Description

Bed Bath & Beyond is an iconic omnichannel retailer in the midst of a massive transformation.  At the heart of this business is the customer.  Consumers love the concept and have for years enjoyed shopping in the stores and increasingly online.  When you encounter a customer shopping at BBBY in the physical stores and watch them you’ll notice there is a lot of touching and feeling of product that is integral to the buying process.  This interaction and ability to feel the merchandise is central to how many of them make their choices about what items to bring home.  It makes intuitive sense, when you touch a bath mat or towel you immediately have a tactile sense of the product and importantly whether you like it.  We’ve done consumer survey work and customer intercepts in stores – customers flat out love the concept – it is a retail survivor.

Transformations of businesses are never easy and the outbreak of COVID came at an awkward time as new management was just taking over at BBBY.  The transformation of BBBY began 18 months ago when the two founders of BBBY, who had served on the board of the company for nearly 50 years, resigned amidst intense shareholder pressure.  Weeks later the CEO who had served in that role for 15-years was out as well.  Following those departures, the board was totally remade, and as of now 10 of the initial 12 directors from 18 months ago are gone.  Importantly, the new board is now filled with retail expertise, a stark contrast to the prior board.  Relatedly, the corporate governance at BBBY went from worst-in-class to best-in-class during the transformation.  We could write pages about how the founders and the old CEO took out a combined $300 million in compensation over 15 years or lament the over $10 billion of cash they used on ill-timed buybacks at prices over $50 per share, but that would just complicate this write-up.

When the old CEO of BBBY resigned, the board set about looking for a new CEO and ultimately hired one of the best choices they could have for the job – Mark Tritton.  Mark comes to BBBY from Target where he was the Chief Merchandising Officer.  At Target, Mark was responsible for all buying, sourcing, product design and development, visual merchandising, and merchandising operations.  This included completely remaking Target’s private label strategy, and in the process, he launched over 30 proprietary brands.  Given that part of the opportunity at BBBY is to improve sourcing and capture the $500 million in upside in EBITDA from these efforts, Mark was a phenomenal choice.

It took Mark about six weeks after arriving at BBBY to conclude that no one in the existing BBBY C-suite was up to the challenge.  So, he fired all of them and limped along through the holiday season in 2019 in search of a new team.  The old team had already royally screwed up merchandising for the 2019 holiday season and stores were out-of-stock on key promoted items causing customers to leave empty handed, setting up 2020 for some very easy comparisons.

Back to the C-suite.  Mark has hired the following new positions: CFO, COO, Chief Merchandising Officer, Chief Digital Officer, Chief Brand Officer, Chief of Stores (this person actually got a battlefield promotion), General Counsel, SVP Owned Brands, Chief People and Culture Officer, and SVP Real Estate and Construction.  The backgrounds of the new team are impressive, and shareholders are lucky to have this new team on the ground.  Most of them have been in their roles for around 3 months.  If you are rolling your eyes and wondering what all this is costing and how this compares to the old team, rest assured it is less expensive.  We understand the old team had over 50 employees making over $1 million in annual compensation.

The first thing anyone looking at BBBY will notice is there are a lot of shares shorted.  At last count, about 70 million shares were short out of about 124 million.  We have spent months listening to the short thesis and have concluded it is centered on lazy analysis which is focused on the company going bankrupt, COVID/cash burn, and operating deleverage.  The company is not going bankrupt given that there is tremendous liquidity on the balance sheet and no covenants.  The COVID cash burn is over. The operating deleverage that bears point to will be dwarfed by the operational improvements underway at BBBY.  The underlying sentiment in BBBY could not be worse, but we believe over the next seven weeks there are several catalysts which will fundamentally change the narrative.

BBBY is a confusing array of businesses, basically a poorly understood conglomerate due, at least in part, to weak disclosures and extremely poor communication historically.  But the conglomerate is in the process of being broken apart and refocused on its core.  So far, BBBY has monetized real estate for $250 million in a sale-leaseback and sold PersonalizationMall.com for $245 million.  In addition, an investment bank is working on the sale of Christmas Tree Shops (CTS) and Cost Plus World Markets (CPWM).  Management has guided that these monetizations will bring in between $105 million and $205mm of additional proceeds.  We think these estimates are conservative and expect actual monetizations to be well above this range.

In addition to trimming non-core assets, BBBY is trimming inventory.  Over the next 24 months, they plan to take $1 billion out of inventory as they reduce product and improve turns.  The other benefit from this effort is improving inventory margins as faster turns mean less clearance sales needed going forward.

Once the non-core businesses are sold BBBY will own 955 core BBBY stores, 127 buybuy Baby stores and 53 Harmon stores.  In terms of guidance, neither CTS or CPWM made money so it is not like a large amount of earnings power is exiting with those sales.  Management has provided the following guidance for how to think about the earnings power going forward:

Starting point – 2019 EBITDA $465 million

Add: $100 million benefit from closing 200 stores – these stores did $1 billion in sales and were EBITDA negative.

Add: $200 million benefit from reducing product sourcing (Part #1) – basically vendor renegotiations.

Add: $150 million of benefit from firing 2,800 employees at corporate and retail banners.

Add: $85 million from cost savings announced in February 2020.

Reduce: $150 to $200 million of reinvestment for growth initiatives – they have been aggressively marketing and adding new users.

EBITDA guide from these activities – EBITDA $800 million to $850 million.

The current enterprise value of BBBY is comprised of the following pieces:

Market cap $1.5 billion

Debt $1.7 billion

Cash $1.2 billion

TEV is $2.1B – So before any of the obvious adjustments, BBBY is trading for about 2.5x the EBITDA guidance from management.

But we know there are substantial pieces of value that will fundamentally lower the TEV.  These are:

Sale of PersonalizationMall.com $245 million (already completed)

Sale of other non-core assets $200 million

Inventory reduction $1 billion

So, when we net these things off, the adjusted enterprise value is $655 million – on this basis BBBY trades for less than 1x the go-forward EBITDA range.

What is interesting about this guidance is that it only has part of the savings from reducing sourcing costs.  You’ll recall earlier in this memo we suggested that supply chain/sourcing savings and increased private label could drive $500 million per year in EBITDA improvement and in the bridge from management there was only $200 million.  Over a couple year period there is the opportunity to gain another $300 million of improvement from sourcing.  Taking this all into account the actual full EBITDA bridge is to over $1 billion of EBITDA.

I’m sure there are bears who will be jumping up and down about these numbers and margin deleverage from e-Commerce sales.  After BBBY gets down to its new footprint going forward, sales will be roughly $8.2 billion and let’s assume over time that online sales go up by 20%.  That is $1.6 billion in incremental online orders.  Further, let’s assume the average order size is $50 that is 33 million shipments and let’s assume that all of them are shipped to consumers vs. BOPIS or curbside pick-up.  If the average shipping cost is $8 – the cost would be $263 million incremental.  Which basically means it is possible over a 5-year period to give back some of the EBITDA savings, but even in that case, BBBY is still producing over $800 million in EBITDA.  However, there are a few things wrong with the logic behind an extra $263 million in shipping expense.  First, the average order size is larger than $50, and second, the amount of BOPIS/curbside pickup is substantial.  Taking these items into account we think moving $1.6B of store sales to online would cost less than $100 million.  Not immaterial, but far from any sort of doomsday scenario.  We think that online orders could deleverage margins by less than 20 basis points for every 3% of total sales that move to online – this is consistent with what other retailers have suggested as well.

So back to where we started a couple pages ago.  BBBY is a consumer favorite.  A retailer that will be a survivor.  BBBY has a rock-solid balance sheet and no leverage issues.  The company trades for below 1x EBITDA and has an excellent CEO and an entire new C-suite team.

There are substantial upcoming catalysts: earnings October 1, Analyst Day (long awaited) end of October, and stock buybacks - we expect hundreds of millions of dollars in stock buybacks to begin very soon.  The upcoming earnings report should be good. Sales have stabilized with management already having reported two of the three months within the quarter – June total sales were down 7% and July total sales were up 2%.  We have heard that sales in August were flat to slightly up.  Importantly, cash flow was positive in June and July (no data has been released for August – which should also be positive).  These results were particularly good in August since BBBY has a huge back-to-college business which has been impacted by a number of colleges that are online only this fall.

Valuation – we see BBBY shares worth $30 to $50 per share and we use a 4x to 5x EBITDA multiple to get to those valuations.  This compares to BBBY trading for roughly $12 per share today.  Within the retail sector this is one of the most attractive stocks we’ve come across.

Catalyst

There are substantial upcoming catalysts: earnings October 1, Analyst Day (long awaited) end of October, and stock buybacks - we expect hundreds of millions of dollars in stock buybacks to begin very soon.  The upcoming earnings report should be good. Sales have stabilized with management already having reported two of the three months within the quarter – June total sales were down 7% and July total sales were up 2%.  We have heard that sales in August were flat to slightly up.  Importantly, cash flow was positive in June and July (no data has been released for August – which should also be positive).  These results were particularly good in August since BBBY has a huge back-to-college business which has been impacted by a number of colleges that are online only this fall.