Why Chewy Should Buy Petco

Pity the poor pet store. Right now, there are no categories of any pet product that are growing in stores that aren’t growing faster online. That’s according to a NielsenIQ presentation made recently at the large pet trade show Superzoo.

It means that if you operate a pet store, you could have faster growth in your business if you could convert the whole thing to an online business.

But it’s not that simple. The online business is highly competitive and attracting consumers to your site or app is very expensive. So often we see online merchants spending as much on marketing as they do on the products in the store.

Being online is where consumers are but it’s still a tough way to make money.

And the pet business isn’t what it was a few years ago. Consumers in households with incomes under $100 thousand are cutting back. They are looking for bargains, discounts, deals and bundles. They want more for less and they are shopping smart.

And they don’t just want to shop online. According to the NielsenIQ presentation at Superzoo:

– 14.2% of pet sales revenue are from consumers who only shop in stores. That’s down 5.3 points from the prior year.

– 3.8% of pet sales revenue are from consumers who only shop online. That’s up by 0.7 points from the prior year.

Fully 82% of pet sales revenue are from consumers who shop both online and in store and that’s up by 4.6 points from the prior year.

If you’re Petco, that’s a real problem. According to ECDB, only 7.1% of Petco’s 2024 revenues were online. Online revenue is an opportunity for Petco but it has not been able to grab that part of the market. The Petco store customers who also want to shop online are going elsewhere.

Then there’s Chewy, with revenue of about $12 billion, about twice the size of Petco, and making almost $600 million in EBITDA (earnings before interest, taxes, depreciation and amortization) in the most recently reported twelve months.

And then there’s consumers. They want to be “omni,” shopping both online and in store. But Petco and Chewy customers find themselves unable to buy their pet food and supplies from the same merchant when they shift channels between online and in-store.

That’s not what consumers want but it’s what they have. And that’s why the two should get together.

That’s a great reason but it’s not the only reason. Here are some others:

For each dollar of EBITDA, Chewy’s shares sell for far more than Petco’s, 26.6x for Chewy and 9.8x for Petco (excluding capitalized leases). No one has a crytal ball but it’s highly likely that an acquisition of Petco will be highly accretive to Chewy shareholders and the Chewy stock will rise when they make an announcement.

The NeilsenIQ report says that consumers want to shop in stores and online, they don’t want one or the other. Chewy is missing out on the purchases consumers want to make in stores and it’s at risk of losing those customers to merchants like Walmart or Target who have both.

Walmart’s continued success pushing back against Amazon has shown that having stores and a unified presentation to customers is an important competitive advantage. As Amazon presses on in pet, Chewy will need more resources to compete and Petco’s stores could become a huge advantage for Chewy.

Both Petco and Chewy are public companies. If Chewy makes a serious offer to Petco, they can’t stonewall it, they must have a response that’s justifiable to their shareholders. With the Petco business under a lot of stress, an attractive offer from Chewy would be compelling.

Since their pandemic-induced highs, Chewy stock is down over 60% and Petco stock is down by over 80%. The changes in retail, the new challenges in pet, the convergence of online and physical stores are all taking their tolls on the companies’ valuations. They both need to change something significant in order to adapt.

(A compelling argument can be made that Chewy should buy PetSmart and not Petco. Chewy and PetSmart are separate companies but they are both controlled by private equity group BC Partners according to Chewy’s proxy statement. PetSmart is bigger than Petco and arguably has better store locations. But financial information about PetSmart is not publicly available. And according to ECDB, PetSmart is probably more than twice as successful online as Petco so PetSmart is going to be less motivated to combine than Petco might be. The common shareholder affiliation between PetSmart and Chewy may be a facilitator of a transaction or it might be an obstacle, it’s impossible to say from the outside looking in.)

Will It Happen?

Most likely not, at least not in the foreseeable future.

Chewy isn’t motivated enough to take a risk as big as an acquisition of Petco. Analysts are optimistic about the stock and the company is projecting revenue and earnings growth through 2028. Petco is also forecasting earnings growth.

Chewy has been expanding into vet clinics and Canada. In big companies, decisions about strategy take a long time and strategy changes can use a lot of resources. They are not likely to change strategy mid-course without a catalyst, especially when their current straetgy is getting a decent market reaction.

And the deal is not without risk. Integrating two large retailers’ systems doesn’t always go well. If the integration of Chewy’s online business with Petco’s stores doesn’t give consumers a seamless experience between the two, customers will go elsewhere and a lot of value will be lost.

A universe of issues involving merchandising, technology and strategy will have to be developed for the combination to work.

The deal will be a threat to their competitors who will press the FTC to shut it down on antitrust grounds. Chewy could win but a fight seems likely.

So why should they do it? Here’s why:

– The combination of their resources is what consumers want.

– If they merge successfully, they will be able to compete effectively in pet against Amazon, Walmart and anyone else who comes along.

– Their buying power and their margins will improve. Anyone who wants to succeed in pet will have to be in their store/site.

– They will become the leading force in the market and that will ensure their success for their customers, shareholders and employees. If it works, the change will be transformational.

Bob Rubin, CEO and Founder of pet industry advisory Breakaway Advisors, says about this idea for Chewy, “If you really want to go up against PetSmart and Walmart and Amazon, you have to do something big like this.”

In the end, consumers have made it clear they want a seamless experience across digital and physical channels. Amazon and Walmart are building the future. For Chewy and Petco, the choice is between being a leader or being left to defend their slice of the market against larger forces. Chewy can afford to buy Petco, whether they can afford not to is up to management.