Description

We believe that buying shares of Bed Bath & Beyond (BBBY) has a highly asymmetrical risk/reward skew, as the company is on a trajectory to repurchase in excess of 25% of its outstanding shares annually at the current stock price while returning an additional 6.8% in annual dividends.  With a cash balance of $902 million, or 71% of BBBY’s current market cap, and an annualized estimated free cash flow yield that could range from 25% - 40% depending on variances in same store comps estimates, timing of cost reduction initiatives, and fluctuations in inventory liquidations, trading investment securities and reductions in other current assets, we believe the company could further accelerate share repurchases and theoretically soak up its entire float in the next two years at the current share price.  During this period, BBBY could return an additional 14% through dividends while leaving remaining shareholders with a much leaner, more profitable store chain, as a substantial portion of its store leases mature in the coming years. There is a plethora of potential catalysts on the horizon that we believe could drive BBBY’s share price meaningfully higher.

Meanwhile, short sellers seem to be in a tenuous position.  As BBBY’s stock has descended into an abyss, short interest has dramatically risen to 64.7 million shares, or 50.7% of the current outstanding share count.  We believe that the combination of BBBY’s accelerated share repurchases and upcoming potential value creation initiatives (i.e. announcement of a permanent CEO, divestitures of non-core brands, further cost reductions) and speculation of a sale of the company catalyzed by the company’s new activist investors could result in a BYND-like squeeze higher in the coming months. 

In December 2018, BBBY repurchased $2.5 million of its stock and from December 31, 2018 through January 26, 2019, the company repurchased $13 million of its shares.  The company’s pace of stock repurchase activity then suddenly accelerated, as $62 million was purchased between January 27, 2019 and March 2, 2019, and $81 million was repurchased in the three months ended June 1, 2019.  Interestingly, the 5.3 million shares repurchased by BBBY last quarter were at an average cost of $15.39, more than a 50% premium to the current stock price. If buybacks further accelerate to $100 million per quarter, it would imply that over 30% of the outstanding shares would be repurchased within a year at the current stock price, bringing BBBY’s remaining float dangerously close to the current short interest.

According to a survey by Yougov, BBBY is recognized as the 8th most popular specialty retail store in the US, above brands like CVS, Ikea and Foot Locker.  Despite the recognition of BBBY as an iconic brand, however, the company’s execution has been abysmal, resulting in a continuous stream of missed expectations and declining same store comps.  We believe that this has resulted in a share price that is depressed well below the company’s intrinsic value. While the market has discounted a high probability of the company’s demise, its recent turnaround efforts, strong liquidity and capital flexibility, and robust cash flow make such an outcome unlikely.

On April 26, 2019, a group of activist investors, which comprised Legion Partners, Macellum Capital Management, and Ancora Advisors, filed a 13D disclosing a 5% position on BBBY and a corresponding presentation in which they outlined the company’s litany of inefficiencies and a series of initiatives that could enable the company to generate $5.35 of earnings per share in 2022.  The activist investor group believes that BBBY could generate a $1.9 billion windfall, or 149% of the company’s current market cap, from the sale of non-core assets and cash flow released from inventory rationalization. Since the activist group filed its 13D just three months ago, however, BBBY’s share price has declined 40%, enabling current investors to scoop up shares for a meaningful discount to the entry price of the group.   

Following the filing of the activist investor group’s 13D filing, BBBY announced 4 new independent directors in cooperation with the group, and on July 23, the company reported that it reduced its corporate staff by 7%, yielding $30.7 million or $0.24 per share of annual pretax savings.  These new initiatives are indicative of BBBY’s long overdue urgency in reducing costs and creating shareholder value. The company’s SG&A as a percentage of sales has risen from 24.9% in FY2011 to 30.4% in FY2018. Every 1% decline in SG&A equates to approximately $0.58 in additional earnings per share. 

The rapidity with which BBBY’s layoffs were announced following its new director appointments could portend to impending near-term divestiture announcements.  The activist group believes that 4 of BBBY’s non-core assets, PersonalizationMall, Christmas Tree Shops, Cost Plus World Market and buybuy BABY could be divested for a total of $1.364 billion, more than BBBY’s entire market cap.  Moreover, they believe that such divestitures would only reduce the company’s EBITDA by $170 million or 22% of our projected FY2019 EBITDA. We believe that any progress in selling non-core assets would result in an immediate upward revaluation of BBBY.

From an operational perspective, while there is a case for BBBY to execute a turnaround driven by stabilizing and driving top-line growth, resetting the cost structure, reviewing and optimizing the company’s asset base and refining the company’s organization structure, we believe that the stock can more than double from current levels even if such initiatives yield disappointing results.  Improving inventory turns from 2.9X to the industry average of 3.7X alone could free up in excess of $600 million of cash, resulting in a cash balance of >$1.5 billion and contracting the company’s EV by a third. This would result in an EV/EBITDA multiple for BBBY of ~1.6X from ~2.4X currently. To put this distressed multiple in perspective, it equates to ~23% of WSM’s EV/EBITDA multiple.  Each 1-point of EV/EBITDA multiple point expansion for BBBY equates to an additional ~$6 per share on the current diluted share count.

One potential source of stabilizing and driving top line growth for BBBY is an acceleration in replacing unprofitable stores with its Next Generation Lab stores.  The company announced earlier this year that it would close a minimum of 40 stores while shifting its focus to open 15 new Next Generation Lab stores. Experiences in BBBY’s Next Generation Lab stores include scarcity product and a greater emphasis on home decor, food and beverage, and health and beauty care.  In addition, the new store concepts test improved sight lines, cross-merchandising, lifestyle merchandising and queue lines, as well as a reduction in inventory. Although the data on Next Generation Labs is scant, the company’s former CEO indicated earlier this year that sales in these stores were 2.2% higher than comparable BBBY stores over a 4 week period, transactions were higher by about 3.7%, product margin dollars were higher by 3.6%, and the product margin rate was higher by 50 basis points.  The Next Generation Lab stores were also achieving inventory reductions approximately 7% better than the inventory reductions already being achieved by comparable stores.

Despite BBBY’s recent abysmal financial performance, the company has substantial financial and operating flexibility, with virtually no liquidity risk for many years to come.  As of June 1, 2019, the Company had approximately $902 million in cash and investment securities (or in excess of $7 per BBBY share). While it is unclear how many of BBBY’s stores are or will be unprofitable, its future minimum lease payments under non-cancelable operating leases will decline 60% over the next 5 years, from $610 million in FY2019 to $242 million in FY2023, enabling the company to shutter unprofitable stores or negotiate more favorable lease terms.  To put this lease roll-off into perspective, WMT’s future minimum lease payments under non-cancelable operating leases will decline only 42% over the same 5-year period. It is difficult to assess the potential benefit to BBBY from a portfolio of leases that have a short remaining duration, but this could be a meaningful lever for the company to cull the most profitable stores from an expansive network while shedding those that are dragging down margins. 

BBBY’s net debt is only $586 million, well less than 1X the company’s EBITDA.  Also, the company has no debt maturities for the next 5 years, with $300 million aggregate principal amount due on August 1, 2024, $300 million aggregate principal amount due August 1, 2034 and $900 million aggregate principal amount due August 1, 2044.  BBBY also has a $250 million revolving credit facility that is completely untapped.

In conclusion, we believe that BBBY is essentially a long-term call option with meaningful upside, a plethora of potential catalysts, and limited downside from current levels.  The stock trades at just 62% of tangible BV, implying that the market is ascribing substantial negative value for the ongoing business despite the company’s strong profitability and free cash flow.  We believe that BBBY investors are essentially being paid to wait for impending catalysts, as the company is on a current trajectory to repurchase 25% of its outstanding shares annually while returning a 6.8% dividend yield.

Catalyst

1)     Divestitures of non-core assets: The activist investor group believes that 4 of BBBY’s noncore assets, PersonalizationMall, Christmas Tree Shops, Cost Plus World Market and buybuy BABY could be divested for a total of $1.364 billion, more than BBBY’s entire market cap. 

2)     Acquisition of the company: Given the activist investor group’s increased influence over BBBY’s Board of Directors, it is possible that the company will explore a sale.  BBBY’s strong cash flow and balance sheet could be appealing to a financial buyer and there may be several interested strategic retail purchasers of the company.

3)     Short squeeze: BBBY is one of the most heavily shorted stocks in the market with over 50% of its outstanding shares and 55% of its float currently short.  Until recently, BBBY’s declining comps and lack of urgency to turn around its operations resulted in understandable complacency among short sellers. It seems, however, that since the activist investor group’s 13D filing in April, the company has become much more proactive in pursuing potentially transformational initiatives, increasing the probability of near-term news items that could result in a major short squeeze.  Also, the stock market seems to be increasingly conducive for short squeezes as indicated by recent surges in heavily shorted stocks such as BYND and OSTK.  

4)     Accelerated share repurchases: BBBY’s share repurchase activity has been accelerating, and the stock is currently more than $5 below the price at which it repurchased in excess of $80 million in stock last quarter.  It is possible that the company could pursue a Dutch tender given the magnitude of the recent share declines in order to take advantage of the dislocation in the valuation and accelerate accretion from share repurchases.

5)     Announcement of a new permanent CEO: BBBY’s interim CEO Mary Winston indicated on the company’s FYQ1 2019 conference call that a leading executive search firm had been hired to recruit a permanent CEO.  The ideal candidate would have transformation and innovation experience in the retail sector, as well as e-commerce and marketing experience. Winston conveyed having generated significant interest from candidates, and the appointment of a qualified candidate could be a significant positive catalyst for the stock.