMX stores are located in the Southeast, Midwest, Mid- Atlantic and West. The company essentially buys, reconditions, and sells cars and light trucks at more than 40 dealerships in about 10 states, mainly in the Southeast and Mid- Atlantic. KMX sells cars that are generally under six years old with less than 60,000 miles; the cars are sold below Blue Book value in a no-haggle environment. KMX also sells new cars at 7 of its dealerships. For the nine months ended 11/30/01, revenues rose 30% to $2.42 billion. Net income totaled $21.4 million up from $9.6 million. Revenues reflect growth in used car sales driven by cross shopping from the new-car financing incentive programs. Unlike the parent company, net income also benefited from an improved S/G/A expense ratio and lower interest expense. Debt/cap for KMX is 9% compared to 67% for Sonic Automation (SAH). Current valuation of Spin-off: Gross margin 13%, EBITDA margin 5%, Net margin 3%, P/E (forward) 32x, EV/EBITDA 17x, P/Book 5x, and P/S 0.9x,

Catalyst

1. The completion of the Spin-off
2. Strong signs of an economic recovery