Tue 10/27/2020 09:27 AM
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2027 Secured Notes, 2028 Unsecured Notes Core Analysis

PetSmart Inc. announced on Monday that it would be issuing $1.2 billion of first lien notes due 2027 (the “2027 Secured Notes”) and $1.15 billion of senior unsecured notes due 2028 (the “2028 Unsecured Notes” and, together with the 2027 Secured Notes, the “Notes”). Proceeds are to be used, together with cash, proceeds from a new $2.3 billion senior secured term loan facility and a $1.3 billion equity contribution from its sponsor, BC Partners, to fully repay debt under its existing term loan facility and redeem its outstanding secured and unsecured notes.

Concurrently with the issuance, PetSmart intends to:
 
“[D]istribute, directly or indirectly, all shares of Chewy Inc. common stock currently held by PetSmart and its subsidiaries (the ‘Chewy Distribution’). Following completion of the Chewy Distribution, PetSmart will not own any shares of Chewy common stock. Accordingly, neither Chewy nor any subsidiary of Chewy will be a subsidiary of PetSmart.”

PetSmart’s capital structure as of Aug. 8, adjusted for the issuance of the Notes and the Chewy Distribution, is illustrated below.
 
A comprehensive report on the Notes is available HERE.
 
Fool Me Once, Shame on You; Fool Me Twice, Shame on Me

In June 2018, PetSmart disclosed that it had declared a dividend composed of 20% of the outstanding common stock of Chewy to its parent company Argos Holdings and that it had contributed 16.5% of the outstanding common stock of Chewy to an unrestricted subsidiary. As a result of the dividend, Chewy became a non-wholly owned subsidiary, and this triggered an automatic release of Chewy’s guarantee and a termination of liens on Chewy’s assets securing PetSmart’s debt.

PetSmart’s $3.1 billion acquisition of Chewy, completed in May 2017, was financed with a $1 billion equity contribution and $145 million of cash and through the issuance of $1.35 billion of first lien notes and $650 million of unsecured notes.

As illustrated below, adjusted for the issuance of the Notes and the 2020 Chewy distribution, since PetSmart acquired Chewy, its adjusted EBITDA has declined by 11%, its total assets have decreased by 29% and its balance sheet cash has declined by 77%; on the other hand, it will have 44% less debt, and leverage decreases by almost two turns.
 

Nevertheless, as illustrated in the issue date flexibility scales copied at the end of this analysis and summarized below, as a percentage of LTM adjusted EBITDA, although the 2027 Secured Notes provide the company with less pari secured debt capacity and about the same dividend capacity compared with the first lien notes issued to fund the Chewy acquisition, they provide the company with significantly more structurally senior debt capacity and more flexibility to transfer assets to unrestricted subsidiaries.
 
 
Notable Issues Under the 2027 Secured Notes

The 2027 Secured Notes and 2028 Unsecured Notes include substantially similar terms and provisions, including negative covenant packages.

Notable issues under the 2027 Secured Notes include the following:
 
  • Increased pari capacity through reclassification, RP capacity - The 2027 Secured Notes include a credit facilities debt basket that permits secured debt not to exceed, other than debt under PetSmart’s ABL facility, $2.3 billion, plus the greater of $1.18 billion and 100% of EBITDA, plus additional amounts in compliance with a 3x first lien leverage ratio, plus debt under “Credit Facilities” not to exceed the greater of $1.1 billion and the borrowing base.

    Although outstanding term loan debt on the issue date is required to utilize capacity under the credit facilities debt basket, there is no explicit prohibition on the term loans being deemed to have been incurred under the 3x first lien leverage component, as long as PetSmart can meet the 3x first lien leverage test; because the company’s first lien leverage at issuance will be 3x, it could likely attribute the outstanding term loans to the 3x first lien leverage basket.

    In addition, although the credit facility basket permitting debt not to exceed the greater of $1.1 billion and the borrowing base provides the company with the ability to incur debt under its ABL facility, there is no requirement that such debt must be incurred under the ABL facility or under a revolving facility more generally; the broad definition of “Credit Facility” would allow the company to incur additional term loan or note debt under this component.

    As a result, the credit facility debt basket could provide PetSmart with about $4.6 billion of additional secured debt capacity at issuance.

    The Notes also permit PetSmart to incur secured debt by utilizing capacity under certain restricted payment baskets including a general-purpose basket (which provides $472 million of capacity at issuance) and under an employee equity buyback basket that provides the company with annual capacity with unused amounts carried forward (specifically, $120 million per year at issuance).

    When combined with a $600 million general-purpose secured debt basket and a $600 million general-purpose liens basket that can be paired with a ratio debt basket, at issuance, the 2027 Secured Notes will permit PetSmart to incur about $6.7 billion of secured debt, plus at least $120 million of additional secured debt per year.
     
  • No anti-PetSmart language - After PetSmart’s dividend of Chewy equity resulted in Chewy becoming a nonguarantor restricted subsidiary, an increasing number of credit agreements and some capital markets debt began adding language providing that, to the extent a guarantor becomes a non-wholly owned restricted subsidiary through a transaction that did not have a legitimate business purpose or with an affiliate of the borrower/issuer, that guarantor would not be automatically released from its guarantee merely because it was now a non-wholly owned subsidiary.

    Neither series of Notes include this language; to the extent PetSmart paid a dividend with the equity of a guarantor under the Notes, that subsidiary guarantor would be released from its guarantee and its assets would no longer secure the 2027 Secured Notes.
     
  • 103% redemptions - Although the 2027 Secured Notes include a 103% redemption for 10% of the 2027 Secured Notes in any calendar year, the 2028 Unsecured Notes do not.
     
  • Lien subordination, release - Amendments that result in the 2027 Secured Notes’ liens being subordinated or released require consent from 66⅔% of holders.
     
  • Asset sale sweeps - The Notes permit PetSmart to use asset sale proceeds to purchase the Notes in the open market at below par prices.
2027 Secured Notes Issue Date Flexibility Scale
 
 
First Lien Notes Issued in 2017 to Finance Chewy Acquisition Issue Date Flexibility Scale
 
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