Bed Bath & Beyond (BBBY) has issued a "going concern" notice. That's basically a warning that a company has to disclose when it is teetering on the brink of bankruptcy. Things have gotten desperate at this point and survival is the goal, not stockholder returns. So the company's recent convertible preferred stock issuance is something of a "Hail Mary" pass to buy more time, but it really doesn't solve the company's problems.
Not so great for shareholders
If Bed Bath & Beyond goes bankrupt, shareholders will likely be left with nothing. So the company doing everything it can to stay afloat is probably the right move for management to make. But investors need to understand just what has happened with the recent convertible preferred stock sale.
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The company had a loan backed by the value of its inventory. The value of this collateral fell below predetermined levels and, thus, Bed Bath & Beyond had breached the covenants of the loan. That risked setting off a chain event, with other lenders coming in to demand repayment of their loans because of the first covenant breach. It appeared very much like the retailer had reached the end of the road. It had also failed to make a scheduled interest payment on some debt.
But it had another trick up its sleeve. The company worked out a deal with Hudson Bay Capital Management, which acted as the lead investor for a larger group, in which Bed Bath & Beyond would sell convertible preferred shares. This provided an immediate cash infusion of $225 million.
The intended use of that money is to alleviate the original loan breach and pay the missed interest payment, buying more time for the company's turnaround effort. Meanwhile, assuming certain milestones are reached, Bed Bath & Beyond has the ability to raise an additional $800 million from the group. It's a complex deal, but the big news is that the convertible preferred shares will lead to massive shareholder dilution if Bed Bath & Beyond survives.
It is, in effect, a leveraged bet for the investors buying the convertible preferred shares. If the company turns itself around, converting the convertible preferred shares into common stock could lead to a huge windfall. If Bed Bath & Beyond seeks bankruptcy court protections, the loss will be relatively small. Current shareholders, however, really lose both ways. If Bed Bath & Beyond survives they will see massive dilution, and thus a muted benefit. And the shares will end up worthless if the company goes belly up.
Not much has changed
Given that even a good outcome for Bed Bath & Beyond is likely to lead to a bad one for shareholders, most investors should avoid this stock today. But this convertible preferred deal isn't the only reason for concern. The cash infusion and ability to raise more money down the road has only bought more time for the troubled company's turnaround effort. Nothing about the business itself has changed, with the company actually warning in regulatory filings that "...we have historically underperformed in implementing management plans..."
A big piece of the problem here comes down to three basic numbers that you can either see directly or calculate from the company's financial statements. (You can also just use a graphing service like YCharts, if you don't want to do the math.)
First, Bed Bath & Beyond is bleeding red ink. It has been losing money since 2019, before efforts to contain the coronavirus pandemic in 2020 closed non-essential retailers. So the company's problems are hardly new or specifically because of the pandemic. Financial performance has not recovered even as the world learns to live with the coronavirus, with supply chain issues, merchandising choices (stocking the undesirable products), and the ongoing closure of underperforming stores, among other things, all weighing on the bottom line.
BBBY EPS Diluted (Annual) data by YCharts
That said, a company can lose money for a pretty long time if it has a strong balance sheet, leaning on either saved cash or the issuance of debt. The problem with the latter option is that debt can quickly become unmanageable. That's exactly the point at which Bed Bath & Beyond has arrived, with the company's debt load increasing by more than 60% over the past year or so. The defaults highlighted above are one sign of the company's debt problem, but not the only one.
BBBY Total Long Term Debt (Quarterly) data by YCharts
This brings up the times-interest-earned ratio, which gives an indication of whether or not a company is capable of carrying the debt burden it has taken on. A number of one or higher indicates that a company is able to cover its trailing 12-month interest expenses. Bed Bath & Beyond's times-interest-earned ratio has been mostly negative since 2019. Eventually lenders demand to be paid, even if that means working through a bankruptcy court.
BBBY Times Interest Earned (TTM) data by YCharts
Simply put, Bed Bath & Beyond may have bought some time, but the heavy burden of the company's material debt load won't go away unless it can start to turn a profit. That's something even management admits it hasn't been able to figure out how to do since the bleeding began prior to the pandemic.
Watch from the sidelines
The fact that Bed Bath & Beyond has become a favorite with the meme stock crowd is likely a key reason why it was able to ink the convertible preferred stock deal. That alone should be enough to dissuade conservative investors from buying shares. If it isn't, the still-weak financial performance of this heavily leveraged retailer should be.
And if these two facts aren't enough to keep you on the sideline, then consider the shareholder dilution that will result if the company does manage to survive this near-death experience. When all is said and done, the risks here vastly outweigh the highly speculative benefits.
