One share to buy as Britain's economy follows America down

As the Bank of England tries to balance rate cuts against inflation, Martin Denholm presents an American view of the British economy, and reveals one share that could buck the downturn.

It's a question I face every time I head back to England, trying to figure out the best way to travel.

And after doing a few sums, there was no contest.

While driving would have offered more freedom and the chance to crank up the CD player, I didn't fancy paying the equivalent of $9.75 a gallon for gasoline, in addition to rental charges. So although the train was hardly cheap - 90 ($176) for the return trip from Southampton to Liverpool - it was much easier on the wallet. Particularly a wallet already getting hammered because of the awful dollar-pound exchange rate.

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Yes, Britain is still in the same shape as the last time I went: Bloody expensive! But although it's enduring several similar economic problems as the US, that hasn't stopped a significant Anglo-American corporate merger...

Bank of England holds at 5% - for now

Having cut interest rates three times since December - from 5.75% to 5% - the Bank of England's Monetary Policy Committee decided to hold fire this time around.

But with more bad economic data this week, many don't expect the status quo to last long. In fact, the bankers could chop again as soon as next month. Consider this:

  • The Chartered Institute for Purchasing and Supply said the British service sector grew at the slowest rate in five years in April.
  • The Office for National Statistics reported that Britain's manufacturing sector output dropped 0.5% in March - the worst performance in six months.
  • The number of mortgage lending approvals has halved over the past year, leaving many homebuyers unable to get financing at an affordable price. In addition, the number of first-quarter home repossession orders shot up by 17% over Q1 2007.
  • First quarter GDP growth crawled in at 0.4%, compared with the 0.6% rate over the final three months of 2007. It was the weakest quarter-over-quarter growth rate since the first quarter of 2005.

Like the Federal Reserve, the Bank of England is trying to balance poor economic data against high inflation. The current UK inflation rate is 2.5% - 0.5% higher than the government's 2% target.

And with the British Retail Consortium reporting that food costs are up 4.7% over this time last year, British households are now spending almost one-third of their income on food and bills. One possible reason why the bank left rates unchanged is because it fears a poor inflation number next week and another cut would make it look irresponsible.

Britain follows the US

Many economists agree that the UK economy is mirroring the US - and with its performance just a few quarters behind the US, the current situation could get worse.

That's a view shared by Bank of England's most dovish monetary policy board member, David Blanchflower, who favors low interest rates over a potential inflationary spike. He says the risk of not being more aggressive with rate cuts could send the UK economy down the same rocky path as America, triggering a sharp economic downturn.

But at least the Bank of England has one advantage. Having seen how the Fed has handled the crisis, it has a better idea of what steps to take to avoid a similar blow-up.

However, the April meeting showed the bankers are split. While six of the nine members favored the interest rate cut, two voted for no change and one (Blanchflower) wanted a larger chop to 4.75%.

While they debate, though, Britain's stock market has actually performed well over the past few months. In fact, since the Bear Stearns mess caused global turmoil on March 17, the FTSE-100 index has risen around 800 points - as you can see on this chart.

And eager to tap into that strength, one of America's big boys just came knocking...

The 'best buy' for America's biggest electronics retailer

With a 20% market share, Best Buy (NYSE:BBY) is already winning the battle against the likes of Circuit City (NYSE:CC). But the world's largest consumer electronics retailer just strengthened further by beefing up its international presence.

The firm announced on Thursday that it will spend $2.1 billion to acquire half of British mobile telecommunications company Carphone Warehouse (CPW.L). Having already worked with Carphone Warehouse for two years and bought a 2.9% stake in the firm last year, this deal will now see Best Buy add to Carphone's existing 2,400 stores and take its large, superstore-style US shops to the UK and Europe under the Best Buy brand name in 2009.

For Best Buy, it's a lucrative opportunity to tap into Europe's annual $175 billion consumer electronics market. And rather than trying to crack the European retail market by itself - a move that has proved tricky for other US retailers - it's teaming up with an already dominant, well-established company (Carphone was founded in 1989) that has the experience, expertise, and strong brand. In addition, Best Buy will take its successful Geek Squad in-home technical support team to Britain.

Moreover, with the high profit margins in the mobile phone market, the partnership will add $5 billion to Best Buy's fiscal 2009 revenues and 5-9 cents in earnings per share.

That's on top of the 11.4% sales jump to $40 billion in Best Buy's last fiscal year, which produced earnings of $1.4 billion, up 2.2%. The firm also offers a $0.52 annual dividend per share (1.2% yield) to shareholders.

So what about the other side of the merger? And how are investors reacting to the deal?

Investors are confused - but this deal will pay off

Judging by the share price action of both Best Buy and Carphone Warehouse, you'd think it's a bad deal. Investors have bailed on the shares over the past couple of days.

Obviously, there are risks - not least of which being the fact that consumer spending is currently slowing as inflation rises and demand for high-end electronics has cooled

But ultimately, I believe it's actually a good move for both sides. In Carphone's case, the firm gains access to Best Buy's hugely successful, proven model, which should give it a healthy boost in the ultra-competitive UK telecommunications and electronics market.

In 2006, Carphone was the first UK company to launch free broadband to almost 70% of the population and in also acquiring Time-Warner's AOL Internet access, it's Britain's #3 broadband provider. It's also O2's retail distributor for Apple's iPhone in the UK.

For investors, it's a chance to play a rebound in the company's shares, with the price having slipped around 13% over the past year. And they don't even have to get used to a convoluted new corporate name like the Carphone Best Buy Warehouse either!

By Martin Denholm, Managing Editor, Mt. Vernon Research for the Smart Profits e-Report,