Stock Market

I’ve long warned about buying Bed Bath & Beyond (NASDAQ:BBBY) stock. No matter how low shares go, any near-term surge predicted by my Profit & Protection system would eventually turn into a dead cat bounce. Even algorithms can have trouble identifying dying businesses.

On Feb. 6, rumors of a last-minute equity deal would briefly stem the tide. BBBY shares would almost double in the trading session, delighting the meme investors who follow the stock. News outlets would later report that investment firm Hudson Bay had agreed to pump $225 million into the home goods retailer, with the promise of an additional $800 million over time, assuming “certain conditions are met.” (Even my former landlord was clearer about the security deposit).

A deeper look into the terms of the unusual financing deal paints a stark picture. Bed Bath & Beyond has delayed bankruptcy by perhaps a financial quarter… or even a year. Yet, the retailer remains on track to lose it all when the money eventually runs out and the landlords come knocking.

BBBY Stock and the Hudson Bay Deal

The unusual financing deal was actually quite straightforward. In exchange for a pile of cash, Bed Bath & Beyond issued Hudson Bay exceptionally generous terms on preferred convertible shares. By one calculation, Hudson Bay could have theoretically turned around and sold its convertible shares for a 14% return the following day.

Of course, the real world will never guarantee such a risk-free return. Bed Bath & Beyond’s $180 million market capitalization means Hudson Bay will struggle to offload its initial stake ($237 million face value), never mind the $800 million it may eventually invest. BBBY’s unusually high trading volumes also do not guarantee a willing buyer’s market. A similarly hyperactive market for meme stock Mullen Technologies (NASDAQ:MULN) has failed to keep shares of the electric vehicle firm above the exchange-mandated $1.

Hudson Bay’s new shares also have a conversion floor of around 71.6 cents, meaning that the investment firm will start to lose money if it dumps shares too quickly.

That leaves every stakeholder in relative limbo.

More Money, More Problems

The most obvious issue to external shareholders is the newly dilutive effect of Hudson Bay’s shares. In total, 23,685 convertible preferred shares, 84,216 preferred stock warrants and 95.4 million common stock warrants were issued. Exercising the common warrants alone would increase BBBY’s share count from 117 million to well over 210 million… and push shares dangerously close to under $1 in the absence of a reverse split.

The more worrying issue is that Hudson Bay’s deal makes it almost impossible for Bed Bath & Beyond to raise more capital. The $800 million of Hudson’s contingent investment almost certainly has a clause against subordinating or diluting its stake. And besides, no reasonable investor would take a significant stake if they knew BBBY’s main investor has every incentive to cash out as quickly as possible.

Creditors have obviously taken the hint. Bed Bath & Beyond’s 2034 bonds continue to trade at 15 cents on the dollar — roughly the same point they did in December 2022. And the retailer’s vendors — the lifeblood of credit to any retailer — remain wary of any turnaround.

Price of Bed Bath & Beyond 2034 fixed coupon bonds

Source: Thomson Reuters

A 2010s Business in a 2020s World

Then there’s the real issue of Bed Bath & Beyond:

Its business model is dying. 

Despite spending handsomely on store upkeep, BBBY has failed to attract enough customers to cover its overheads or large interest payments. In the past 12 months, the firm has burned through $607 million in cash before counting store upkeep. Adding in those costs pushes free cash flow to negative $1.05 billion.

In other words, Bed Bath & Beyond is burning cash so quickly that its $225 million from Hudson Bay might last only 2.5 months. An additional $800 million infusion might tide it to Christmas.

Other home goods retailers are also facing the pinch. Container Store Group (NYSE:TCS) — long considered the gold standard in the home goods industry —  has failed to generate meaningful cash flow since 2021. Even Wayfair (NASDAQ:W), an online furniture retailer, recently announced it was laying off another 10% of its workforce last month. My kitchen-related spending spree is obviously over.

But Bed Bath & Beyond is in particularly bad shape because of its poor relations with its suppliers. Vendors were already wary of the retailer’s dealings before this latest mess. Rising solvency concerns have pushed them over the edge. Many of BBBY’s shelves sit bare.

When Bankruptcy Is a Better Way Out

Last month, I noted how Redditors might have saved Bed Bath & Beyond from bankruptcy… if only they kept shares above $25. The company’s popularity among retail investors meant that management still had a chance to raise the billions it needed (not just $1 billion from Hudson Bay) to right the ship.

But four short weeks later, BBBY is now on an even more certain path toward irrelevance. Its last-minute dealing with Hudson Bay gave the retailer enough cash to repay missed interest payments and keep the lights on… but not enough to embark on a meaningful turnaround plan. BBBY’s deal with Hudson Bay also forces the retailer to continue running its cash-burning business, rather than liquidate operations and save what assets remain. In an ideal world, Bed Bath & Beyond would have simply declared bankruptcy, restructure its debts, and only then attempt to save its business.

Though my Profit & Protection system continues to see BBBY as a potential turnaround (and 100%-plus spikes will almost certainly happen), longer-term investors are better off staying away from this inevitable bankruptcy.

On the date of publication, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Tom Yeung is a market analyst and portfolio manager of the Omnia Portfolio, the highest-tier subscription at InvestorPlace. He is the former editor of Tom Yeung’s Profit & Protection, a free e-letter about investing to profit in good times and protecting gains during the bad.

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