PetSmart Shops Assets Amid Activist Pressure

NEW YORK (The Deal) -- PetSmart Inc. (PETM)  the self-proclaimed largest retailer of pet products, said late Tuesday it will explore strategic alternatives including a sale.

Advising the pet retailer on its strategic review is JPMorganSecurities  (JPM) and Wachtell Lipton Rosen & Katz.

"Notwithstanding our confidence in the Company's future prospects, following a detailed Board review of the Company over the last several months, including many constructive conversations with a wide range of shareholders, we have decided to explore options to maximize shareholder value, including a potential sale of the Company," said Gregory Josefowicz, PetSmart's chairman, in a statement.

The Phoenix-based company has been under pressure from activist investor Jana Partners since early July when the hedge fund revealed a 9.9% stake in a regulatory filing, saying that it intended to discuss alternatives with management including a sale.

Jana has received backing from asset manager Longview Asset Management LLC, which not only supported the sale idea, but said that in some situations it might even consider rolling its 9% stake in the retailer into a leveraged buyout. Since that time, Jana has consistently been barking for an auction of PetSmart.

On Monday, the hedge fund said, in a regulatory filing it had received an "anonymous, unsolicited package," that included business plans related to the company's third and fourth quarter results, plus a cover letter noting the company had "missed internal projections." Jana urged management to share the information with shareholders.


Having officially put itself on the block, potential acquirers will be crunching the math for the deal. And it's a deal that makes sense, the math for the deal, especially one that involves private equity.

With about $250 million in cash on its balance sheet, and almost $520 million in debt, PetSmart has an enterprise value of approximately $7.18 billion, based on a market cap of about $6.91 billion. That valuation is a multiple of 7.63 times the roughly $940 million in Ebitda PetSmart is estimated to generate in the fiscal year ending Jan. 31, according to Bloomberg data.

But that enterprise value is based on the affected stock price. On July 2, the day before Jana Partners announced its stake, PetSmart closed at $59.81 per share, 14% below where it closed on Tuesday at $69.70 per share.

At nearly $60 a share, PetSmart had a market cap of about $5.95 billion. Adding debt of nearly $520 million and subtracting cash of about $250 million to that amount (per Bloomberg data), would equate to an enterprise value of $6.22 billion or a valuation multiple of 6.6 times the $940 million in Ebitda projected for its current fiscal year.

That's under the unaffected 7 times multiple PE firms look for when considering potential buyout targets. A 20% premium to the unaffected price would equate to an offer somewhere in the vicinity of $72 per share.

Plus, PE firms merging PetSmart with a portfolio company could generate cost-saving synergies and provide room for an even higher bid. Historically, PE firms can end up paying multiples in the high single digits for more mature retailers. At $72 per share, the company would have a market cap of $7.14 billion based on roughly 99.2 million outstanding and an enterprise value of $7.41 billion.


PE would have to finance around 25% of such a deal with equity or cash, equating to about $1.85 billion at the $72 per share price. The approximately $5.29 billion remaining could be financed with debt, which would only be about 5.63 times Ebitda. This is all assuming Longview doesn't roll its stake into a buyout. If the firm did, it would reduce leverage and equity needed to finance a transaction.

A deal might also look different if competitor PetCo Animal Supplies Inc., backed by PE firms Leonard Green & Partners and TPG Capital, were to merge with PetSmart.

The two PE firms could either buy out PetSmart and take it private, or have PetSmart acquire PetCo, with the two firms taking shares in the listed entity, allowing them to exit the long-held portfolio company.

The company also reported second quarter results, saying that net income was up 5.1% to about $98 million, compared to roughly $93 million for the same period a year prior, while net sales increased 1.4% to $1.7 billion. Comparable store sales, however, were down a half percent. In Wednesday morning trading, PetSmart's stock was up under 1%, to $70.17 per share, giving it a market cap of nearly $7 billion.

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