How do you destroy a company generating more than $7 billion in revenue? Easy, bury it under a mountain of debt. Private equity firms often get a bad rep and for good reason. Their recent track record when it comes to high profile acquisitions and performance has been less than stellar. Sports Authority went out of business in 2016 and Toys”R”Us followed it shortly after. Both companies were bought out and saddled with debt by PE firms at a time when they needed free cash flow to adapt. Now it seems like PetSmart may be one of the next giants to fall.
PetSmart made headlines in 2017 when it bought Chewy.com for $3.4 billion in what was the largest e-commerce acquisition to date. Chewy, a still unprofitable company was supposed to be the guiding light of the new PetSmart. It was going to help it diversify its client base, increase consumer retention, and give it a major foothold in e-commerce, a space it had been poorly performing in.
But PetSmart didn’t have the money to buy Chewy, so it bought them with debt. That wouldn’t have been so bad in 2014. Back then PetSmart was generating over $7 billion in revenue and had low debt levels, but in 2015 BC Partners acquired PetSmart in a leveraged buyout for $8.7 billion dollars. This loaded them up with debt and putting them in a similar position to Toys”R”Us. Sales were still strong but now a large portion of their revenue would have to be diverted to interest payments. Worse yet, BC Partner had no experience in the pet industry or the US retail market.
By the time the deal for Chewy closed PetSmart found itself shackled to $8.1 billion in debt. Even worse, while PetSmart was used to generating 34% gross margins at their brick and mortar locations their overall gross margins dropped to 25.8% when including Chewy. Then in August of 2017 their CEO, Michael Massey left without naming a successor. He was followed shortly after in 2018 by Ryan Cohen, co-founder and CEO of Chewy. While Chewy was able to name a new CEO PetSmart has not. It has been eight months since Michael Massey’s departure with no word of his successor.
With same store sales and traffic (key indicators for brick and mortar businesses) falling PetSmart finds itself in need of a way to survive. Instead PetSmart is planning to open up to 60 new stores in 2018. In a time when you would think they’d want to invest in further integrating Chewy into their core business they’ve decided to move further in the opposite direction. The company seems unorganized and confused. They have no clear leader and they’re saddled with more debt than their debt holders are comfortable with.
There doesn’t seem to be a clear path for PetSmart to get out of this unscathed. Large scale closures will need to happen to reduce expenses if they can’t figure out how to pay down both the interest and principle of their more than $8 billion of debt. This is both a lesson to independents and a massive opportunity. Now is the moment for independent pet retail stores to invest in their low cost web based presence. This is the time to invest in new and interesting products that hold promise. Now is definitely the time to be aggressive. With PetSmart in a holding pattern and the summer months quickly approaching independent have the opportunity to make an impact.
We know the warning signs to look out for and while it’s still early days PetSmart seems to be setting off some bells. It’s not often that giants fall but when they do it’s usually fast. We expect to see hesitation on the part of both lenders and suppliers, two key stakeholders that can largely determine the fate of PetSmart moving forward. We’ll be keeping a close eye on how this story develops but at the moment it’s outlook seems grim.