Circuit City rebuffs legitimate offer to take company private

Last Monday, the directors of the electronics retailer Circuit City rejected a $17-per-share bid by Highfields Capital Management, opting instead to stick with current strategies to recoup market share and improve earnings. This decision signals the board’s support for the current management. But in announcing the rejection, the company’s chairman, W. Alan McCollough, offered nothing to assure shareholders that this was the right decision.

From two standard perspectives, Highfields’ bid offers a premium on Circuit City’s market price of $15.48 as per yesterday’s close. Based on a discounted cash flow analysis, Smith Barney’s analysts valued Circuit City’s stock at $16. Using a price to earnings ratio, they valued the stock at only $15 dollars. Clearly, if shareholders wanted to get out of the game while ahead, Highfields offered them a chance to do so.

For those investors who would have opted for the Highfields’ bid, Circuit City’s board offered consolation by doubling a planned stock buyback to $800 million. Smith Barney’s analysts estimated that for every million shares repurchased, earnings per share will increase by a penny. Using this calculation, EPS should increase almost 52 cents provided the market price hovers well near the higher end of its 52-week high, $17.49.

Looking ahead, Circuit City’s prospects are murky. Smith Barney’s analysts are reassured that the company’s free cash flow will be less volatile in the near-term. But it’s unclear if this cash flow will result from one-time events like closing stores as leases come up for renewal, or from operational improvements and investments that can generate long-term returns for shareholders. According to securities law (as I understand it), the board must act on what it considers the best short-term option for the shareholders. With the current information available, it is difficult at best to determine if rejecting Highfields’ bid maximizes short-term shareholder value.

Smith Barney’s analysts don’t expect Highfields to renew its offer. Nor do they expect Circuit City’s board to accept anything less than a $20-per-share bid. With the rejection, shareholders may have lost their best option to cash out.