After 18 years of following Circuit City Stores Inc., Richmond analyst Ken Gassman said he is convinced that investors can't make money by jumping in and out of the stock.
"You can't trade it, because just about the time you think it's time to sell, it leaps," he said. "If you're going to try to predict what's going to happen to the price of Circuit City shares, you have to have great clairvoyance."
The clairvoyance of hindsight is about all most Circuit City watchers can claim after the stock's latest leap, which over the past three weeks has pushed the share price to $79.78 1/4 Friday from about $65 in trading on the New York Stock Exchange.
Analysts for half a dozen Wall Street firms recently have issued "buy" recommendations on Circuit City, but brokerage clients got the word only after the stock had started to move higher. Merrill Lynch & Co. caught the wave, providing new insights into the company just before the stock took off. Gassman's clients at Davenport & Co. also profited from his long-standing view that Circuit City is a stock to hold onto.
Anticipating the swoops of the stock is difficult because Circuit City's fortunes now depend not only on the success of the familiar consumer electronics stores but also on two costly diversification efforts.
The company has made a massive investment in CarMax Group, the chain of mega-used car lots that are based on the same principal of unsurpassed selection as the Circuit Stores. And it has gambled millions on Divx, a variation on the digital versatile disc (DVD) format that is vying to replace video tape as the preferred medium for watching movies at home.
CarMax is five years old and only now is on the verge of making a profit. Divx has yet to prove it can survive, let alone prosper. It could be the next Betamax, said skeptics who believe the Divx vs. DVD battle will end the same way as the format war between Betamax and VHS.
The uncertainties about CarMax and Divx have hobbled Circuit City stock, which has failed to keep up with rising shares of the company's two closest competitors, Best Buy Co. and Tandy Corp., which owns Radio Shack. Circuit City shares have risen 73 percent over the last 12 months, while Tandy is up 89 percent and Best Buy, recovering from a deep slump, has gained 172 percent.
All three companies are emerging from a period of operating turmoil, adjusting their stores to meet changing consumer habits and new consumer-electronics technologies. All three have bright prospects because a new cycle of innovative products is drawing consumers to their stores.
At Circuit City stores that have been open for a full year, sales for the first quarter, ended May 31, were 9 percent ahead of last year. As a result, Circuit City said its first-quarter profit will be about 25 cents a share, up from the 20 cents that had been expected.
Digital products are the principal drivers of this consumer-electronics cycle: digital satellite TV receivers, digital cameras, digital answering machines and the new digital video disc players.
Rapidly falling prices for personal computers also are playing into the hands of the consumer electronics retailers, even though the stores are not making much of a profit by selling low-priced PCs. When the price for a PC ranged from $2,000 to $3,000, the buyers were more affluent and more likely to go to specialty stories. Now, with some PCs selling for the cost of a high-end TV set, Circuit City and Best Buy are getting the business.
The profits the stores make come not from the computers themselves, but from the ancillary products consumers buy. For example, the profit margin on a printer cable can often be more than that of a computer. And the extended warranties that are a major profit center for Circuit City are easier to sell to first-time PC buyers than to computer veterans who know there is no need to buy a three-year warranty on a computer that will be obsolete in two years.
But PC profits remain puny, compared with what retailers can make when a new consumer product comes along. Cycles in the business are marked by the introduction of innovative products likely to wind up in most homes: color televisions; videocassette recorders; compact disc players; and DVD technology, in which a disc the size of a CD can hold a feature-length movie.
Early adopters are willing to pay top dollar to be first on the block, making $400 DVD units more profitable than $129 CD players. This Christmas holiday season will be the first big one for DVD, and the first year is always the most lucrative in a product's life cycle.
Along with selling the DVD players, Circuit City has invested in the launch of Divx, a DVD variation designed for no-return rentals. Divx machines cost a little more than standard DVD players and they can play regular DVDs as well as specially encoded Divx discs. A rented Divx movie essentially self-destructs after three days of the initial viewing, so it does not have to be returned to the store. Divx movies can be reactivated, however, by special circuits inside the machine that dial up the Divx vendor and bill a consumer's credit card for another rental period.
As several electronics manufacturers are making Divx players, other retailers are selling them and a few movie studios are issuing movies in the format. Analysts say Divx outsells conventional DVDs in stores that stock both formats.
But many retailers refuse to stock Divx discs because of Circuit City's involvement. Talks with Blockbuster Inc. to add Divx rentals to its inventory have collapsed. And Paramount Pictures, which was supposed to put its movies on Divx, is holding back. Salomon Smith Barney Inc. analyst David Strasser said Paramount agreed to join in only after a certain number of Divx machines were sold; that level has not been reached.
The most serious negative aspect for Divx, however, is that Circuit City has failed to find a partner. Hoping to limit the losses, the company has tried to sell part of the venture to a movie studio or an equipment maker.
Gloomy as that diagnosis sounds, Gassman and the two analysts who follow Circuit City for Merrill Lynch -- Peter Caruso and Kirk Taniguchi -- have concluded it might be good news because it would force the company to take action. The Merrill analysts said Circuit City officials have told them that if Divx doesn't turn around soon, "some tough decisions would have to be made."
Gassman said he thinks Divx still has a shot at success, but that Circuit City's chief executive is prepared to make the call on Divx's development. "I think Richard Sharp will bite the bullet if it doesn't show some encouraging signs soon," Gassman said. "If he doesn't have one or more significant retail chains signed up by the holiday season, then Divx's life is limited."
CarMax also has a limited time to prove itself, analysts said. "I think that time is this year," Gassman said. "Circuit City has got to see signs of progress toward profitability in CarMax or, yes, Richard Sharp will pull the plug."
Gassman thinks that will not be necessary, and other analysts agree that the prognosis is more positive for CarMax than Divx. Defying predictions that CarMax would at best break even this year, Circuit City recently disclosed that the operation will report a first-quarter profit of 2 cents a share. That's still far short of what CarMax will have to earn to justify the millions Circuit City has invested, but it's a start.
The Merrill Lynch analysts said Circuit City "indicated at a recent meeting we sponsored that its appetite for CarMax losses is waning." While Divx might simply be allowed to die, the cure for CarMax would be to stop spending money on expansion. "As a result, we don't see CarMax as a major risk factor anymore," they said.
Failure of either CarMax or Divx would be a major setback for Circuit City, which is within five years of saturating the nation with electronics stores and needs to develop a new venture to ensure long-term growth.
But Gassman, who says he's learned not to predict what Circuit City stock will do, thinks the market might react positively. "If Divx goes away," he said, "the stock goes up."
A Look at . . .
Circuit City Stores
Business: Retailer of consumer electronics and major appliances. The company also operates CarMax car dealerships and Digital Video Express Stores.
Chairman, chief executive: Richard L. Sharp
Ticker symbol: CC on the New York Stock Exchange
Local employees: 2,235
Web address: www.circuitcity.com
Circuit City stock price
Friday's close: $79.78 1/4
SOURCES: Company reports, Bloomberg News