Private Equity Is the Tail Wagging PetSmart's Dog

The pet supplies retailer is taking seriously the demands of its biggest shareholders.

Jul 18, 2014 at 2:53PM


Under pressure from private equity investors to sell itself, pet supply specialist PetSmart (NASDAQ:PETM) is jumping through their hoops and is reportedly in talks with investment bankers to discuss strategic alternatives -- but perhaps also to initiate defensive strategies.

It was hedge fund Jana Partners that started barking for PetSmart to sell itself. With the pet supply company's stock underperforming the S&P 500 over the past year, the PE firm announced it had taken a 10% stake in PetSmart and wanted the company to explore a sale or other alternatives to enable shareholders to enjoy a significant return of capital.

Although initiating discussions following an activist investor's command is not uncommon -- there's a certain fiduciary responsibility on the part of the board of directors to at least begin considering the possibility -- the piling on by passive investor Longview Asset Management also urging a sale was seen as a significant development and helped bring the pet supplies company to heel. An activist investor typically takes a position in order to effect substantial change at a company; you know where they're coming from. A passive investor, on the other hand, is usually seen as supportive of management, so Longview, which owns 9% of PetSmart's stock, coming out in favor of a sale is a big deal.

Talking to investment bankers is a bigger step for the pet supplier to take than the review it initially began of ways to return more capital to shareholders, such as through increasing its dividend, repurchasing more of its stock, or even taking on more debt. 

PetSmart currently pays a dividend of $0.78 per share that yields 1.4%, for a 22% payout ratio. According to data compiled by Bloomberg, that's significantly less than the average 35% payout offered by companies comprising the S&P 500. It further notes that PetSmart spent approximately $485 million buying back shares over the past 12-month period ending Feb. 2. Its last quarterly report showed it had around $300 million in cash, equivalents, and restricted cash on hand and little in the way of long-term obligations, other than the capital leases for its stores.

The pet retailer has been suffering from a slowdown in business that's affected retailers all across the landscape, but is also coping with competitive pressure from mass retailers like Wal-Mart and Target, both of whom have expanded their pet supply offerings, and from Amazon and its website. While revenues were up 1.1% last quarter, same-store sales inched lower 0.6%, with comparable transactions decreasing 2.2%.

Even so, PetSmart has been recording multiyear double-digit increases in earnings per share and last year generated more than $468 million in free cash flow. That's lower than the half-million dollars or so it generated the year before, but that had more to do with compensation-related matters than any failings in the business.

Pet supplies remains a growth industry. According to the American Pet Products Association, more than-two thirds of U.S. households own a pet, with dogs remaining the top choice at 57% and cats coming in second at 45% (fish are a distant third at just over 14%). Overall spending hit a record $55.7 billion in 2013, enough to apparently cause Del Monte to sell its well-known fruit business, the biggest in the country with a 30% market share, in favor of focusing on its pet food business. It was a little-realized fact that Del Monte was also the fourth-largest pet food maker.

Screen Shot

Source: American Pet Products Association.

Yet it's also become apparent that the rate of growth is slowing. With more retailers devoting more of their attention to the profit-making centers of pet supplies, namely premium and super-premium food, PetSmart is starting to lag. Wal-Mart, for example, introduced an ultrapremium dry dog food, Pure Balance, that contains no soy, wheat, or corn additives, no artificial colors, no preservatives, and no chicken by-products. 

PetSmart has been bolstering its online offerings to counteract the threat that Amazon represents, but repositioning such as that takes time, time it apparently doesn't have as private equity looks for short-term gains. It may be wagging its tail right now to please its masters, but its discussions with investors could lead it to take a defensive posture too, and it could always end up biting the hand that's fed it.

Bank of America + Apple? This device makes it possible.
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its destined to change everything from banking to health care. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here

Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends, Apple, Bank of America, and PetSmart. The Motley Fool owns shares of, Apple, and Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information