PetSmart Takeover Talks Get Ugly

July 29, 2014

Talks about a possible takeover of Phoenix-based PetSmart Inc. went from cordial to borderline hostile Tuesday when the company's largest shareholder sent a letter to its board of directors using some strong, accusatory language.

The shareholder, a multibillion-dollar hedge fund called Jana Partners, stepped into the limelight earlier this month when, in another letter, said PetSmart was undervalued and not keeping up with industry competition. Jana left its door wide open for a conversation about a possible sale of the company, but since then, PetSmart's response has been, "Thanks, but no thanks."

But that didn’t sit well with Jana Partners, which has amassed almost 10 percent of the company since May. In its letter Tuesday, Jana said it was “stunned” that PetSmart wouldn't even talk to potential buyers. It used words like “failure,” “micromanaging” and “disastrous” to describe the direction it thinks PetSmart management has been taking the company in recent years.

Right now, PetSmart is virtually debt free, which is why it’s attractive to investors like Jana. So to make a takeover less attractive and more expensive for potential buyers, PetSmart is currently looking to load itself up with huge debt. If PetSmart follows through, Jana threatened in its letter that it would take measures to switch the makeup of PetSmart's board at the next annual meeting. That could give Jana board representation and thus more sway at the highest levels of the company.

“Most companies want to remain independent because when you consolidate companies, one of the management teams is gonna get wiped out," said Robert Mittelstaedt, the retired dean of Arizona State University's W.P. Carey School of Business. He said another reason companies resist hostile takeovers is because they know the goal of the buyers is always to make huge profits within a short period of time.

“They know that they don’t care about the really true long term and they don’t care about the survival of the company from a standpoint of the employees or other shareholders," Mittelstaedt said.

Sometimes, he said, companies aren’t necessarily better off after a takeover.

Take arts and crafts store Michael’s, for example. Two massive private equity firms used about $5 billion in loan debt to buy Michael’s and take it off the public stock market in 2006. Eight years later, the firms took Michael’s back to the stock market last month, but it's debut has so far been lackluster. Michael's still has tons of debt on its books from that 2006 takeover, and Wall Street investors are wary as a result.

Yet if the two private equity firms walked away right now, they could triple their investment.