Bed Bath & Beyond - An Excellent Investment With Takeover Target Potential

| About: Bed Bath (BBBY)

Bed Bath & Beyond Inc. (NASDAQ:BBBY) is a high-quality participant in the home furnishings retail industry, and is thus affected significantly by the housing industry. It sells a wide variety of merchandise such as linens, bath items, kitchen items, and basic house wares through a network of 993 BBBY stores in all 50 States, and a total of 1,173 stores. It also owns Christmas Tree shops, "buy buy BABY" stores, and Cost Plus and also has web site sales. Its immediate strategy is to open approximately 300 more stores in the coming years coupled with growing same-store sales.

BBBY has an outstanding long-term record of financial strength and profitability. The company has no debt. It generates a return of 26% on total capital. Sales are expected to continue to grow at 11.5% per year from the current level of $10.8 billion. BBBY pays no dividends, preferring to reinvest its cash flow in expansion, a sound strategy when it can generate 26% on capital. In 2012 BBBY generated $1.23 billion cash flow from operations but needed only $0.24 billion for capital expenditures in its stores, leaving almost $1.0 billion free cash flow, which it used to buy back BBBY shares; this benefits shareholders because each share then owns a slightly larger share of the business.

BBBY looks highly attractive from a valuation perspective. It trades at just 7.5X EBITDA, quite a modest valuation for such a highly successful liquid public company. Furthermore, the P/E ratio of 12 is below the market, and is below the expected growth rate of EPS, which is 14%, indicating the share value doesn't fully reflect the company's growth prospects.

BBBY may be an attractive M&A target for a strategic competitor or a large private equity firm. At a typical premium of 30% it would be a $19 billion deal, well within the reach of many possible buyers. Furthermore, it's possible the company could be receptive. The two co-founders and Chairmen are Warren Eisenberg, 82, and Leonard Feinstein, 76. Between them they own about 1.8 million shares - an $117 million value, and another 30% would gain them another $35 million! Since BBBY has no debt, the purchase price could be leveraged easily with $6-$7 billion of debt.

The stock currently trades for $64.75 per share. As a takeover target BBBY would be valued at more than $85. As a long-term investment with a future EPS of $8 and a market average multiple of, say, 15x the stock should have a future value in excess of $120 per share.

Disclosure: I am long BBBY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.