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Should Bed Bath & Beyond Dilute Its Stock After The Rally?

Bed Bath & Beyond's business is in trouble. Should the company issue more shares to raise cash and save it from bankruptcy?
  • Bed Bath & Beyond's stock has soared recently thanks to a short squeeze.
  • The retailer's business fundamentals are worrisome; the company needs more cash to avoid major liquidity problems.
  • Even though issuing more equity may help de-stress the company, in the short term, the dilution may negatively affect BBBY's trading activity.
Figure 1: Should Bed Bath & Beyond Dilute Its Stock After The Rally?

Figure 1: Should Bed Bath & Beyond Dilute Its Stock After The Rally?

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How Can Bed Bath & Beyond Benefit From a Higher Share Price?

In the last month alone, Bed Bath & Beyond  (BBBY) - Get Bed Bath & Beyond Inc. Report stock has risen nearly 140%, without any big changes or improvements in its business fundamentals.

This recent surge is likely due to a short squeeze. The stock is popular among retail "meme" investors, and short interest is higher than 40% of BBBY's stock float.

Short sellers have targeted Bed Bath & Beyond because of the company's deteriorating business fundamentals. It has failed to meet loss-per-share and revenue estimates for the last four consecutive quarters.

A sudden increase in a company's share price can be beneficial in several ways for the business. Through this, it is possible to raise more money by:

  1. Issuing secondary offerings, by which the company sells new shares for cash. This dilutes the float but makes the company more valuable as it raises more cash.
  2. Issuing stock compensation to employees, diluting shareholders. This is a way of rewarding the company's employees with shares or options, rather than cash.
  3. Performing mergers and acquisitions using company stock, which can save cash on the amount it pays for shares.

Bed Bath & Beyond Already Has a Liquidity Problem

During the past year, Bed Bath & Beyond had been undergoing a turnaround plan designed by its former CEO, Mark Tritton. Tritton's goal was to revamp the company's core business to optimize its operational efficiency.

But Tritton's financial plan included prioritizing share buybacks, rather than paying down some of its long-term debt of nearly $1.2 billion.

As mentioned in a previous article, in the last quarter alone, Bed Bath & Beyond reported cash and cash equivalents of $107 million. The implication here is alarming — Bed Bath & Beyond is starting to struggle to pay its obligations.

Although the company can still pay its obligations in the short term, its assets-to-liabilities ratio — which measures a company's liquidity — has fallen over the last few quarters to its lowest level in recent history.

Currently, for every $1 of debt that Bed Bath & Beyond pays off, there is only 1 cent left for the company.

Figure 2: BBBY current ratio.

Figure 2: BBBY current ratio.

The pressure on Bed Bath & Beyond has increased since activist investor and GameStop  (GME) - Get GameStop Corporation Report chair Ryan Cohen bought nearly 10% of shares. At the time of his purchase, Cohen demanded that the company make a series of strategic changes. A few months later, CEO Mark Tritton stepped down.

More recently, after the company reported another troubling quarter, Freeman Capital revealed that it had become a Bed Bath & Beyond shareholder to push for debt realignment.

According to Bank of America analyst Jason Haas, debt restructuring will not solve Bed Bath & Beyond's liquidity problem. The analyst points out that having a source of liquidity should be much more important for the company at the moment.

Dilution May Be the Solution

Many shareholders — especially those focusing on short-term trades — fear dilution.

Despite adding to the company's cash flow, dilution reduces the ownership stakes of shareholders and is generally bearish for the share price in the short term.

But I believe that Bed Bath & Beyond's management cannot afford to play with its liquidity situation. Even though it is not in a crisis yet, the company is in a worrying liquidity position for the medium to long term.

Mad Money's Jim Cramer has warned that Bed Bath & Beyond needs more cash as soon as possible:

BBBY's management should look to AMC Entertainment  (AMC) - Get AMC Entertainment Holdings Inc. Class A Report as a good example. Although the movie theater chain was on the brink of bankruptcy, it managed to raise over half-a-billion dollars in cash by issuing equity.

For those who expect to hold onto Bed Bath & Beyond shares for the long term, dilution would be a good way to ensure healthy liquidity for the company. However, an initial drop in BBBY's stock price would be inevitable.

(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting Wall Street Memes)