Description

Bed Bath & Beyond is a US homeware retailer. If you live in the US you're almost certainly familiar with the business so I'm going to keep the introduction brief. They operate 1,500 stores in the US and Canada. In that total, 976 are the Bed Bath & Beyond concept. The other 524 are made up of 126 Buy Buy Baby stores, 81 Christmas Tree Shop stores, 261 Cost Plus World Market stores, 53 Harmon stores and 3 One Kings Lane Stores. The company was founded in 1971 and enjoyed a pretty epic multi-decadal run growing its store footprint, revenue and earnings. The company listed in 1992. They then took EBIT from $20m that year to a peak of $1.6b in 2013. That number shrunk to $122m last year.

They're now toast. 

The market doesn't give you many opportunities to short walking zombies at market caps above $1b but this is one of them.

This is why.

The core concept - Bed Bath & Beyond - retails a wide assortment of domestic merchandise and home furnishings. This includes categories such as bed linens, bath items, kitchen textiles, tabletop items, basic housewares, furniture, wall decor and various consumables. buybuy Baby is a specialty retailer focusing on young infants and children. Christmas Tree Shop sells a mish-mash of seasonal products. Cost Plus World Market sells a particularly eclectic mix of home furniture, decor, gifts, apparel, coffee, wine, craft beer and several international food products. Harmon sells cosmetics. One Kings Lane is an online home decor business.

This company predominantly sells branded products. Think Tempurpedic mattresses, Ugg quilts, Zwilling knives, Starbucks coffee pods, Le Creuset skillets, Kitchenaid mixers, etc etc etc. Lots of these tend to be slightly higher price point, one-time purchases. This leaves their assortment ripe for online price comparison and e-commerce substitution.

The company has little private label exposure. They refuse to disclose it as a percentage of sales. They will only say it's lower than our peers and it needs to be higher. This also leaves them more exposed to competition from e-commerce.

The company is massively behind the curve on omnichannel retailing as a result of prior management's complete and utter refusal and/or inability to see the writing on the wall. They ploughed ahead for years as if nothing was wrong (paying the CEO a small fortune along the way). They had a website that couldn't dynamically price. They had no BOPUS offering until a few months ago. They had hiked minimum delivery sizes in a desperate attempt to lose less money selling online. The management team was eventually changed after activists showed up and the board had to do something to appease them but the damage to the business was already done.

The problem the company has is that it's selling a commodity product with a cost-disadvantaged operating model. The penny-drop moment here was when the company disclosed that they had decided to decouple pring in-store and online, cutting their online prices below their in-store prices. They did this because - paraphrasing - we can't compete online at our in-store prices and we can't make money in-store at where our online prices need to be. If that's not a company telling you it's toast, I don't know what is.

They confirmed this issue more recently (likely without realising it). They said they cut prices to match competitors and promoted hyper-aggressively during the period from Thanksgiving to Cyber Monday last year. They confirmed this was a meaningfully loss-making exercise. They only managed to grow comparable sales 7% during that one-week period. If you throw everything you have at the consumer and can only grow 7% while discounting product so aggressively that you're haemmoraging cash, it's clear that your model just doesn't work anymore.

The company has steadfastly refused to ever give any kind of segment breakout of its concepts so we only have consolidated numbers to go on and boy are they ugly.

These charts tell the story better than I can. 

The business has averaged -3.1% SSS for the last 12 quarters and -6.8% for the last 4.

The business has seen TTM gross margins go from 38.9% in early 2015 to 33.3% today, i.e. -560 bps of compression.

The business has seen TTM EBIT margins go from 13.1% in early 2015 to 1.1% today, i.e. -1200 bps of compression.

The market has already given you two great opportunities to short this stock. The first was in early 2019 when activists arrived on the scene with 130 pages of slides and a plan for management that could be summarised as "be less useless". That took the stock up from $10 at the start of the year to $18 at the highs before the company printed a few more disastrous quarters in case anyone had forgotten just how useless they still were. That took the stock from $18 in April to $7 in August. The activists were successful in one regard. They got rid of the old CEO who "resigned" in May 2019. The company announced that they had hired Mark Triton from Target in October 2019. Triton was Target's former CMO and seems to have been well-regarded. The stock went from $7 back to within a gnat's hair of its prior $18 high as the narrative shifted to refreshing and upgrading the management team, turning around the core business and divesting non-core assets (real estate + smaller concepts). To give credit where it's due, they largely executed on the last point. They announced the sale of various real estate assets via a $250m S&L in January 2020. They announced the sale of PersonalizationMall.com to 1-800-FLOWERS.COM for $252m in February 2020. They announced the sale of One Kings Lane in April 2020 (likely for de minimus proceeds).

I think we're looking at the third great opportunity today. The crux of the bull-case here had been that you have a new and improved management team with a runway to make operational improvements and turn around the brand. The turnaround was always going to be hard but that runway has evaporated.

If you take the most recent FY (ending February 2020) they reported $122m of Adjusted EBIT.

That number was achieved after they classified $143m of OpEx as exceptional (a mix of severance costs, activist campaign costs and a loss from the S&L) and $170m of COGS as exceptional (a "one-off" inventory write down). 

Lets ignore the fact that severance costs are likely to continue as long as Bed Bath continues to exist and that writing down inventory by $170m and calling it a one-off just puffs up the reported adjusted gross profit number. In fact, why not write all the inventory down to zero while we're at it.

That $122m is going to be ~ $20m lower once you roll through the incremental rent costs from the S&L they completed in January, so the relevant number is now ~ $100m.

The company has an interest bill of ~ $72m per year (all of which is in long-dated bonds so unlikely to change much anytime soon, or benefit from lower interest rates).

That leaves the company looking at ~ $30m of PBT.

The company has been running at just over -3% SSS for the last 12 quarters. If they had repeated that in the coming year, that would have been $330m of lost revenue and ~ $120m of lost gross profit. Net that against the $85m of savings they're targeting under the restructuring program announced in February and that still leaves them in the red - even on their heavily adjusted basis.

This is all before COVID.

On March 19, they announced that they would - the following day - close ~ 800 Bed Bath & Beyond store locations that did not have a health and personal care department until April 3, 2020 and that they would continue operating ~ 700 essential stores, including the Company's buybuy BABY, Harmon and other concepts, as well as any Bed Bath & Beyond stores that do have a health and personal care department.

On March 22, they announced that by the morning of March 23, they would temporarily close all their retail stores across the US and Canada, other than buybuy BABY and Harmon, until April 3, 2020.

On April 2, they announced that based on the latest guidance from federal, state and local government and health authorities, and in the interest of the health and safety of its customers and associates, Bed Bath & Beyond is extending the temporary closure of its retail stores until at least May 2, 2020.

On April 24, they announced that they were further extending the temporary closure of these stores until at least May 16, 2020. They also announced an expansion of the network of locations customers can Buy-Online-Pick-Up-In-Store (BOPIS), or enjoy contactless, curbside pick-up.

On May 8, they extended the temporary closure of all their retail stores across the US and Canada, other than buybuy BABY and Harmon, until at least May 16, 2020.

On May 22, they announced plans to re-open ~ 600 additional stores to the public, including ~ 500 Bed Bath & Beyond stores, ~ 50 Christmas Tree Shop stores and ~ 50 Cost Plus World Market stores. In addition to buybuy BABY and Harmon stores, which remained open, this would mean that ~ 50% of the company's total store fleet was expected to be open by June 13.

On June 22, they announced a new $850m ABL and, at the same time, that they expected ~ 95% of the total store fleet to re-open by the end of the week and nearly all stores to re-open by July 2020.

I'm happy to walk through the math in Q&A if there's interest but on my calculations, I think this episode (ignoring the damage done the the longer-lasting impacts of COVID on employment and consumer spending or to their competitive position) cost them ~ $250m of NOPAT/FCF or roughly $2 per share. That's revenue that I don't think they ever get back. This is not a deferred iPhone purchase. This is product that was bought elsewhere on Amazon, Wayfair, Williams Sonoma. Equally importantly, it trained a portion of the customers they still have left to shop elsewhere.

Risks

The CEO comes up with something innovative & turns the business around. I can't say it's impossible but I can say that it's a herculean task. It's pretty clear that bricks & mortar retail has not been a kind space to those looking to turnaround struggling assets. The Best Buy example gets trotted out regularly here but that misses two key points. First, Best Buy was dominant in its category (~ 25% market share). Second, Best Buy sells a bunch of stuff where advice and service is a real part of the customer value proposition. We might all know which iPhone we want but they barely make any money on those anyway. Everything else in CE is just about dynamic, complex and expensive enough that the in-store personal touch is worth the trip.

They manage to sell more non-core assets at good prices. I think this is unlikely for a number of reasons. The old CFO told me that they sold almost all of what could be sold from a RE perspective in the $250m S&L from January this year. They've already sold One Kings Lane for basically nothing. They're in the process of trying to force the PersonalizationMall.com deal to close as the buyer is trying to walk away. There's not a lot left after that. The only asset that could be worth something is buybuy BABY but they've intimated that neither that asset nor Harmon is for sale. That leaves just Christmas Tree Shops and Cost Plus World Market, both of which are likely worthless. The other point that the sell-side seems to miss whenever they trott out their SoTP arguments is that if buybuy BABY is actually a relatively healthy business, it just implies that the trends for core Bed Bath are even worse, margins are even lower and that it will be an even more arduous and costly exercise to turn that brand around. The BofA analyst seems to think buybuy BABY is doing ~ $100m of EBIT. I've no idea how they come up with that number but if it's true, it implies that core Bed Bath was already deeply loss-making on an adjusted basis and before COVID. The idea that buybuy BABY is somehow a structural winner in retail that bulls are pushing is also misguided. Babies R Us liquidated for a reason. Mothercare in the UK liquidated for a reason.

The other risk is really mark-to-market. Though borrow is reasonably deep and only costs ~ 5% today, the stock does still have a 58% short interest. That would normally be enough for me to pass on the idea no matter what but I've been following this company closely enough for long enough to have complete confidence that the stock is ultimately going to zero and so I'm making an exception. That said, it does mean you are prone to the occasional squeeze and should size the position accordingly.

Catalyst

Bankruptcy.