Jana Urges PetSmart to Pursue Sale Instead of Taking on Debt

PetSmart Inc. activist investor Jana Partners LLC, ratcheting up its campaign against the pet-care chain, urged the retailer to put itself up for sale before “short-circuiting” its prospects by taking on debt.

PetSmart has been considering changes to its capital structure with an eye to returning more money to shareholders. Jana, a $10 billion hedge fund run by Barry Rosenstein, said in a letter to the board today that it would prefer the company conduct a “fulsome review” and engage with prospective acquirers rather than pursuing a leveraged recapitalization.

“Given PetSmart’s chronic underperformance and significant private-equity interest in the company, a sale in this case very likely offers the highest risk-adjusted return for shareholders,” Jana said in the letter. “A leveraged recapitalization is appropriate only where a company can credibly say that it will drive future value higher by addressing the underlying causes of its share price underperformance.”

Jana disclosed a 9.8 percent stake in Phoenix-based PetSmart on July 3, urging the company to seek a sale, improve operating performance and return “significant” capital to shareholders. It also sought improved disclosures and a shake-up of management and the board. PetSmart responded on July 7, saying its board “has been reviewing potential changes to the company’s capital structure, with a focus on returning capital to shareholders.”

PetSmart shares fell 0.3 percent to $70.23 at the close in New York. The stock has declined 3.5 percent this year.

‘Unjustifiable Entrenchment’

With a leveraged recapitalization, a company borrows money in order to repurchase more stock or pay dividends. That move typically makes the business less attractive to prospective buyers -- something PetSmart investors wouldn’t appreciate, Jana said in today’s letter.

“Should the board adopt any debt the terms of which would make a sale more difficult or enter into acquisitions that could deter a sale, shareholders will rightly see this as a wholly unjustifiable entrenchment device,” Jana said.

Matt Sherman, a spokesman for PetSmart, didn’t immediately return a phone call seeking comment.

Petco Animal Supplies Inc., a PetSmart competitor, was acquired by private-equity investors led by Leonard Green & Partners LP in 2006. Buyout firms also may be interested in PetSmart, thanks in part to an attractive financing market, Jana said.

Strategic Missteps

PetSmart has underperformed its peers for a decade through “years of operational and strategic missteps,” including poor Internet sales, pricing, cost management, store formats and product innovation, the hedge fund said today.

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.

While most of New York-based Jana’s investments aren’t activist situations -- where a fund uses its stake to push executives and directors to make changes that boost shareholder returns -- it is 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.

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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