gordonOn December 14th, PetSmart agreed to be taken private in an $8.77 billion transaction led by BC Partners, a European based private equity fund with a history of consumer and retail investments, largely outside of the US. The deal, the largest private-equity buyout of 2104, values PetSmart at 9.1x the company’s adjusted trailing twelve month earnings before interest taxes and depreciation.  PetSmart’s equity holders will receive $83.00/share in consideration if a superior bid does not emerge and the transaction is approved.

The deal described above reflects a 39% premium to the prevailing per share equity price just prior to the disclosure of Jana Partners, an activist investor, equity position in the company in July 2014.  BC Partners and its co-investors — Caisse de depot et placement du Quebec, Longview Asset Management and StepStone Group, LP — outbid Apollo Global Management and KKR & Co., among others, for the asset. The buying group is financing an estimated 6.5x EBITDA to fund the transaction.  Citigroup, Nomura, Jefferies, Barclays and Deutsche Bank have committed to provide $6.95 billion of debt to pay for the deal. The financing package consists of $6.2 billion in fixed debt, expected to be split between roughly over $4 billion of term loans and $2 billion of bond, and a $750 million asset-based revolver to support daily operations. 

I am an on record as predicting that a transaction involving PetSmart was unlikely.  My view was that the necessary equity premium to justify a transaction PetSmart would have been exceedingly hard to generate for a private equity fund and that the strategic buyer landscape was small. I correctly surmised a combination between PetSmart and Petco would have too many impediments (though Petco was not given a real opportunity to buy the company but may proffer a superior bid if so chooses), including regulatory concerns. However, I underestimated how much debt financing would be available for a private equity buyer to support the purchase price.  In my defense the debt markets were roiled by macro fears at the time of prediction.

In thinking about the implications of the transaction, I offer the following summary:

  • Financial Engineering at Work. I view this transaction as a triumph of financial engineering.  A combination of excess liquidity in both the public and private debt markets as well pent up demand for large cash flow generating assets by private equity made this transaction viable.  The buyers must believe there are additional cost rationalization opportunities beyond the $200 million Profit Improvement Program management announced on the November earnings call.  More than one bidder who dropped out of the process proffered their view that additional opportunities appeared evident to support the required debt load. I am not expecting much change to the strategy and operating framework David Lenhardt laid out on the May 21, 2014 earnings call.  While being outside of the public reporting sphere, save for any public debt requirements, will allow PetSmart to pursue some strategies that sacrifice near term profits for long term growth, the anticipated transaction debt load will limit flexibility in this regard.  Moving PetSmart forward will be more about better execution of tactical store level decisions and incremental strategies, than “big bang” opportunities.
  • Lost Transparency. As we have detailed here previously, the pet industry lacks performance transparency. The vast majority of manufacturers and retailers are private companies or divisions of public enterprise with limited disclosure requirements. As a result, the industry is starved for timely fact based performance data. A publicly traded PetSmart provides the general public insight into the direction of the industry. That information is both free and timely. The company’s quarterly conference calls provide a wealth of information on category level performance and pet consumer trends.  Once private, this transparency will dissipate.  We think that is a real loss for the industry.
  • Not the Last Transformational Deal.  The take private of PetSmart is not the first transformational deal of this cycle and it won’t be the last. The number of large private pet companies across industry categories has swelled over the past five years. Whether it is an acquisition of Blue Buffalo, a public listing for Big Heart Brands, or a sale of Hartz Mountain, we expect that more big deals are on the horizon.

/bryan

Note: This blog is for informational purposes only. The opinions expressed reflect my view as of the publishing date, which are subject to change.  While this post utilizes data sources I consider reliable, I cannot guarantee the accuracy of any third party cited herein.

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