I'll start with the disclosure that I have been long one Chewy July 17 28 put since January 28. As of yet, Chewy has failed to go in the direction I need it to. As is the case with most “financial news” out there, most of the analysis of Chewy I've seen has been superficial, so I thought I'd put some of my own armchair speculations into writing. Firstly, I'll give the basic rationale against Chewy. Chewy is basically an online retailer of pet food, pet medications, and other pet products. By traditional valuation methods, Chewy is the most overpriced stock on the market, and the competition for that title isn't even close. Listed below are the six largest market cap US companies with both negative total equity, and negative earning estimates for both current year and next year earnings.
Company Market Cap P/Sales Quick Ratio
Chewy 17.6B 3.63 .28
Wayfair 8.5B .93 .82
Nutanix 3.3B 2.63 1.64
Tubman
Centers 2.5B 3.8 .81
Biohaven
Pharmaceutical 2.2B N/A 4.96
Cincinnati Bell 746M .49 .69
With equity and earnings both negative, we can turn to the price to sales ratio for valuation purposes. Biohaven Pharmaceutical has no revenue, but it's a biotech company, and therefore can't be meaningfully compared to other companies through these valuation methods. Only Taubman Centers, a real estate investment trust that invests in commercial property, has a worse P/sales (and not by a huge amount). I also listed the quick ratio (a liquidity measure). By this measure, Chewy is substantially worse than any of the other five companies.
So why are so many people buying Chewy stock? For some, sales growth is the driver. Quarterly sales growth for the past three quarters has been 4.1%, 6.6%, and 10.2%. For others, the narrative of Chewy as the next Amazon is compelling. Recently, Chewy stock has performed very well because it is identified as a 'stay at home stock' that is gaining customers as a result of the pandemic. Some analysts, however, see this as an area of concern. The increased business during the pandemic will increase costs (hiring more employees, etc.), but the customers may return to their favorite brick and mortar stores when the pandemic ends. It should also be noted that pet stores have generally stayed open during the pandemic.
While you are probably familiar with Chewy as an online pet store, what you might not know is that Chewy is a subsidiary of PetSmart. More on that later.
Adendum:
Chewy's 2019 annual report states:
"As of March 26, 2020, PetSmart beneficially owned more than 50% of our outstanding shares of common stock and, together with its affiliates, exercised control over more than 95% of the voting power of our outstanding common stock. So long as PetSmart and/or its affiliates remain our controlling stockholder they will be able to control, directly or indirectly, and subject to applicable law, all matters affecting us"
PetSmart was acquired by BC Partners, a private equity firm, in 2015 for $8.68B. The details of how the subsidiaries within subsidiaries are organized is a little complicated, but essentially BC Partners acquired Chewy in 2017. Chewy then went public in June of 2019 (with BC Partners/PetSmart retaining majority ownership). This brings me to the crux of my question. Why would PetSmart spend two years developing a competitor to it's own business, then sell this competitor through an IPO? The question is sharpened by the fact that PetSmart has its own website selling the same types of products that Chewy sells, with features like free delivery and autoship, just like Chewy offers. In fact, their websites have somewhat similar color schemes and fonts in some areas. Let's take a look at another excerpt from Chewy's annual report:
"PetSmart is not restricted from competing with us in the pet supplies business, including as a result of acquiring a company that operates as an e-tailer for pet supplies. Due to the significant resources of PetSmart, including financial resources, name recognition and know-how resulting from the previous management of our business, PetSmart could have a significant competitive advantage over us should it decide to engage in the type of business we conduct, which may materially and adversely affect our business, financial condition, and results of operations."
So, now we arrive at my conspiracy theory. Chewy is building a brand and customer base that is quite valuable, but the project is being carried out in a way that is likely to be financially unsustainable. Once Chewy nears bankruptcy, PetSmart will acquire the rest of the company at a small fraction of the current share price. This will complete PetSmart's long term plot to get investors to pay for its e-commerce division.
