Greenberg: Bed Bath & Beyond Positioning for a Bid?

This article appeared at 2:00 p.m. EDT on RealMoney Sept. 7.

SAN DIEGO (RealMoney) -- Here's what you need to know. Ken Hackel of CT Capital in Alpine, N.J. is bullish on Bed Bath & Beyond (BBBY) .

I don't always agree with Ken (perhaps notably on Herbalife (HLF) ), and he's not always 100% right (who is?). But in my discussions with him over the years, he has been almost always more right than wrong in the names he and I have discussed.

And nobody -- and I do mean nobody -- knows how to analyze cash flow the way Hackel does. He authored the tome Security Valuation and Risk Analysis, which is a serious dive into analyzing companies with a focus on cash flow.

And with Bed Bath & Beyond, cash flow (and its quality) is a big part of his story.

From Hackel's private report on Bed Bath & Beyond, which he generously shared with me:

"It is not often we would recommend investment in a firm which is losing market share though they remain the dominant player in several categories; yet in the case and analysis of BBBY, I believe overall fears to be exaggerated, and when considering the firm's current valuation, makes it an excellent investment opportunity."

He goes on to say:

"Although the shares have, as of last month now underperformed the S&P 500 over the past five years, the firm has superior relative free cash flows and cost of capital. Even recognizing the firm's lead in several categories is being brutally challenged by the proliferation of online services, many of whom have cost and tax structure advantages, our analysis concludes the risks and consistency metrics make an investment in BBBY to be one which offers a superior return, especially relative to the general equity benchmarks."

And:

"Operating and free cash flows remain large and consistent. Despite some plateau in these metrics, the firm has always been centered on its ability to produce excess cash, even during recessions. The last year BBBY did not generate free cash flows was in 1994."

Hackel also believes the company's free cash flow could get an added surge of $50 million to $100 million if Congress, under fire to do something to keep U.S. companies from seeking inversion, lowers the statutory tax rate to 25%. Bed Bath & Beyond is entirely domestic.

Here's where it gets interesting.

Bed Bath & Beyond has been an aggressive buyer of its own stock, "consuming close to all of its operating cash flows," Hackel says. The board recently approved another $2 billion repurchase.

As it turns out, he is not a fan of buybacks. He believes they add no capital and don't produce any free cash flows "while raising the cost of equity capital and weight average cost of capital."

So, why is he willing to look beyond it with Bed Bath & Beyond?

"You never look beyond it, just take it into account," he says. "Capital structure is altered and flexibility is diminished. In the case of BBBY, after making such adjustments, given the new valuation multiple, the conclusion is reached."

And that conclusion? From Hackel's report:

"The fact its Board would approve a $2B share repurchase on top of an existing large authorization at a time revenues and margins are compressing is quite intriguing and certainly out of character for this firm's founders and Board. My experience has been such an action is either stupid (Lehman) or signals an impending hire of an investment bank to seek bids (cloaked under 'maximizing value'). As unlike Lehman at its end, BBBY is an impressive cash producer with a strong credit, I believe its recent announcement could very well be the initial salvo towards a sale."

Hackel's bottom line is that regardless of how it gets there, Bed Bath & Beyond's fair value is closer to $77.48 than its current price in the mid-$60s.

Want more from Herb Greenberg? Sign up for Reality Check, his institutional research product, and get the watch list of all the companies on his radar with detailed analysis.

At the time of publication, Greenberg had no positions in stocks mentioned but positions can change at any time.

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Herb Greenberg, editor of Herb Greenberg's Reality Check, is a contributor to CNBC. He does not own shares, short or trade shares in an individual corporate security. He can be reached at herbonthestreet@thestreet.com.

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