With every move it becomes more obvious that PetSmart is the patsy. On April 29th Chewy filed documents for an initial public offering. The move shouldn’t come as a surprise considering PetSmart’s owner, private equity firm BC Partners had begun shifting assets in back in 2018.
If shifting assets doesn’t sound completely above board to you, you’re not alone. PetSmart’s bondholders — the businesses on the hook for about $8 billion in debt — sued PetSmart for weakening their rights over the Chewy unit of the business. With Chewy further out of their grasps bondholders face higher losses in the event PetSmart can’t pay back it’s $4 billion loan due in 2022 or it’s additional notes due in 2023 and 2025.
What’s going on
In late 2014 BC Partners purchased PetSmart in a leveraged buyout (I’ve talked about it here). The way it works is simple. PetSmart was a public company with public shareholders, PetSmart then took out $8.7 billion in debt and purchased all of its shares making it the sole shareholder of itself. Lastly, PetSmart then transferred all of the shares but none of the debt over to BC Partners. At the same time PetSmart is delisted from the stock market and BC Partners is given full control. (This of course is a simplification so various details are lost or not made public).
The deal closed in 2015 and two years later in 2017 PetSmart — under the direction of BC Partners — bought Chewy for $3.4 Billion, with BC Partners chipping in $1 billion for the purchase. A year later BC Partners authorized PetSmart (which is the on paper owner of Chewy) to transfer 16.5% of its stake in Chewy to an unrestricted subsidiary and another 20% to Agros Holdings (PetSmarts holding company) placing 36.5% of Chewy under the direct control of BC Partners and more importantly, out of reach of all existing bondholders and creditors.
During this time PetSmarts debt was trading at distressed levels. Bondholders realizing what BC Partners was doing began suing PetSmart arguing that PetSmart was insolvent at the time of the transfer. PetSmart and it’s lenders ended up settling in April 2019 shortly before the Chewy IPO was announced.
Chewy’s the exit
Through everything PetSmart has cemented itself as the fall guy. By using PetSmart as a vehicle BC Partners was able to acquire Chewy and only pay $1 billion, less than a third of the final acquisition price. Last year PetSmart stated a $4.5 billion valuation for Chewy, if the $4 — $5 billion range holds BC Partners direct stakes will be valued at $1.46 to $1.82 billion.
Everyday it looks more and more like PetSmart is not meant to succeed. While Chewy has grown revenue for PetSmart remains flat. All investments have been directed towards Chewy in an effort to dress it up for its IPO to the detriment of quasi-parent company PetSmart.
Even if Chewy (a company which lost over $267 million last year) raises $500 million during their IPO, a number that seems unlikely, there’s nothing that says it will go towards paying any of the $8 billion in debt PetSmart currently holds. In fact, their filing states proceeds from the IPO will go towards working capital and other general corporate general purposes, not debt repayments.
The picture is starting to become more clear. BC Partners has shielded themselves enough to recoup and make money from their initial investment. In the event BC Partners decides to only maintain their 20% stake look for them to target a higher price for the IPO. At that level they’ll be able to recoup their initial investment and use the remaining 16.5% of Chewy as a bargaining chip with PetSmarts bondholders when the first $4 billion in debt comes due in 2022.