On Monday, shares of Bed Bath & Beyond (NASDAQ:BBBY) suddenly jumped 22% on massive retail buying. High short interest — and a rock-bottom price — had created the perfect conditions for a short squeeze. Gleeful Reddit-based investors have since pushed shares up another 120%.
It’s not the first time the home goods retailer has rewarded meme investors. In June, my quantitative Profit & Protection system flagged Bed Bath & Beyond as a cheaply priced turnaround play.
“A hoard of Reddit investors could easily send shares up 200% or more,” I wrote. … Right before Reddit investors sent shares up 200%.
But away from the Wall Street trading floors and social media hype, Bed Bath & Beyond’s underlying business is looking increasingly fragile. On Jan. 10, the firm announced results that missed expectations by a mile, sending its business into the closing acts of a retail “death spiral.” And although Redditors are valiantly pushing prices higher, they’ll have to send shares into the $25 range before BBBY stock has any chance of salvation.
Bed Bath & Beyond: Beware the Retail ‘Death Spiral’
Retailers have long boosted returns by paying suppliers late. For every 30 days a firm like Bed Bath & Beyond can draw out payments, its return on capital invested increases by around 12%.
Some retailers like Amazon (NASDAQ:AMZN) take the concept one step further and don’t pay suppliers until the inventory is sold.
In good times, this creates a virtuous cycle. Companies like Walmart (NYSE:WMT) can have negative working capital — a case where goods are sold to end customers before suppliers are paid. That frees up cash to build new stores, creating more negative working capital to build even more stores, and so on.
When things go wrong, however, the feedback loop quickly runs in reverse.
In November, suppliers to Bed Bath & Beyond began withholding shipments, worried that a potential bankruptcy could snarl payments. Others reduced credit limits to the retailer just as the busy holiday shopping season was kicking off.
Unsurprisingly, the bare store shelves turned customers off.
“Inventory was constrained and we did not achieve our goals,” the company announced in its Q3 press release. Revenues declined 33% in the quarter, driven by a collapse in same-store sales.
That has caused more vendors to pull credit lines and inventory, which will eventually show up in even lower customer numbers as 2023 progresses.
Running on empty. A Bed Bath & Beyond store in Burlington Massachusetts, Jan. 11, 2023
Running Out of Options
This isn’t the first time a retailer has entered a death spiral. In 2018, Toys R Us folded after a bankruptcy warning caused suppliers to cull previously negotiated credit lines. And discount retailer Tuesday Morning (NASDAQ:TUEM) only emerged from bankruptcy after securing a $110 million lending facility backed by three major investment banks.
In other words, once a retailer destroys trust with its vendors, rebuilding inventory takes a lot of cold, hard cash.
Bed Bath & Beyond’s management seems keenly aware of the credit risk. In Q3, CEO Sue Gove reiterated that the firm is on track to close 150 stores in fiscal 2022. That would allow the retailer to shift inventory from closing stores to remaining ones, buying it more time to work out debt obligations. And BBBY has wasted no time in slimming down both its rank-and-file staff and C-suite officers. (The firm now has so many interim managers that half of its management team page lacks headshots).
But even the best efforts by management might not suffice. The company still burned through $1.05 billion in the past 12 months despite reducing $223 million in working capital. And with only $154 million of cash left in the bank, management has virtually no good options left.
First, consider the debt market. The home goods retailer already holds $1.9 billion in long-term debt, up from $1.2 billion a year ago. Prices of its 2024 senior unsecured debt trade at 9 cents on the dollar, according to data from Thomson Reuters, and its 2034 debt trades at 7.25 cents. No investment bank concerned with its own survival would underwrite bonds that eventually prove impossible to sell off. Bed Bath & Beyond has already failed to complete a debt exchange, which initially expired on Jan. 4.
Second, there are hard asset sales. The retailer currently holds only $1.4 billion in inventories and $2.3 billion in real estate and other property-related line items. On paper, that covers only three-quarters of its debts. And in reality, it’s probably far worse. As Sears CEO Eddie Lampert realized in the early 2010s, selling off hundreds of store locations and their operating leases all at once happens at steep discounts. And in Bed Bath & Beyond’s case, it’s liquidating stores just as a recession seems imminent.
Then there’s the long-shot option of a buyout. Firms like American Airlines (NASDAQ:AAL) and Hertz (NASDAQ:HTZ) both escaped bankruptcy in recent years (and rewarded shareholders with 400%-plus returns) after white-knight investors swooped in. But Bed Bath & Beyond has too few intangible assets for buyout firms to make a high bid. The same exercise I did for determining the residual value for Hertz during its bankruptcy case comes to an unfortunate, big fat zero for Bed Bath & Beyond.
Can Redditors Save BBBY Stock?
That leaves one more question: Can Reddit investors save Bed Bath & Beyond?
At first glance, it certainly seems possible. AMC Entertainment (NYSE:AMC) raised over $2 billion from investors during the 2020-2021 meme stock mania with well-timed stock offerings. GameStop (NYSE:GME) would do the same to the tune of $1.7 billion. A windfall that large would allow BBBY to erase its entire long-term debt.
But dig a little deeper, and investors will quickly see that Bed Bath & Beyond faces an uphill battle to raise that type of money. BBBY’s common stock is still only worth around $360 million at its current $4 price. An at-the-market offering (if regulators even approve one) might raise $150 million or $200 million at best, barely covering two months of cash burn. Shares would have to rise to $25 (a $2.1 billion valuation) for the firm to raise the kind of capital it needs to stay in business for the next 12 months.
Even if shares were to rally to the $25 range, as they did in August 2021, the company will still have to deal with an outdated business model. Same-store sales are in freefall, and no amount of cost-cutting will hide the fact that BBBY’s e-commerce business declined around 33% last year. As Morningstar analyst Jamie Katz puts it, “companies cannot cut their way to greatness.”
Reddit investors, of course, could still profit handsomely from the company. In 2018, shares of then-bankrupt Sears would see shares rise 100% at least 4 times before disappearing from public markets. And investors should expect no less from BBBY’s financially leveraged stock.
Nevertheless, buy-and-hold investors should remain far away from Bed Bath & Beyond. Even if the New Jersey-based firm survives another several years, it will look more like Toys R Us in its final stages of the retail “death spiral” — grappling with a vicious feedback loop of fleeing vendors and customers alike.
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.