Late last summer, Bed Bath & Beyond had a new chief executive, a new strategy and $375mn in new cash from a canny investment firm, Sixth Street Partners. Together, they were meant to propel the US home goods retailer through the 2022 holiday season and reverse a long, dangerous slide in sales.
The optimism quickly reverses, exposing tensions between the company and its supposed rescuer that show the knife-edge nature of distressed-debt investing in a slowing US economy.
Within weeks of investing, Sixth Street was quietly questioning the turnround plan of the CEO, retail veteran Sue Gove, while company insiders were complaining about what they saw as the investor’s tightfistedness, people familiar with the matter say. After a disastrous holiday season, with like-for-like sales falling a shocking 40-50 per cent in the fourth quarter, any hope of a 2023 comeback was snuffed out when creditors chose to play hardball.
Last week, those tensions culminated in Bed Bath & Beyond’s Chapter 11 bankruptcy filing. The business now risks a liquidation that could cost thousands of jobs and impose huge losses on shareholders and many creditors.
Years of financial and operational mis-steps contributed most to the company’s collapse. But court filings and interviews with key players about the events of the past eight months reveal the delicate dance between companies desperate for rescue capital and the Wall Street players who roll the dice on big returns from such high-wire situations.
The number of bonds classified as distressed in Morningstar’s high-yield bond index grew more than fourfold between 2021 and 2022, and asset managers have dedicated hundreds of billions of dollars towards betting on troubled businesses.
Sixth Street, which now manages $65bn, was no stranger to teetering retailers. The firm had loaned money to the likes of Toys R Us and JC Penney, reporting that such retail loans produced an annualized return exceeding 20 per cent. And Sixth Street designed its Bed Bath & Beyond investment to protect itself if things went wrong.
The $375mn infusion, led by Sixth Street alongside smaller partners, on August 31st was in the form of a “first-in, last-out”, or Filo, loan. Only the company’s existing revolving credit facility with JPMorgan, which was backed by inventory and other assets, ranked above the Filo in repayment priority.
“It’s one thing to lend money to a healthy company that later gets sick. It’s totally different to lose money because you knowingly lent money to a sick company and didn’t do a good job protecting yourself,” said Kristin Mugford, a former investor at Bain Capital now at Harvard Business School.
By late 2022, however, Sixth Street grew concerned when Bed Bath & Beyond briefly pursued a bond exchange that it saw as a distraction from cutting stores more drastically, people familiar with the investor’s thinking say.
By early 2023, with vendors reluctant to supply inventory after the dire holiday season, JPMorgan and Sixth Street told the retailer that breaches in the terms of its loans constituted a default.
Bed Bath & Beyond was facing bankruptcy, but in February what Gove called a “transformative transaction” seemed to offer an escape route. A hedge fund, Hudson Bay Capital, said it would buy about $1bn worth of equity, albeit over several months and subject to certain conditions.
The unusual transaction involved the fund buying convertible preferred stock at a discount and converting it into common stock, which it would quickly sell at a profit into a market boosted by a burst of meme stock mania.
As part of the deal, Bed Bath & Beyond’s lenders waived the threatened default, with Sixth Street putting in another $100mn to get JPMorgan on board. The cash from the Hudson Bay share sale and the second Sixth Street loan, however, was used to pay off JPMorgan’s revolving loan rather than to invest in the business.
Between the first part of the Hudson Bay deal and other stock sales this year, Bed Bath & Beyond raised more than $400mn. But the company saw Sixth Street as a barrier in the way of it raising more.
Uneasy with the company’s strategy and losses, Sixth Street was “unwilling to approve the debtors’ projected budget,” Bed Bath & Beyond stated in court papers. That condition, together with a falling share price, kept the company from tapping hundreds of millions more from Hudson Bay that could have kept it afloat longer.
Had its Wall Street backers been more accommodating, company insiders lamented, it might have pulled off a turnround. “It was death by a thousand cuts . . . it was impossible to operate the business,” said one.
For its part, Sixth Street pointed to the hundreds of millions of dollars it had infused as proof of its good faith. Its lawyers noted in court last week that it had agreed on five separate occasions not to enforce defaults.
The bankruptcy process will now determine just how deep the losses are for Bed Bath & Beyond’s stakeholders. The company, which is also seeking a buyer, has estimated that its liquidation value would be just over $700mn. Shareholders are expected to recoup nothing while its junior bonds, with a face value of $1bn, are trading below 5 cents on the dollar.
Sixth Street has now provided another $40mn through a “debtor-in-possession” loan that will fund Bed Bath & Beyond’s stay in court while yielding about 12 per cent interest annually. To secure this loan, the company reluctantly allowed Sixth Street to transfer or “roll up” $200mn of its existing loan into the DIP loan, which will be repaid first from any sale or liquidation proceeds. Its remaining claim of $347mn, including accrued interest, ranks lower in the hierarchy and could still suffer losses.
DIP loans had become less common since the financial crisis of 2008-9, said Jared Ellias, a Harvard Law School professor, so “this may indicate a change in the market for distressed financing or, more likely, the absolute desperation of Bed Bath & Beyond’s position.”
The judge overseeing the case noted that Sixth Street did not provide the extra $40mn “altruistically”. A lawyer for the investor told the court that the “roll-up was always the economic consideration for providing another round of capital”.
Bed Bath & Beyond added that it could not find any source of junior financing and that Sixth Street would not consent to “priming financing” from another party that would push it down the repayment hierarchy.
Even so, the retailer admitted that it had little choice but to take what Sixth Street was offering. It was, its investment banker wrote to the court, “the most favorable executable transaction available”.