July 3 (Bloomberg) -- PetSmart Inc. shares surged after hedge fund Jana Partners LLC disclosed an activist stake in the pet-care company and urged it to undertake a strategic review, including a potential sale.
Jana, the $10 billion firm run by Barry Rosenstein that’s known for pushing corporate managements to make changes, acquired about 9.9 percent of Phoenix-based PetSmart in stock and options, according to a regulatory filing today, and “expects to have discussions” with management, the board and other investors.
Shares of PetSmart, which sells pet-care supplies and services in stores in North America and online surged 13 percent to $67.28 at the close in New York, the biggest one-day gain since May 2012. The stock had fallen almost 18 percent this year through yesterday, giving the retailer a market capitalization of almost $6 billion.
PetSmart needs to improve operating performance and capital allocation and return “significant” capital to shareholders, Jana said. The fund also called on the company to improve disclosures and the composition of management and its board.
The retailer “has languished lately as competitive pressures within the pet supply retail sector have intensified. We do not foresee a quick fix,” Brian Nagel, an analyst at Oppenheimer & Coo., said today in a note. While the company “possesses the characteristics of a retail takeout candidate, we view a sale of the chain at this juncture as unlikely.”
PetSmart said today in a statement that it welcomes communication with shareholders and that its board and management are committed to creating value for shareholders.
PetSmart Chief Executive Officer David Lenhardt replaced Bob Moran in June last year, after rising through the ranks since joining the company in 2000 from Bain & Co. Gregory Josefowicz took over Moran’s role as board chairman. Moran opted not to stand for re-election after earlier announcing plans to be executive chairman.
The retailer, which has about 53,000 employees, operates more than 1,340 pet stores, as well as 200 in-store dog and cat boarding facilities. Rival Petco Animal Supplies Inc. was acquired by private-equity investors led by Leonard Green & Partners LP in 2006.
While most of New York-based Jana’s investments aren’t activist -- where a fund uses its stake to push executives and directors to make changes that boost shareholder returns -- it’s those campaigns that attract the most attention. Jana’s recent targets, where it has sought board seats or the separation and divestment of assets, include Oil States International Inc., URS Corp., QEP Resources Inc. and Agrium Inc.
PetSmart’s relatively low valuation -- before the news of Jana’s stake pushed shares up -- may appeal to private-equity suitors, with potential double-digit returns, David Strasser, an analyst at Janney Capital Markets, said today in a note.
The stock’s closing price yesterday was about 13 times trailing 12-month free cash flow, which was a 41 percent discount to the median multiple for U.S. retailers with market values larger than $1 billion, according to data compiled by Bloomberg.
PetSmart also earns less operating profit for each dollar of sales than its peer group average, which means an acquirer would have an opportunity to boost margins, data compiled by Bloomberg show.
With almost twice as much earnings before interest, taxes, depreciation and amortization than debt, PetSmart’s leverage ratio may be low enough for a debt-funded buyout, the data show.
Deals within industries have also caught Jana’s attention recently. Earlier this year, the fund invested in Walgreen Co., the largest U.S. drugstore chain, which has a stake in Alliance Boots GmbH. Rosenstein said in May that Jana was working behind the scenes with Walgreen, which is mulling a full takeover of the U.K.’s largest pharmacy chain.
Jana also bought a stake in AerCap Holdings NV in a bet that the Schiphol, Netherlands-based aircraft-leasing firm will benefit from its purchase of American International Group Inc.’s International Lease Finance Corp.
Activist investors tend to buy at least 5 percent of a company’s stock and flag their intention to actively engage executives and directors by disclosing their holding in a 13D filing with the U.S. Securities and Exchange Commission.
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