BBBY - Bed Bath & Beyond: Approximately 600 Million More Shares Available

Summary

• The BBBY board has around 600 million additional shares available to sell - about 5x the current float.
• I believe BBBY is probably insolvent, and the board has a fiduciary duty to creditors.
• BBBY’s tender for its unsecured bonds has failed, and in my view, the company has little hope of avoiding bankruptcy.

On January 5, Bed Bath & Beyond ( BBBY ) issued a business update (the “ 1/05Update ”) included both an update on its results for the quarter ending 11/26/22 (" Q3 ") and the news that its tender for all of its unsecured bonds had failed to attract sufficient interest and was therefore being canceled.

The Situation in September 2022

At the time of their Q2 earnings call, late in September, BBBY had approximately $2.5 billion of debt facilities, including obligations to reimburse drawings under letters of credit and the undrawn portion of their revolving credit facility, which for the purpose of this article I will divide between that debt secured on BBBY’s inventories & receivables (the “ Secured Debt ”), and that with no security (the “ Unsecured Debt ”). (Readers wishing for more detail on the debt structure are advised to consult my previous article " Bed Bath & Beyond: Potential Acceleration Of Largest Debt Tranche Could Cause Liquidity Crisis "). The earliest tranche (the “ Near Tranche ”) of Unsecured Debt (currently $215.4 million) is due in August 2024, while all of the Secured Debt (up to $1.505 billion) comes due in or before 2026. However, ALL of the Secured Debt will be immediately due and payable in May 2024 if the amount due under the Near Tranche has not been paid down or reduced to no more than $50 million at that time (the " Acceleration Issue ").

In my view, it was clear in September that BBBY had no realistic possibility to generate enough cash to pay the debt which will or might come due next year and also that lenders will be unwilling to provide a refinancing to a company which Moody's has recently downgraded to Ca . Therefore they needed to take some significant action to resolve this issue, and so they did.....

The Bond Exchange Offer

On November 21, BBBY invited all holders of the Unsecured Debt to exchange their notes for bonds with substantially different terms & conditions. Since the tender offer has failed, I will not bore readers with the details of the offered securities. It is sufficient for now to note that all had maturities later than the Secured Debt (thus avoiding the Acceleration Issue). The offer was to be good until December 5. However, not enough of the Unsecured Debt was tendered for BBBY to proceed. The offer was extended to December 5, then to December 19 and finally to January 4, but to no avail. As of December 19 (the last data provided ) only 18% of the Near Tranche notes had been tendered.

It seems that bondholders feel that they will get a better (or less bad) deal in bankruptcy than was offered by the company.

So far as debt maturities are considered, BBBY has therefore returned to the September status quo ante .

The Current Situation

The failure of the bond exchange was not the only bad news in the 1/05 Update. While BBBY did not disclose full financials for Q3 2022, it did disclose that sales had dropped approximately 33% from the same period in 2021 while the crucial SG&A expense dropped by only approximately 15%. This means that the loss for Q3 2022 was worse than the loss for Q3 2021 even without the approximately $100 million impairment charge BBBY tells us they are considering. BBBY did not tell us the operating cashflow numbers, but given the announced loss, and the fact that Q3 always sees a substantial increase in inventories ($241 million in Q3 2021), I anticipate another substantial cash burn.

The market reacted very badly to the 1/05 Update with BBBY's shares immediately losing almost half their value.

At some point during the quarter ending 5/28/22, BBBY became, from a balance sheet point of view, insolvent. At the end of that quarter. BBBY's $5.17 billion of liabilities exceeded their $4.95 billion of assets.

In New York (BBBY is a New York corporation), as in Delaware, and every other state to the best of my knowledge, insolvency has serious consequences for directors, including a shift of their fiduciary duty from being owed only to their company and its shareholders to being also owed to creditors (readers should note that I am not a lawyer and any legal points in this article should be verified with a lawyer before being relied upon). Therefore, I believe that insolvency on the balance sheet was very concerning to BBBY directors. However, the asset/liabilities test is not the only test of solvency, and it is not the test on which New York relies.

This, I suspect led to the "going concern" analysis which appeared in the Q3 10-Q and was discussed in my previous article. At that time, the management concluded:

The analysis reappeared in the 1/05 Update but with a strikingly different result:

This suggests to me that BBBY has now reached a stage where its directors owe their fiduciary duties to creditors, as well as to the company & its shareholders.

Additional Shares Available

The BBBY board has shown that it is willing to issue shares to attempt to mitigate its financial situation. According to BBBY's prospectus issued in connection with the ill-fated bond exchange offer, (the " November Prospectus "), they have issued more than 36.7 million shares between 8/31 & 11/21, and they may have only just begun.

According to page 67 of the November Prospectus, the BBBY board can, without consulting shareholders, sell approximately 600 million additional shares. This includes (as of 9/22) 264.8 million shares of treasury stock and 348.4 million shares of authorized but unissued stock.

This is approximately five times the current float of 117.3 million shares.

Conclusion

Given all the bad news on BBBY, readers may wonder why the common stock retains any value at all. Yet as I write this (about 6.10 pm Tokyo/4.10 am Eastern on January 9), I am watching a massive spike in the premarket - now over $2.10, more than 60% up from Friday. What is going on? Those who have read my articles before will know that I am very interested in meme stocks and in other situations where the weight of large numbers of small investors can move a stock in ways which seem irrational to investors looking at more traditional methods of valuation - earnings, leverage, corporate structure, etc.

The investment theories used by such small investors are, of course, various, but an idea of the most popular can be gleaned from perusing the online fora where such investors congregate to share ideas and encourage each other - reddit, StockTwits, YouTube etc. Using such evidence, I have come to the belief that there are two main theories motivating these investors to keep buying BBBY.

The first is that BBBY and/or its buybuy Baby division are so intrinsically valuable that Ryan Cohen and/or Carl Icahn will shortly sweep in to buy the company. According to the theory, these gentlemen are so interested that they will not wait to buy out of Chapter 11, but will buy almost immediately, and at a premium, while disregarding the impact that consolidating a company with approximately $1 billion of negative equity will have on their balance sheets, and on the confidence of their respective investors/shareholders. I will leave it to the reader to assess the likelihood of this.

The second theory is (stop me if you've heard this before) that there will be a massive short squeeze of BBBY stock. Facially, there I some support for this, as NASDAQ's latest figures of 37,481,334 represent a not insubstantial 32% of the current float and it is very likely that short interest has increased since NASDAQ's 12/15 assessment. However, I have shown above that the board has a very large number of shares available to sell, and the reason for my extended discussion of directors' fiduciary duties to creditors above is to support my opinion that not only will directors want to sell those shares into any material share price increase, but that they have a duty under NY law to do so, because, while it is exceedingly unlikely that they will avoid bankruptcy, they will increase funds available to repay creditors.

Investors should sell/avoid BBBY stock and sophisticated investors should consider taking a bearish position, either by going short or (as in my case) by using option spreads. My preferred strategy is a bear call spread, where I sell a call option at a strike close to the money, buy a significantly OTM call option to hedge against spikes, receive a net premium (which can be quite high due to the volatility of this stock) and keep the premium when, as I expect, the stock closes lower than the strike price of the lower option leg. However, this is a popular trade and opportunities are transient, so those interested in replicating the trade will need to keep a close eye on option premiums. I prefer this approach to simple shorting because, unlike in an unhedged short, the risk is capped - to the difference between the strike prices less the net premium. However, the return from the trade is also capped (at the net premium).

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