Deal Mechanic: Gain in cats and dogs

UK readers of a certain vintage may, in their younger days, have ocasionally found themselves in pet shops: chances are these were usually dark, dingy fetid places that you wouldn’t wish as a home on your least favourite gerbil. That’s a world away from the sleek, modern superstores of Pets at Home. With their giant rabbits, gleaming aquariums and pooch pampering tables, they’re more like a visitor attraction than a shop (as many parents with small children have discovered to their advantage).

Happily, part of this success story is a private equity success story. Pets at Home initially rose to national prominence with the backing of 3i in the 1990s. UK mid-market firm Bridgepoint then bought the business for £240 million in 2004 and owned it until 2010, when it was bought by its current owner, US giant Kohlberg Kravis Roberts, for £955 million (after an auction process that attracted most of the industry’s big names).

Pets at Home turned out to be a great investment for 3i, which reportedly pocketed £91million when the company was sold in 2004.  And it was an even better deal for Bridgepoint: that sale to KKR equated to a money multiple of eight times its invested capital, and an internal rate of return of over 90 percent. No wonder managing partner William Jackson recently told Private Equity International that the deal was a “clear favourite”.

But that’s not why it’s a worthy subject for this column. The key point is that its time under private equity ownership has unquestionably been good for Pets at Home, too. 3i invested some £25 million over eight years to help the chain grow. During Bridgepoint’s time at the helm, revenues more than doubled (growing, on average, by 14 percent a year); profits almost quadrupled (from £22 million in 2004 to £84 million in 2010); and its store estate expanded from about 100 to about 250, creating about 1,500 new jobs. Last year, in its first full year as a KKR portfolio company, profits climbed 11 percent. From the humble beginnings of a single store in Chester in North-West England, Pets at Home is now a fully-fledged billion-pound retail giant.

In other words, private equity did what it’s supposed to do: make the business substantially better. But how, exactly?

UPGRADE POTENTIAL

Guy Weldon, a partner at Bridgepoint and the head of its UK investment activity, admits that the firm’s task in 2004 was not to fix a broken business. “It was really all about unlocking the potential of an already good business, rather than executing some sort of turnaround.” This was a good solid business, in a nation of animal-lovers, with customers who are likely to keep buying and spending whatever the weather, season or economic cycle. That’s why Bridgepoint had to fight so hard to win the business in a very competitive auction (in fact at the time, it was thought to have paid a high price).

Operationally, Bridgepoint’s first priority – and the area it felt offered the greatest opportunity – was margin improvement. This had two major consequences.

The first was a huge emphasis on boosting own-label sales – an area that had been previously neglected. “That was very important,” says Weldon. “Pets at Home developed from scratch their value, core and silver ranges, which is the equivalent of good, better, best in supermarket language. They also developed their own brand specialist ranges, the two best known of which now are Wainwrights and Purely. Because own-label has a gross margin that’s something like 13 percent higher than branded products, it’s not only good from a top line perspective but also very powerful from a profitability growth perspective.” From a standing start, these own-label goods ultimately came to constitute more than a quarter of all revenue by the time of the sale to KKR.

The other big contributor to margin improvement was the business’s success in developing a direct import programme, predominantly from China, to reduce costs. By 2010, it was buying up to $70 million of goods from China – again, from a standing start. 

There was only one major strategic change: a plan already in place to pursue a smaller high-street format was quickly abandoned. “They thought it would be interesting to pursue a dual rollout strategy, with this high street concept and the retail park stores. We canned that at the outset, and said we thought it was better to focus on the already established and successful concept.”

With that established, it was full steam ahead; Bridgepoint felt there was a big expansion opportunity, given the weakness of the competitive landscape. However, it was also keen to update the look and feel of the stores – which ultimately accounted for a large part of the extra £90 million of capital expenditure Bridgepoint ploughed into the business. “We developed a new store concept which became the bedrock of an accelerated rollout program, as well as a refurbishment of quite a big part of the existing estate.”

So what did this mean in practice? As well as introducing a more contemporary feel, and a stronger departmental organisation (so dog owners could shop in one place, cat owners in another, and so on), the key, says Weldon, was “bringing a sense of theatre and occasion to the stores”. This focus on the overall retail experience was smart thinking: having giant rabbits for children to pet encourages families to come to the shops, and possibly even to spend money. “The animals in the stores probably accounted for less than 3 percent of total sales, but they were at the heart of what the retail proposition was about.”

A similar ethos underpinned the Groom Room, a new service introduced for washing and grooming dogs. This has obvious financial upside: it’s an extra revenue line, with a high margin, and by virtue of being a service, potentially represents a recurring revenue stream. But because it all happens in a glass-walled room within the main store, there’s also an element of theatre about it. And there’s nothing like the sight of a poodle being shampooed to loosen the purse strings.

MANAGING CHANGE

Management was one area that did change substantially under Bridgepoint. “11 of the 15 person management board were appointed under our ownership,” Weldon explains. “But it was less a case of upgrading the people in existing functions – though there was a bit of that – and more about broadening the team by appointing people into new functions. So for example the buying director, the multi-channel director, the marketing director, the head of pets, the logistics director – none of those titles existed when we bought the business, but they were all senior members of the management team six years later.”

As Jackson told PEI last year: “It had a less than perfectly formed management team, but they had many of the ingredients of success…. [They] had huge energy and benefited from youth in the sense that they were open-minded and keen to learn, and as a consequence were much more flexible than most management teams. They really had a hunger to drive change.”

Internally, the new and improved management team made some interesting changes. Staff training received a lot of attention: staff were put on a ‘steps’ programme whereby they could earn more money as they completed more training, with the ultimate aim of creating more in-store experts. Recruitment was improved by introducing the so-called ‘hamster wheel process’, which focused on candidates’ behaviour rather than the past experience. The focus was on hiring enthusiasts: 93 percent of staff, from the CEO down, owned a pet.

Feedback was also encouraged via an annual survey called ‘We’re all ears’, where staff were able to rank their part of the business by a number of criteria.

All told, this had measurable benefits. Staff engagement (as measured by the survey) jumped from 66 percent to 89 percent. Even more impressively, staff turnover fell from 78 percent in 2003/4 – a high number even by the standards of the retail industry – to 19 percent in 2010. So judging by these stats, Pets at Home became a better place to work.

Commercially, management also oversaw big improvements in product innovation – driven by head office, the business got to the point where it was churning 30 percent of its products every year – and in marketing, including the launch of a national TV advertising campaign to boost awareness.

ONWARDS AND UPWARDS

So what will the next chapter be in the Pets at Home growth story? After all, KKR would not have paid out a sum like that (equivalent to 11.4 times the company’s projected earnings for 2010) without being pretty confident that Pets had plenty more left in the tank.

The firm refused to talk about its specific plans – as you’d expect with such a new investment. But the likelihood is the strategy will be broadly the same, only more so: more new stores, more own-label ranges, more grooming salons… The attached veterinary business, Companion Care, may also be a focus: it expanded to 53 practices under Bridgepoint, but it still looks to have some growing room.

It’s likely that Pets at Home will also benefit from being part of a bigger portfolio, both in terms of costs savings and idea sharing; KKR knows retail pretty well, having previously invested in the likes of Alliance Boots, Toys’ R’ Us, Dollar General and Maxeda. And it’s already welcomed Pets into its Green Portfolio Program, the initiative aimed at improving environmental performance (and thus financial performance) across KKR’s portfolio.

The salient point though, perhaps, is that ten years ago KKR wouldn’t have got out of bed for this company. Now, thanks in no small part to private equity investment, Pets at Home is the kind of retail proposition that would interest every big financial buyer on the planet. That’s worth celebrating. 

 

DIAGNOSTIC: KEY FACTS

Pets at Home began as a single pet shop in Chester in the early 1990s. Its expansion was backed by UK listed group 3i in the late 1990s

UK firm Bridgepoint bought the business in 2004. During its seven years of ownership, revenues more than doubled and profits almost quadrupled to £84 million. 150 new stores were opened and 1,500 jobs created

Investment in own-label ranges and sourcing more products from China boosted profit margins from 10 to 18 percent

11 of the 15 senior managers at the time of the company’s eventual sale were Bridgepoint appointees

KKR bought the company for £955 million in 2010. Profits jumped 11 percent in its first full year of ownership

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