American pet owners are probably all familiar with Chewy, an e-commerce pet food and products supplier that will quickly ship those heavy bags of dog or cat food right to your doorstep at competitive prices. No longer did one of the authors of this article have to walk 30 minutes round trip in the dog days of humid DC summers to pick up and carry a 30 pound bag of Taste of the Wild grain-free high prairie recipe to feed an English bulldog and a French bulldog. Leveraged finance attorneys, investors, lenders and borrowers should also be familiar with Chewy, though for reasons that highlight the complexities and risks associated with today's leverage finance market.
Pet owners were not the only group fascinated by Chewy and its dominance in the e-commerce space. Long-standing brick-and-mortar pet food and product retailer, a private-equity led investor group acquired PetSmart in a leveraged buyout worth $8.7 billion in 2015. PetSmart's brick-and-mortar retail offerings were, however, quickly losing market share in the face of the convenience that consumers demand in the e-commerce era. PetSmart targeted Chewy and spent $3.35 billion to acquire Chewy in 2017, funded in part by adding $2 billion to PetSmart's existing debt load. In June 2019, PetSmart and its investors cashed in on the Chewy acquisition, spinning out the company in an IPO that valued Chewy at $8.77 billion, over 2.5 times what PetSmart paid for the business. But what about the lenders holding over $8.2 billion of PetSmart leveraged debt (plus commitments for a $955 million asset-based revolving credit facility)? Surely they would be able to cash out on the deal? Unfortunately for the lenders, the transaction quickly morphed into a cautionary tale for leveraged bond and Term Loan B investors.
As is common for leveraged facilities of this type, PetSmart, as a borrower, was required to:
cause all of its material wholly-owned domestic restricted subsidiaries to provide upstream guarantees, pledge the equity interests of such subsidiaries; and cause such subsidiaries to grant a security interest in substantially all of their assets to secure the PetSmart secured debt. Accordingly, upon its acquisition by PetSmart, Chewy became a guarantor of the PetSmart secured and unsecured debt and pledged its assets to secure the PetSmart secured debt.
PetSmart continued to struggle financially, causing its senior debt and unsecured debt to trade at reported levels of 80 cents and 50...