On Tuesday August 19th PetSmart (NASDAQ:PETM) announced they are acquiring Pet360.com as well as exploring a potential sale of the business. While the latter should come as no surprise given how outspoken Jana Partners has been about pressuring a sale, it overshadowed the possibility of an acquisition by PetSmart. Given the simultaneous announcement, the acquisition deserves a look.
The Pet360 piece
The acquisition of Pet360 for $130 million in cash with the potential of $30 million in performance-based payment is a vital piece to management's commitment to grow shareholder value and silence the critics of e-commerce competition. During the Q2 2014 conference call CEO David Lenhardt mentioned the sale will close sometime in September. As I noted in my previous article, I believed online competition was overstated and this recent purchase compels me to look into their logic.
Pet360.com is an online community resource designed to provide tips, advice and shopping for pet parents. Their brand portfolio consists of PetFoodsDirect.com - an online pet food and supply shop that launched in 1997; PetMD - an online library for pet health info; BlogPAWS - the largest professional network of pet bloggers and social media enthusiasts and Only Natural Pet - a complete line of natural pet supplies. The Pet360 network has an immense online presence with over 30 pet websites.
The Pet360 brand reaches over 12 million pet parents per month and generates $100 million in revenue though they are not profitable yet. In the recent earnings release PetSmart management iterated that Pet360 and PetSmart will run as two independent entities. Pet360 is a fully stand-alone business with its own distribution capability and pet pharmacy, but the real value lies in PetSmart being able to offer their exclusive products to a greater share of customers. These exclusive products have nearly 2x the margins as the non-exclusive products. Transitioning some of the 12 million plus pet parents on Pet360 from the grocery brands to the higher margin channel exclusive food brands will help drive revenue expansion.
Looking at the graph below from ComScore, as reported by Credit Suisse, it's evident the two companies target different demographics. PetSmart has a higher income, family oriented customer base that would suggest higher average purchases. With the addition of Pet360 they'll have greater penetration into a different market segment. This is instrumental in PetSmart pushing their higher-margin omni-channel products into more carts and provides a wider diversification of customers.
In conclusion, the acquisition of Pet360 has immense potential to further grow shareholder value through an established online client base. Risks include a longer than anticipated path to profitability with PetSmart having to pick-up the slack. Continued lower in-store traffic and sales headwinds could provide additional revenue challenges. Management's iteration during their Q1 2014 earnings report that they were looking at strategic acquisitions indicates that this deal may have been in the works for months and before the pressure from Jana Partners to seek a buyout. With management guiding $4.29-$4.39 earnings per share for 2014 and a 5 year average P/E of 19.7, shares appear slightly undervalued. An offer to take the company private would bring further rise in share price.
Disclosure: The author is long PETM.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.