California-based bebe stores, inc. (NASDAQ:BEBE), a women’s apparel retailer with 147 stores in the U.S. and Canada and suffering slow sales for some years, finally pulled the plug May 27, ceasing all retail operations.
That’s the bad news. The good news is that it will live to fight another day.
Why does this matter?
Well, for bebe shareholders, it means their equity is still worth something. Often, when a company goes bankrupt, the equity is cancelled, and shareholders are out of luck.
For investors here in Canada looking to buy retail stocks like Canadian Tire Corporation Limited (TSX:CTC.A) and Dollarama Inc. (TSX:DOL), it’s a great example of why you need to pay attention to the balance sheet.
The beginning of the end
The writing on the wall became very apparent for all bebe stakeholders in June 2016 (the company’s fourth quarter) when it announced a joint-venture partnership with Bluestar Alliance LLC, a New York City licensing company that takes brands on the down and out and injects new life into them.
Bluestar uses its extensive retail network to find licensee partners, such as department stores interested in their various brands, and works with those partners to grow the business. It’s an asset-light model where pretty much everything but the marketing and design is outsourced to others. When done well, it can be very profitable.
Bluestar Alliance contributed US$35 million to the partnership in return for slightly less than 50% ownership, with bebe owning the rest.
More of the details
To cease its retail operations, bebe will pay its landlords US$65 million to close all of its stores using the US$27 million in cash on its balance sheet along with US$22 million it expects to receive in July when the sale of its 244,000-square-foot distribution centre closes. The remaining US$16 million payable to landlords will come from a US$35 million loan it’s obtained from Great American Capital Partners, a U.S. specialty finance company.
On May 30, the company transferred to the joint-venture ownership of its website domains, including www.bebe.com and www.bebeoutlets.com. That says it has no plans for the internet (the joint venture has found a third party to handle both the online and wholesale business who pays a royalty), and its sole business will be collecting distributions from the joint venture.
Here’s what’s left after winding down its retail operations.
- It will liquidate US$35 million in inventory for US$9 million in cash based on getting 40% less the liquidator’s commission.
- bebe will sell a 50,000-square-foot design/production studio in Los Angeles and two condos estimated to be worth US$18 million.
- It will have a US$35 million loan.
- It’s net operating losses are approximately US$300 million, which are worth $12 million, or 4% of the total according to section 382 of the Internal Revenue Code.
- The 50.01% ownership interest in the joint venture carried on the balance sheet is at US$2.4 million.
Bottom line
bebe’s current market cap is US$48.2 million.
Assuming, and these are very rough calculations, all of the above plays out, it will have net cash of just US$4 million (the cash generated from real estate sales, etc., from above less loan) and the joint-venture asset to show for all of its work to avoid bankruptcy.
However, the upside potential of the 50.01% interest along with the attractiveness of the net operating losses to any buyer of what is now effectively a holding company should keep its share price from cratering to zero.
None of this would have been possible if bebe didn’t have a reasonably strong balance sheet, albeit one that was rapidly deteriorating due to accumulating losses, to stave off bankruptcy.
The moral of the story: it never hurts to buy stocks with little or no debt and lots of cash on the balance sheet. It’s even better if they’re making money.
If you want to learn how to value businesses with a lot of moving parts, bebe is an excellent lesson.
