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PetSmart's $8.7 Billion LBO Is Already Paying Off For Consortium Led By BC Partners

This article is more than 8 years old.

Americans spent some $60 billion on their pets last year – and it appears that cat and puppy love is turning the $8.7 billion leveraged buyout of pet supply giant PetSmart into a home run deal.

Roughly ten months after PetSmart's takeover was sealed by a consortium of PE buyers led by BC Partners, the company is returning a whopping $800 million dividend to its new owners. That cash return, equivalent to about 38% of the cost of PetSmart's take private deal, comes as the retailer has exceeded expectations in increasing profits and sales under its new management, led by CEO Michael J. Massey, a retail turnaround artist who formerly led Collective Brands, the parent company of Payless ShoeSource.

Massey, supported by a team at BC Partners, put together an operational improvement plan during the due diligence and closing of the PetSmart deal, which is boosting margins and giving fuel to a 2016 expansion plan. Within 30 days of closing the deal in early March 2015, PetSmart's management ranks were reshuffled, with seven senior managers and a significant portion of VP-level employees being replaced by a team handpicked by Massey and BC Partners. This new team is striking pay dirt in achieving the operational improvements that have turned some large retail buyouts, for instance KKR's takeover of Dollar General , into major successes.

Massey implemented zone pricing at PetSmart, ending a nationwide pricing formula. He also shifted pricing on individual items, bolstering volumes for those that were overpriced, while raising prices on goods selling for too little. Shipments of inventory to the company's over 1,400 stores were changed to account for the sales volume of each location, mitigating issues of oversupply. Working capital, often a low-hanging fruit for PE operators, was improved.

The Massey/BC Partners team also found significant expense improvement by opening a 30-person sourcing team in Asia for PetSmart's hard goods, in addition to analyzing thousands of expense line items above $1,000. That re-focus on expense caused PetSmart to switch its credit card processing to First Data , and re-open auctions for vendor contracts.

These moves are apparent in PetSmart's improved finances.

Earnings before interest, taxes, depreciation and amortization (EBITDA) have risen over 16% through the first nine months of 2015, a tripling of EBITDA growth rates. EBITDA margins, meanwhile, have increased 140 basis points to 15.7%, and cash flows have improved markedly. None of this rising profitability has come at a cost of overall growth. Through nine months, revenue growth has nearly doubled to 4.6%, leading to $7.3 billion in total sales.

“We saw a lot of improvement based upon being more focused on expense and being margin focused," Massey told FORBES, reflecting on PetSmart's first year in private hands. He adds, "We drastically changed the organization of the company so we could act and make decisions more quickly.”

What once was a somewhat inefficient operation that let profits leak out the door is now re-focused and ready to grow, says Massey.

Under its PE owners PetSmart has also embarked on a major data effort to better understand its customers. The insights gleaned are unsurprising: Customers love bringing their pets to stores and find retail outlets are a social place for cats and dogs, and their owners. However, this means PetSmart expect to bolster investment for services like veterinarians, day care, and grooming that bring pets to store locations, instead of cutting them.

"The sense of community at PetSmart is off the charts,” says Massey, who's family owns Rocky, a bichon fries; Darby, a Shiapoo, and an 11-month old English cream golden retriever named Daisy. "This business is about smiles and kisses."

PetSmart is returning the $800 million to investors because the business is a year ahead of plan, according to Massey. Often private equity buyers finance dividend payments to their limited partners with debt, a move known as a dividend recapitalization. In PetSmart's case no debt is being used. In fact, the company's net debt after the dividend will be 5.6-times its EBITDA, lower than the 6.4x leverage multiple it carried at the close of the LBO on March 11.

"You had a company Petsmart that is a market leader in a very attractive retail category, which is relatively recession resistant and growing," says Raymond Svider, the executive at BC Partners leading the PetSmart deal. "Against that backdrop of stability and leadership you had a company that could be meaningfully improved by a talent upgrade,” and renewed investment into the business, he adds.

This year PetSmart plans to increase the rate of its store growth from the 50 locations it opened in 2015. “This is a company that can grow dramatically," says Massey. Last fall reports of a merger with private-equity backed competitor Petco surfaced, however, that talk has abated amid rising antitrust risks in retail consolidation efforts.

An interesting feature of PetSmart's buyout is the number of investors who ultimately participated in the deal, which was is one of the largest since the financial crisis, and was stuck at a time when troubles in LBO financing markets surfaced.

Canada-based pension fund, La Caisse de depot et placement du Quebec, StepStone and Longview Asset Management all participated in the initial take private, and BC Partners subsequently syndicated the deal to over two dozen limited partners. In total, BC Partners offered $1.2 billion in PetSmart co-investment to its LPs.

At a time when buyout deals come against a tightening credit market, the quick success at PetSmart may indicate PE firms have a way of navigating the current market jitters.