(Bloomberg) -- PetSmart Inc. lenders are looking to gain an edge in their dispute over the handling of Chewy.com assets by leading the choice of the next administrative agent now that Citigroup Inc. has quit the role, according to people with knowledge of the matter.
Citigroup had been acting as PetSmart’s term loan agent, which plays a role in the way negotiations take place when borrowers and creditors disagree. If the original agent quits, PetSmart’s credit agreement gives term-loan lenders the right to name the successor, who could be friendlier to their claims, according to the people. The creditors can invoke that clause now that Citigroup has resigned. They would still need PetSmart’s consent for their choice, said the people, who asked for anonymity to discuss private matters.
“The power is now in the hands of the lenders," James Wallick, an analyst at Xtract Research, said in an interview. “Clearly the lenders will want to pick in their favor.”
A friendly agent could make it easier for lenders to unwind the recent shuffling of Chewy’s equity that puts stakes beyond the reach of creditors, and push back against the notion that the switch cancels the guarantees and liens promised to them under PetSmart’s credit agreement.
The changes involve distributing stakes totaling 36.5 percent to a parent company and an unrestricted subsidiary. A group of lenders led by Arnold & Porter Kaye Scholer instructed Citi not to grant the release of liens after the transfer, the people said.
Citi’s departure raises questions about whether the bank was comfortable with PetSmart’s transfer, according to Scott Josefsberg of Covenant Review. “Typically if an agent resigns, it’s because the agent is questioning whether some transactions were permitted, or it’s worried about risk to its reputation,” Josefsberg said in an interview. Some investors also have concerns about the lack of detail PetSmart provided in answers to Citi’s counsel, Latham & Watkins.
PetSmart had sent a letter requesting Citi’s signature and acknowledgment of the release of liens and guarantees under the credit agreement following the Chewy transfer, but Citi and Latham & Watkins didn’t give explicit consent, the people said. A representative from Citigroup declined to comment, and representatives from Arnold & Porter and PetSmart didn’t respond to messages.
If the majority of lenders don’t agree on a successor, Citi can appoint a replacement within 30 days under the debt documents, the people said. “That agent will typically act on behalf of the lenders,” Wallick said.
In documents sent to lenders and their advisers, PetSmart said that the transfer of Chewy equity was permitted under the credit agreement, and caused an automatic release of the liens and guarantee, according to the people. The same guarantees and liens are pledged to the company’s senior secured notes under the debt documents, the people said.
Investors have been given very little detail on the situation, Josefsberg said. If the subsidiary is no longer wholly owned and the releases are automatic, “the question then becomes whether the agent needs to give its consent at all,” he said. The company maintains that any agent is required to give consent for the releases under the credit agreement, one person said.
Creditors opposing the equity transfer are concerned it’s the first step in a plan that would bring new cash into other parts of the company, without improving the outlook for units where they have claims on assets. Investors and analysts have speculated the decision to move the equity out of their reach could set the stage for an initial public offering, the sale of a minority stake in Chewy or a distressed exchange.
Lenders have been bracing for such a move since PetSmart’s results began to decline following the Chewy acquisition. In the third quarter of 2017, the first reported after the purchase, the combined companies lost $56 million. PetSmart hired a new chief executive officer as of June 11, J.K. Symancyk, who previously was CEO of Academy Sports + Outdoors.
Across PetSmart’s capital structure, creditors have been preparing for negotiations. PJT Partners Inc. was brought on as financial adviser for the crossover group of term lenders and noteholders represented by Paul Weiss Rifkind Wharton & Garrison, the people said. PJT declined to comment.
“The bloom is off the rose a little bit, because it looks like things haven’t gone well with the Chewy acquisition," said Larry Perkins, chief executive of consulting firm SierraConstellation Partners.
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