PetSmart moves stake in Chewy.com, loan agent hires counsel

04 June 2018
PetSmart has moved a 16.5% stake in Chewy.com to an unrestricted subsidiary, using its ability to make a sponsor dividend as the mechanism for the transaction, said four sources familiar with the matter. The announcement put investors on alert for more details about the ramifications of the move, which has echoes of J.Crew’s controversial transfer of intellectual property into a new subsidiary and out of reach of its lenders.
 
Chewy is no longer a wholly owned subsidiary of PetSmart. The unit’s guarantees of the term loan have been released, resulting in the release of the guarantee under the PetSmart’s senior notes, the sources continued. For its part, PetSmart credit facility agent Citigroup has hired legal counsel Latham & Watkins to review the company’s decision, according to two more sources familiar.
 
In today’s disclosure, the company said its board of directors made multiple balance-sheet maneuvers, including the declaration of a dividend on 1 June in the form of 20% of the outstanding stock of Chewy to its parent company, Argos Holdings. As such, PetSmart invested 16.5% of the outstanding common stock of Chewy in the form of capital contributions to a wholly owned unrestricted subsidiary of PetSmart.
 
PetSmart also noted it will continue to evaluate its capital structure and purse additional transactions.
 
Last year, investors initially hailed PetSmart’s USD 3bn acquisition of Chewy as a credit-enhancing, transformative deal giving the retailer entrée into the growing online market for pet supplies. But soon after the April 2017 acquisition closed, PetSmart’s capital structure descended into deeply distressed levels as earnings didn’t measure up to expectations.
 
More recently, investors had become increasingly wary that sponsor BC Partners would seek to siphon the value of the Chewy business out of the PetSmart borrower, as reported.
 
Management told investors just last month as part of one-on-one meetings that the company had no plans to spin out Chewy.com.
 
During an earnings call scheduled for 5pm ET today, investors will be looking for clarity as to whether PetSmart, like J.Crew, will seek to use the transferred assets to entice junior bondholders into an exchange backed by assets at the new entity, sources said.
 
Indeed, while the capital structure’s trading reaction was somewhat muted today, the company’s USD 1.9bn 7.125% senior unsecured notes due 2023 had the most positive reaction, gaining 2.4 points to trade at 50.75, according to MarketAxess.
 
Meanwhile, PetSmart’s earnings for fiscal 1Q18 – also released today in tandem with the asset transfer news – showed increases to both the top and bottom lines, said three of the sources.
Total net sales increased 43% to USD 2.54bn for the quarter, which ended 29 April, versus USD 1.78bn in the prior-year period. However, excluding Chewy, net sales eased by 0.5% to 1.78bn.
 
The company generated financing-adjusted EBITDA, excluding unrealized cost savings, of USD 271.7m during 1Q, up 5.1% from USD 258.5m year-over-year, sources continued. However, the 1Q18 figure includes a USD 52m adjustment related to a lag for change in vendor allowances, sources noted. Unadjusted EBITDA in the quarter was roughly USD 170.6m.
 
Comp-store sales declined 2.3% in the quarter, while gross margins compressed by 700bps to 25.8%. However, its gross margin in 1Q increased 120bps after excluding Chewy and factoring in the accounting change in vendor allowances.
 
The results pegged LTM financing adjusted EBITDA at USD 1.004bn, including USD 104.7m in total unrealized cost savings. That would put leverage at around 8x, based on total debt of approximately USD 8bn.
 
At quarter-end, the borrower had USD 327.8m of cash and an undrawn revolver. Last month, the company announced that it reached an agreement with lenders to extend the maturity of its Citibank-agented USD 750m ABL revolver, to 10 December, 2021 from March, 2020.
 
PetSmart’s USD 4.2bn Libor +300bps (1% floor) TL due 2022 is quoted in the 77.25/77.78.21 context, compared to a 78 context in mid-May, according to Markit. Its USD 1.35bn 5.875% first liens bonds due 2025 edged down 0.125 to 69 yielding 12.696%, according to MarketAxess.
 
The USD 650m 8.875% unsecured bonds due 2025 strengthened by 0.125 to 47.875 today, according to MarketAxess. The notes traded at a 68 context in early January.
 
Messages left for Citi, Latham and a spokesperson for PetSmart and its owner BC Partners were not returned.  Acuris, publisher of Debtwire, is a portfolio company of BC Partners.