PetSmart to Undertake Review After Jana Takes Activist Stake

PetSmart Inc., under pressure from hedge fund Jana Partners LLC to pursue alternatives including a sale, is reviewing changes to its capital structure to return more money to shareholders.

There is no assurance that the review will lead to any actions, and the timing of potential changes is uncertain, the Phoenix-based pet-supply retailer said in a filing today.

PetSmart shares surged the most in two years last week after Jana, the $10 billion firm run by Barry Rosenstein, took a 9.9 percent stake in the retailer and said it was pursuing discussions with management, the board and other investors. Jana said the company should consider a sale and that it needs to return “significant” capital to shareholders while improving its operating performance.

“It’s not clear to me that a buyout does anything,” Sean McGowan, an analyst at Needham & Co. in New York, said today in an interview. “There aren’t any easy fixes because there aren’t any obvious problems.”

Executives have already worked to boost growth and returns in recent years by slowing expansion and adding higher-margin products such as super-premium pet food, McGowan said.

Lower Payout

PetSmart has a payout ratio, which measures the percentage of its profit paid out as dividends, of about 18 percent, according to data compiled by Bloomberg. That’s about half of the 35 percent average ratio for companies in the Standard & Poor’s 500 Index. The company spent about $485.4 million buying back stock in the year through Feb. 2, according to data compiled by Bloomberg.

“Returning that cash to the shareholders in the form of a repurchase or a dividend increase, or taking on more debt -- they could accelerate that,” said McGowan, who recommends holding the shares.

PetSmart rose less than 1 percent to $67.86 at 11:46 a.m. New York time. The stock gained 13 percent after Jana’s filing on July 3, the most recent trading day. The shares had fallen almost 18 percent this year before that filing.

Slower growth is “inevitable” at the retailer now that the easy fixes are completed, McGowan said. He added that management needs to put more emphasis on online sales, where PetSmart has a “great opportunity” to compete with, the online pet-supply site that is part of Inc.’s Quidsi Retail unit.

“Their biggest vulnerability, which they’ve ignored, is online,” McGowan said.

Jana’s Goals

Jana, which is known for pushing corporate managements to make changes, also called on PetSmart to improve disclosures and the composition of management and its board.

PetSmart responded to Jana’s filing with a statement saying that it welcomes communication with shareholders and that its board and management are committed to creating value for shareholders.

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.

PetSmart’s relatively low valuation -- before the news of Jana’s stake pushed the shares up -- may appeal to private-equity suitors, with potential double-digit returns, David Strasser, an analyst at Janney Capital Markets, said in a note last week.

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. PetSmart rival Petco Animal Supplies Inc. was acquired by private-equity investors led by Leonard Green & Partners LP in 2006.

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