Bed Bath & Beyonds earnings report could have been called Bed Bath & Brag, according to
2004 the New Jersey newspaper The Record in April However, Bed Bath & Beyond (BBBY) had the
performance to back up its boastfulness. Since going public in 1992, the home goods retailer, based in
Union, New Jersey, had never missed an earnings estimate. For fiscal year 2003 (ending February 29,
2004) BBBY announced net income of $399 million on net sales of $4.5 billion, representing 22
percent growth in revenue and 32 percent growth in income over the previous fiscal year
In 2004 BBBY was amidst a large-scale expansion after adding 85 new stores in the preceding
fiscal year. This growth had been financed internally with cash from operations. As analysts noted in
summer 2003, the growing cash position of the company was causing return on equity to deteriorate.
For a management constantly seeking ways to improve shareholder return, adding debt to the balance
sheet was one possibility. In early 2004 interest rates were at an all-time low, making it an attractive
time to consider issuing debt and executing either a share repurchase or a one-time special dividend.
BBBY was founded in 1971 by Warren Eisenberg and Leonard Feinstein. Initially, Eisenberg and
Feinstein opened two stores, one in New York and one in New Jersey, under the name bed n bath.
These small specialty stores carried primarily bed linens and bath accessories. In 1985 the company
opened its first superstore, carrying a full line of domestics merchandise (bed linens, bath items, and
kitchen textiles) and home furnishings (kitchen and tabletop items, small appliances, and basic
housewares). In 1987 the company switched its name to Bed Bath & Beyond to reflect its broad
merchandise offering. In March 2003 the co-founders turned over the CEO title to Steven Temares but
retained their status as full-time co-chairmen
BBBY had been one of the early pioneers of the big box retail concept, which entailed
dedicating a large, stand-alone store to a category that had previously been part of the offerings of
large, general merchandise stores. While large department stores typically devoted about 20,000
square feet to home furnishings, BBBY stores averaged over 33,000 square feet and sometimes
exceeded 80,000 square feet. This large size enabled BBBY to stock more than 30,000 SKUs (stock
keeping units) in a typical store. By carrying a broad variety of household items, from bedding to bath
items to kitchenware, BBBY offered one-stop shopping convenience for customers. In addition to its
broader merchandise selection, BBBY maintained an everyday lower price policy that put its prices at
or below department store sale prices.
Historically, sales for BBBY were less seasonal than for many other retailers, and brand name
items comprised the majority of sales. BBBY used several of its stores to test new merchandise and
constantly updated its merchandising mix. Recent additions included fine china and window
treatments.
In look and feel, BBBY stores differed from competing stores. Groups of related products were
displayed together in different parts of the store, creating the impression that the superstore was
comprised of several separate specialty stores. In each store, a racetrack walkway ran throughout,
encouraging customers to shop many different categories. Rather than investing in expensive store
furnishings, BBBY put the focus on its merchandise, which was displayed from floor to ceiling. As
most of the inventory was on display in the store, approximately 85 to 90 percent of store space was
devoted to selling area (with the remainder used for warehousing, receiving, and office space).
In addition to its Bed Bath & Beyond stores, BBBY also owned Harmon Stores, a discount health
and beauty aid retailer, and Christmas Tree Shops (CTS), a retailer of home dcor, giftware, and
seasonal merchandise. At the end of fiscal year 2003 BBBY operated 575 Bed Bath & Beyond stores,
30 Harmon stores, and 24 CTS stores. Generally, stores were located in the suburban areas of
medium- and large-sized cities. BBBY leased all of its stores over terms ranging from five to twenty
years in duration.
Significantly, BBBY had no long-term debt on its balance sheet. Upon acquiring CTS, BBBY
immediately paid down its debt ($21.2 million, including prepayment penalties). The company
maintained lines of credit for $125 million but had no outstanding borrowing under these lines.
Industry journalist Don Hogsett commented on BBBYs debt-free balance sheet: In another boost to
profits, the retailer doesnt borrow money; it banks it, generating interest income as opposed to the
interest expense that choked so many other companies. Although many analysts considered BBBYs balance sheet a strength that permitted greater
flexibility, some commented on the risks of its growing cash balance. A sell-side equity analyst
commented, They ended the year with $867 million in cash and short-term securities even after a
$200 million all-cash acquisition. By 2007, we project their cash balance to grow to over $3 billion.
A buy-side analyst expanded on this view: I think BBBY is an excellent concept and company. . . .
Clearly, they are doing something right with regard to managing their business, since their results have
been fantastic for as long as I can remember and the stores are awesome. However, a big issue among
investors is their capital structure. No investor wants to see all that cash sitting on BBBYs books.
They use it for store growth and small acquisitions, but they really do have too much excess cash. We
have been begging the company to initiate a share repurchase program, but they are very old
fashioned and set in their ways: cash is king and debt is bad. BBBYs management might have been
worried about the reaction of the ratings agencies to increasing its leverage. Exhibits 7A and 7B show
median values of key financial ratios for bonds in various Standard and Poors bond rating categories.
These concerns raised questions about BBBYs historical capital structure: was it the most
effective one for the future? By paying out excess cash and issuing debt, BBBY could improve return
to equity holders and raise earnings per share. Exhibit 8 shows pro forma figures at a 40 percent debt
to-total capital structure. This pro forma assumes that the company would use $400 million in excess
cash and $636.3 million in borrowed funds to repurchase its shares. BBBY could also consider adding
significantly more debt, such as recapitalizing to 80 percent debt-to-total capital. In the 80 percent
debt-to-total capital scenario, it would borrow $1.27 billion and use those funds, in addition to the
excess cash, to execute a share repurchase. Another suggested possibility was to pay out the funds to
shareholders via a one-time special dividend. Although share repurchases were more commonly used,
management was cognizant of the recent changes in taxation policy that were thought to have
eliminated the tax disadvantages of dividends.
As of early April 2004 BBBY was in a position to issue a mix of short-term and long-term
maturity bonds that would have a blended interest rate of 4.5 percent. (Exhibit 9 shows the prevailing
market interest rates.) Given the low interest rates in early 2004, the climate seemed favorable for
BBBY to consider adding debt to its capital structure. The Federal Reserve Funds rate was at a 46-
year low of 1 percent, although speculation was mounting that the Fed would soon raise its rate and
trigger an increase in interest rates. BBBYs window of opportunity for issuing debt at low rates
seemed to be growing shorter
