Bed Bath & Beyond
From Buy Buy to Bye Bye
One of the great stories of corporate success and failure is playing out today in the financial press. This is the story of Bed Bath & Beyond and it is well worth following. In today’s post, I will provide some background which will help you make sense of the current state of play at BBBY. But watch the press for more on this subject, which should be of particular interest to those of you pursuing careers in corporate finance or strategy consulting.
Students who have taken my corporate finance course will recall the Bed Bath & Beyond case we studied in class. The published case was set in the spring of 2004, when BBBY was still in its glory days and led by its founders, Warren Eisenberg and Leonard Feinstein. Bed Bath & Beyond was at the time one of America’s great retailing success stories and the biggest problem faced by the Company seemed to be what to do with the vast amounts of cash rapidly building up on its balance sheet. In the professional world of corporate finance, this is what we call A Nice Problem to Have.
At the time of the published case, BBBY was opening a new store every four days, same store sales growth was in the high single digits, revenues were growing at 20% annually and gross margins were strong and stable. Net income and EPS were growing at a rate of 30% annually and the Company was generating over $500 million of annual operational cash flow, more than enough to fund the Company’s rapid growth. The Company had over $1 billion of cash on its balance sheet and no debt. The BBBY share price had increased 40x in the twelve years since going public, making Bed Bath & Beyond one of the most loved companies (and stocks) in Wall Street history.
After going public, the BBBY founders retained only a minority stake in the Company, albeit a large one, but they ran the Company as if they owned it all. And there was never any doubt internally or externally as to who was in charge or to whom credit should be given for the Company’s continuing success. Warren and Lenny had relinquished the CEO title in 2003, but they remained in control as executive co-chairs. And while they gave senior management and store managers a fair amount of operational leeway, and compensated them well, all of the Company’s key merchandizing, financial and strategic decisions were made at the top. Yes, BBBY had a shareholder-elected board of ‘independent’ directors, but the directors were selected by Warren and Lenny and their role seems to have been limited largely to applauding the continuing success of the Company and its founders.
As is the case with most great retailing companies, the BBBY founders were not only masterful merchandisers they were also quite savvy financially. Warren and Lenny understood the power of OPM (Other People’s Money), most notably in the form of lease finance and supplier credit. But despite their aggressive use of operating OPM, Warren and Lenny abhorred financial debt. Since the Company was founded in 1971—it initially operated as two small specialty stores in New York and New Jersey before expanding into the nationwide chain of 1500 stores which we know today— BBBY had borrowed very little money and had always paid it back very quickly. At the time of the published case (2004), BBBY had no financial debt and around $1 billion in cash on its balance sheet, projected to grow to several billion dollars over the coming years. The Company paid no dividend and had never bought back any of its shares (other than perhaps to offset the issuance of employee options).
Although Warren and Lenny were perfectly happy with this situation, not all of their public shareholders felt the same way. The Company’s stock price was still growing strongly, but in recent years return on equity had fallen substantially (from 30% to 20%) due to the relatively low return earned on the Company’s large and growing cash pile. Public shareholders and equity analysts saw no reason why BBBY should hold this much cash, most of which would never be used in operations, and many questioned the financial rationale for remaining debt-free and foregoing the equity valuation boost provided by the so-called “tax shield” on debt (resulting from the tax deductibility of interest expense). And so over the years a number of vocal shareholders and analysts began lobbying the Company to initiate a more aggressive shareholder return policy.
Warren and Lenny did not have much patience for shareholder questions, let alone shareholder activism, and so they initially ignored the noise about capital structure. But the pressure from Wall Street continued to build and eventually Warren and Lenny agreed to consider various options for returning excess cash to shareholders.
The easiest way to do this would have been to initiate a regular dividend and grow it over time in line with the growth of profits or free cash flow. But Warren and Lenny did not like dividends. They were by this time both quite rich by virtue of their BBBY shareholdings, they no plans to sell their BBBY shares and they presumably had well developed estate plans to minimize the tax hit to their estate beneficiaries on their death. And from their own personal perspectives, they didn’t see the point of moving excess cash from the corporate treasury, which they controlled, into their own bank accounts, where the cash was not needed and would incur a substantial personal income tax payment. Other shareholders did not view things in quite the same way, of course, but Warren and Lenny refused to budge. And so the Company paid no dividends.
Eventually, however, Warren and Lenny agreed to begin distributing excess cash to shareholders in the form of share buybacks. Unlike dividends, this was tax efficient, as capital gains were then taxed at a lower rate and only selling shareholders paid the tax. Buybacks also had the effect of increasing the Company’s reported EPS and ROE as well as Warren and Lenny’s percentage ownership stake in the Company. (They did not sell shares into the buyback program.) Over the ten years from fiscal 2005-2014, BBBY distributed over $5.5 billion of cash to its shareholders, funded entirely with excess cash generated from operations, and the Company remained debt free. And although the Company’s growth began to cool off during this period, the Company’s share price continued to perform well, increasing from a 2008 financial crisis low of under $20 (when the Company bought very few shares) to a high of $78 in November 2013 (when it bought many more).
In a major change in corporate financial policy, however, the Company decided in FY 2015 to lever up its balance sheet with financial debt, to the tune of $1.5 billion. This borrowed money was used not to open new stores, to make acquisitions or to invest in its digital infrastructure and e-commerce strategy (as BBBY’s competitors were doing), but rather to fund more share buybacks which could no longer be paid for entirely out of current operating cash flow. This was a classic example of financial engineering, ironically undertaken by a company historically known for its fiscal conservatism and its debt-free balance sheet. I do not know what motivated the Company to make this rather abrupt change in financial policy, but whatever the rationale and however well received it might initially have been on Wall Street, the Company’s timing proved to be quite poor.
As fate would have it, the Company’s operating performance began to deteriorate markedly not long after it levered up the balance sheet. Same store sales growth went negative, increased price competition drove down gross margins, operating costs increased and the Company’s annual operating profit fell from $1.6 billion in FY 2015 to a loss of $200 million in FY 2020. But despite the Company’s poor operating performance and prospects, and the $1.5 billion of financial debt now on its balance sheet debt, the Company not only continued to buy back shares it also initiated a regular dividend payment. And so another $4.5 billion of cash moved out of the Company and into the bank accounts of its shareholders, primarily those who sold shares into the buyback programs. And this was all done on Warren and Lenny’s watch.
By September 2019, BBBY’s business was struggling and the share price had fallen by almost 90%. It was now clear that Lenny and Warren had lost the plot and the rest of the board was not doing its job. Activist shareholders organized and forced a restructuring of the board, which included the resignations of Warren and Lenny. The CEO and several other key executives were also let go and the Company began to reorganize and restructure. But just when it seemed like BBBY might finally be getting its act back together, covid hit.
The covid pandemic had a devastating impact on brick and mortar retailers, including BBBY, as well as on the broader economy. In response, the US government provided unprecedented amounts of fiscal stimulus to companies and consumers and the Fed took interest rates back to 0% and flooded the markets with liquidity. This aggressive governmental response kept many businesses afloat, including many retailers (particularly those with strong e-commerce platforms, some of whom did quite well during the pandemic). At BBBY, the new board and management team accelerated their restructuring efforts. More stores were closed, non-core operations were sold and merchandising strategy was turned upside down with a big move into more private label branding. Despite the highly uncertain outlook for the economy and the company, BBBY’s share price rallied strongly from a covid low of $4 to $35 by early 2021.
Alas, the BBBY share price in early 2021 did not prove to be a good predictor of future company performance, although the shares did hold onto much of their gains into the first months of 2022. In April, the Company announced poor year-end results, highlighting significant supply chain and inventory issues, and the stock price resumed its fall (as did the broader stock market). And just last week BBBY announced a 25% fall in sales for its first fiscal quarter (ended May 28), along with the firing of its CEO and several other key executives. The BBBY share price fell 24% on the news and is now trading at $4.50, off 70% year to date and off 90% from its all-time high.
And so today the future of Bed Bath & Beyond is very much in doubt. The Company has jettisoned much of its most recent merchandising strategy and is looking to sell its one growing business, Buybuy Baby, rumored to be worth $800 million or so. BBBY’s total equity market cap is now under $400 million and the Company is levered at over 6x, with financial debt of $1.3bn (excluding lease debt). And despite its various restructuring efforts, the Company is losing money hand over fist and bleeding cash, reporting a $350mm net loss and close to $500mm of negative operating free cash flow in the latest quarter. The Company has just $100 million left in the till, compared to a cash position of $1 billion a year ago (and despite a recent borrowing of $200mm). A financial default seems increasingly likely, with BBBY bonds trading at under 40 cents on the dollar. And the Company has hired financial restructuring advisors, who may turn out to be the only ones associated with BBBY who will make any money this year.
This does not mean of course that Bed Bath & Beyond will disappear entirely from the retailing landscape, although your local store may well close (if it hasn’t already). But we should expect to see significant future changes in ownership, leadership and capitalization at the Company. And while it may be premature to say “bye bye” to BBBY, the glory days of “buy buy” are certainly behind us. Which is a sad way for Warren and Lenny to end their days, reflecting on what they once built and how they let it all go away.
But what about that $10+ billion of shareholder distributions discussed above? Was this a good thing for the Company to have done or not? It is likely true that these share buybacks may have hastened the Company’s demise, particularly the debt-financed distributions made in recent years. And it is also likely true that some of this money could and perhaps should have been reinvested into the business, say to build a more robust e-commerce capability which might have mitigated some of the recent losses. Does this mean the buybacks were a bad idea?
Not necessarily. At the end of the day, all companies—even the most successful ones like BBBY— have corporate lifecycles and very few companies survive intact and unchanged forever. The key word in corporate strategy is not 'growth’ or even ‘survival’, it is ‘adaptability’. The most successful long-lived companies reinvent themselves regularly, and they return capital to their shareholders when they can no longer do invest the money in a value enhancing manner, earning a return above their cost of capital. The biggest financial mistake many companies make is investing too much shareholder capital into declining businesses in the hope that throwing more money at problems will make them go away and somehow turn a bad or declining business into a good or growing one. It is one of the merits of capitalism that cash returned to shareholders is redirected from mature or troubled businesses into other more dynamic and promising ones. Warren and Lenny may not have fully understood this, but their activist shareholders certainly did and they welcomed the cash distributions.
Let’s just hope they didn’t put all this money into Netflix and Peloton.
Links:
Bed Bath & Beyond CEO Exits as Sales Plunge, WSJ, June 29, 2022
Bed Bath & Beyond the Point of No Return, WSJ, June 29, 2022
Bed Bath & Beyond Burning Through its Cash Reserves, WSJ, July 1, 2022