San Diego For two years, the stock of retailer Petco Animal Supplies has been a dog because management has been screwing the pooch. Since 2000, it has piled up debt so insiders could make fat and fast bucks. Because it has concentrated on financial finagling, not its business, it has fallen far behind its Phoenix competitor, PetSmart.
Now you have to wonder if Petco's shareholders have the intelligence of a cur -- or a flea. Late last month, these stockholders overwhelmingly approved a debt-financed buyout at a price well below another bid. Petco will be purchased by two groups of investors, Leonard Green and Partners and Texas Pacific Group, that pulled the same stunt six years ago, amassing 600 percent profits as they dumped their stock.
It was a flip job: after buying the then publicly held company with borrowed money in 2000, they took it public again in 2002. By late 2004, Green/Texas Pacific had jettisoned all their shares, which they had given themselves for only 49 cents each. Green/Texas Pacific will certainly flip Petco again: they will sell the company if anyone is dense enough to buy it, or they will bring it out in still another public offering.
This process is called a leveraged buyout, and it makes no economic sense other than to enrich a group of piranhas. All over the country, leveraged buyouts are picking up steam, and some observers, notably the New York Times, are concerned. In a leveraged buyout, financial sharks buy a company with as much as 90 percent debt, usually junk bonds. Often, the buyers pay themselves a succulent dividend. The company goes private for a short time, then goes public again, and the insiders, who have put little of their own money in the deal, get rich quick as they dump their stock.
That's what's been happening at Petco. In 2000, the two buyout groups, Leonard Green and Partners and Texas Pacific Group, bought the company for $600 million, only $190 million of which was their own money. The rest was debt. The company went private and then went public again in 2002, and although it was stumbling from the debt load, the stock soared, and the buyout group dumped its shares for $1.2 billion, amassing a profit of more than 600 percent, according to a suit that has been filed in superior court. The suit unsuccessfully attempted to thwart the recent buyout. Having failed that, it now seeks to get damages of $200 million, according to Darren J. Robbins of Lerach Couglin Stoia Geller Rudman and Robbins.
Petco's shareholders last month went for a $29 offer from this buyout group because the price was 49 percent higher than the stock was selling for when the deal was suddenly announced in mid-July. That's a juicy premium. However, there was a much juicier $33-a-share offer from PetSmart on the table.
Management walked away from that higher offer, claiming that antitrust considerations would delay or perhaps abort the merger. Ah, but PetSmart offered Petco shareholders $3.50 a share if the deal didn't go through. And it was doubtful that the antitrust lads would have blocked this one anyway: together, Petco and PetSmart have about $5.7 billion of the pet supplies industry, estimated to be running near $39 billion annually. That's around 15 percent.
With the $33 offer and a $3.50 consolation bonus, the PetSmart deal was a "win-win" for Petco shareholders, says Robbins. Petco shareholders preferred to lose-lose, apparently not fully cognizant that Leonard Green and Texas Pacific have been using the company as a "personal piggybank," says Robbins, and will do so again in the next flip, probably two years hence.
Petco kept its shareholders in the dark about its pending plans. On July 14, 2006, it suddenly announced that it would be bought by Green and Texas Pacific for cash. The news release did not mention that Green/Texas Pacific had bought the company before. In addition, the release said a special committee of the board had studied "an expression of interest" by a buyer. That was stated in the singular. But on August 11, the shareholders learned in a special proxy that PetSmart in April had offered a $30 to $32 buyout. So that July 14 news release was wrong; there had been two expressions of interest. Shareholders also learned in August that Green/Texas Pacific had made the first bid on March 25 at $26.50 a share. After the Pet- Smart bid of April, the two parties engaged in a bidding battle (usually called a pissing contest), in which each alternately boosted its offer.
Another thing revealed in that August 11 confessional was that before Green and Texas Pacific made the March 25 bid, their partners already had snapped up 3.2 percent of Petco stock. This means that after those partners dumped the last bit of their shares in October 2004 at above $35, they waited while Petco stock plummeted and began snatching up shares again at lower prices. Nice timing for a group that had controlled the company only a few years earlier.
Back in March, Petco management concluded that the initial offer looked good, because investors were skeptical about management's embarrassingly consistent missing of earnings targets. And among other things, Wall Street questioned the company's long-term pricing strategy in its stores. For some time, Petco had been pricing goods too high; that's one thing that motivated big-box retailers like Wal-Mart and Target to put more oomph behind the pet supplies business. Those two, along with grocery stores, were devouring Petco. That's a major reason why Petco shares were almost cut in half after the buyout group sold the last of its stock at $35.60 in October 2004.
In April, May, and June, Petco weighed the offers as they hopscotched upward. The company said it pondered the antitrust question -- a contrived defense against PetSmart. On July 13, the buyout group jumped its bid to $29. That would be $1.8 billion, of which $1.35 billion would be burdensome debt. The next day, Petco announced that it would accept it -- with shareholders unaware of the $33 bid on the table.