Description

SUMMARY

VIC member, mjw248, posted an excellent writeup articulating the Short thesis for PetMed Express (“PETS”) in May 2021.  To summarize, his/her thesis was PETS “pandemic-juiced results” would reverse due to a proliferation of new competition.  His/her thesis proved correct and I’d encourage you to read the writeup for a detailed background.

Instead of rehashing mjw248’s thesis that continues to unfold correctly, I will provide an update for PETS newly appointed CEO.  The new CEO is unproven and his actions have quickly pushed PETS into a becoming a melting ice cube.

NEW UNPROVEN CEO

In August 2021, PETS replaced its 20-year CEO Mederes Akdag w/CEO Matt Hulett.  Hulett had exactly zero experience in the pet healthcare industry or as a public company CEO (LINKEDIN).  Instead, he has many short stints at unrelated tech companies.   

Hulett’s “claim to fame” was being President at Rosetta Stone (“RST”), which was acquired at a nice premium.  But, Hulett primarily led the Language segment hence 70% of his compensation was tied to Language’s results (per RST’s proxy).  From TTM 2Q18 to 2Q20, revenue from RST’s Language segment fell 5%.  During the same timeframe, revenue from RST’s Literacy segment (housing Lexia) rose > 40% and Literacy (not Language) likely led to attracting an acquirer.

I think labeling Hulett as “unproven” is arguably too kind.  On public earnings calls, he seems promotional and arrogant, despite also appearing to lack a tangible/credible plan to turnaround PETS.  To summarize my perspective on him, I’d point you to his own website called “Startup Whisperer”, where he markets his book called “Unlock” (https://startupwhisperer.com/).

One year after being appointed PETS CEO, Hulett replaced PETS long-term CFO w/Christine Chambers.  Like Hulett, she has zero pet healthcare experience.  Her only CFO stint was 18 months at RealNetworks (RNWK) where she oversaw its share price declining over 80% to < $1/share.  Prior to RNWK, Chambers overlapped w/Hulett at RST as a VP of Finance.

PROFIT DECLINE ACCELERATES

Thanks to COVID/WFH/stimulus, PETS EBITDA briefly rebounded from $33mm in FY20 to $40mm in FY21.  Perhaps, PETS long-time CEO realized this rebound was not sustainable and a turnaround would be very difficult.  And/or perhaps, PETS Board knew the same and thought a new leader was the only option.  Either way, new CEO Hulett seems to only have accelerated the demise of PETS.

Since FY21 (ending 3/31/21), PETS LTM Revenue fell 16% while LTM EBITDA dropped 55% to only $18mm.  Competition coupled w/operating deleverage, discounting, and “investing for growth” (i.e., bad cost management) are to blame.  PETS business certainly has some seasonality, but its run-rate 3Q23 EBITDA is now < $3mm.  Worth noting, Chewy’s (“CHWY”) LTM Revenue and EBITDA rose 28% and 17% (respectively) since TTM 3/31/21.

Historically, PETS has a net cash balance sheet and high FCF.  However, these redeeming qualities could be fading given PETS rapid decline in profits and recent investments (highlighted below).

RECENT INVESTMENTS = DESPERATE ACTIONS

CEO Hulett’s grand plan seems to be attempting to transform PETS into CHWY.  We think this will continue to fail miserably because CHWY is years ahead of PETS, has far more scale ($10b in Rev vs. < $300mm for PETS), and therefore capacity to invest to continue widening its moat.

Nonetheless, CEO Hulett has announced three “strategic initiatives” in his attempted transformation.  First in April 2022, PETS formed an exclusive partnership w/Vetster, which is a vet telemedicine startup.  PETS will sell pet meds to Vester clients and Vester will offer their telemed services to PETS customers.  Oh and of course, PETS also paid $5mm for 5% of Vetster while Hulett received Board observer rights.  (Correct, not even a Board seat).  Like many of CEO Hulett’s press releases, this partnership announcement came w/a promotional and misleading statement – “first of its kind to enable pet telemedicine on a mass scale”.  In reality, CHWY has had a similar service: SOURCE.

Then last month (January 2023), PETS announced the $36mm acquisition of PetCare RX (“PRX”), which is a leading supplier of pet meds, foods, and suppliers.  PRX seems like a mini-CHWY given ~40% of sales are not from meds.  Yet, PRX seems subscale (only $40mm) and has lower margins than even PETS.  Importantly, PRX was led by Jeanette Loeb.  She was the first female partner at Goldman Sachs and smart enough to sell PRX for cash (not equity).  Once again, CEO Hulett made a promotional and misleading statement when describing the PRX purchase.  During PETS Analyst Day, he said “it [PRX] is expected to immediately deliver double-digit topline growth”.  To be clear, he means PRX’s $40mm of Revenue will increase PETS current < $300mm Revenue by 10%+.  I honestly don’t understand how he is allowed to so blatantly mislead investors in a public forum.

This month (February 2023), PETS announced another partnership w/Pumpkin Insurance Services (“Pumpkin”) so that PETS can offer pet insurance to customers.  The announcement disclosed very little in terms or details.  Unsurprisingly, CHWY already offers this: SOURCE.  In fact, pet insurance is a crowded space w/a few examples here: Lemonade, Spot, and Embrace.  Like CEO Hulett’s other actions, I doubt this partnership will meaningfully differentiate or materially improve PETS’ trajectory.

VALUATION

PETS has net cash (after the PRX acquisition) of ~$3.25/share.  Therefore, PETS trades for ~25x LTM EPS of ~$0.65 ((~$20 stock - ~$3.25 net cash)/~$0.65).  A Bull might argue LTM EPS does not include PRX, but 3Q EPS was down ~90% y/y so LTM EPS appears inflated regardless.

Pro form for PRX acquisition, PETS has ~$300mm LTM Revenue and ~$21mm LTM EBITDA (assuming PRX = PETS 7% LTM margin).  Over LTM, PETS Revenue declined 7% and EBITDA margin contracted 300 bps.  Assuming PETS PF Revenue falls only 5%/year and margin contracts 200bps/year, then this would lead to EBITDA of $8mm in two years.  That would barely be sufficient to cover CapEx.

$8mm EBITDA would translate to ~$0.15 of unlevered EPS.  Assuming PETS maintains its current 25x P/E and adding ~$3.25/share in net cash would imply a fair value of ~$7 per share and a ~65% return.  Said differently, 25x P/E equates to ~10x EBITDA.  Both multiples seem generous for PETS as a company w/falling profit, operating an increasingly competitive market, and led by an unproven CEO w/out a credible plan.

Catalyst

Continued earnings declines

Value-destructive acquisitions

New competitive entrants