PetSmart’s LBO Price Reveals Appeal of Unloved Stock: Real M&A

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Shareholders of a stock that no analysts have been recommending just got a great deal.

In a year that’s had the fewest U.S. leveraged buyouts since the financial crisis, PetSmart Inc. was able to clinch a transaction. BC Partners is taking the pet-supplies chain private in a deal valued at about $8.6 billion, or 9.2 times its earnings before interest, taxes, depreciation and amortization. That’s 16 percent higher than the median multiple in U.S. retail LBOs of the past five years, according to data compiled by Bloomberg.

At $83 a share, the offer represents a record price for the stock and tops what PetSmart shareholders had been expecting a suitor would pay. Earlier this year, PetSmart began showing signs that intensifying competition from Inc. and other retailers was weighing on its business and the shares were languishing near a two-year low.

“We remain surprised that PetSmart found a buyer,” said Brian Nagel, a New York-based analyst for Oppenheimer Holdings Inc. “But what this deal says is, despite all the concerns out there about Internet competition and such, there’s still a lot of value at these traditional retailers.”

Since the company said it was exploring a sale in August, analysts have been advising investors not to add to their holdings of the stock. For BC Partners, PetSmart offers strong cash flow and low debt, and the chance to build on cost-cutting and online efforts.

LBO Drought

The interest in PetSmart came at a time of weak demand among financial buyers to undertake large buyouts even as their cash stockpiles surge to record levels. There have been only 26 LBOs in the U.S. this year, the lowest since 2009, data compiled by Bloomberg show. Two-thirds of those were smaller than $1 billion.

BC Partners beat out other bidders, including Leon Black’s Apollo Global Management LLC and KKR & Co., during an auction that came down to negotiations over the weekend, people with knowledge of the matter said. That may spur speculation about what retailers the suitors that lost out on PetSmart could look to next. Abercrombie & Fitch Co., Ann Inc. and Guess? Inc. have screened as some of the industry’s best LBO candidates.

Activist Involvement

PetSmart became vulnerable after posting the fifth-worst performance among retailers in the Standard & Poor’s 500 Index in the first half of the year. Activist investor Jana Partners then stepped in and urged the retailer to sell itself.

“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, a $10 billion hedge fund run by Barry Rosenstein, said in a letter to PetSmart’s board in July.

The following month, PetSmart announced that it was exploring a sale. Over that time, the stock had gone from below $60 to around $70.

Of the 25 analysts that later updated their recommendations, 24 gave the equivalent of a hold rating and one had the equivalent of a sell. Their maximum price estimate was $80.

Given that PetSmart closed at $77.67 last week -- even though interest from multiple private-equity firms had been reported -- it shows that investors didn’t expect an offer to reach $83.

“This is obviously a nice premium to where the stock was prior to Jana Partners’ filing,” Bradley Thomas, a New York-based analyst at KeyCorp’s KeyBanc Capital Markets, said in a phone interview. “Seeing the stock up roughly 5 percent today tells you that the final announced takeover price is higher than what the market had expected.”

The stock closed Monday at $80.97.

Buyout Allure

For BC Partners, there are two ways to “win” with this deal, Thomas said. The first is for PetSmart’s operations to improve, and the second is to orchestrate an eventual merger with its closest rival, Petco Animal Supplies Inc. Petco, taken private in 2006, is still owned by private-equity firms Leonard Green & Partners and TPG Capital Management.

“What’s so exciting is that potential for consolidation,” Thomas said. “Down the road, Leonard Green could look at buying from BC Partners, or BC Partners could look at buying from Leonard Green.”

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