m8bA common refrain in the pet industry is that to predict the future of the consumables category, you need only to look back on the prevailing human trends three years prior. Today, I would argue that this rule-of-thumb applies more broadly, to a cross section of pet industry categories, than previously appreciated. As an example, the rise of ecommerce in the pet industry follows a similar trajectory to a number of human categories that were thought to be “Amazon proof”.  This is why I think pet industry participants should be paying attention to recent funding deals for Freshly, Inc., whose $77 million Series D was led by Nestle, USA, and Chef’d, LLC, whose $17.6 million Series B was led by Campbell Soup Company.

Both Freshly and Chef’d are in the business of delivering fresh food to your door step.  In the case of Freshly, these are fresh prepared meals, which require minimal intervention to get them from the packaging to the plate.  Chef’d delivers personalized meal-kits, which you then prepare at home, in as little as 10 minutes.  As a side note, I’ve never completed a meal kit from any company in under an hour, but maybe that says more about my cooking skills than anything else. Notably Chef’d partners with culinary and media personalities to create menu inspirations.  That said, what these companies deliver is less interesting than who is financing the growth of their business.

Large human food companies have significantly increased their investment activity in emerging food brands over the past 24 months.  Major industry players have set up dedicated investing units to source and evaluate opportunities.  The human food industry has largely outsourced its research and development function to start-ups who are seeking to capitalize on emerging consumer trends.  These companies become investment or acquisition targets if their solution set demonstrates the ability to resonate with a large enough audience and if their production processes can scale.  However, this pattern has, to-date, largely been confined to product companies.  Freshly and Chef’d are direct-to-consumer distribution companies cloaked in a product orientation.

The pet industry has its Freshly and Chef’d corollaries.  Companies like JustFoodForDogs and The Farmer’s Dog, have both recently received major cash infusions from financial players.  There are numerous others competing for this emerging space — Ollie Pet, NomNomNow, PetPlate, to name a few.  Yet, I believe the investment trend illustrated by the Freshly and Chef’d transactions tells us more about the real value of scale direct-to-consumer businesses such as A Place for Rover and Bark & Co., than the potential for fresh food delivery in the pet category, whose future we also think is bright.

What the pet food and products manufacturers have in common with their human counterparts is their core means of distribution are under siege by small retailers who provide better service and/or in-store experience as well as by the internet.  As such, any opportunity to get directly to the end customer is highly coveted, and therefore of great value. Within the pet category, there are a very limited set of players that have proven their ability to directly access a critical mass of pet owners.  Therefore, as large manufacturers look for direct-to-consumer exposure they will be left with a choice of ascribing a very high value to an asset with breadth or taking a calculated risk on an upstart.

What these large strategics are looking for is the ability to build a relationship directly with a consumer that is tied solely to the product or offering, and that exists outside of that buyer’s relationship with any retailer, physical or digital. If they own the customer they can look to monetize him or her in a variety of ways, capturing more the the margin along the way. We believe this trend to be applicable to both product and service providers in the pet category.

The question then becomes what would a tie-up between a Mars/Purina/J.M. Smucker Company and a Rover/Bark & Co. mean for the acquired entity.  Would consumers have the same affinity for their Bark Box if it only included treats from the buyer organization, or is the lack of affiliation that part of the value proposition?  We don’t know the answer to that question, but if we follow the story of Freshly and Chef’d going forward, we may well find out.

/bryan

Note: This blog is for informational purposes only. The opinions expressed reflect my view as of the publishing date, which are subject to change. While this post utilizes data sources I consider reliable, I cannot guarantee the accuracy of any third party cited herein.

 

dylan“The times they are a-changin” – Bob Dylan

Industry analysis is easy when everything is moving up and to the right.  When market conditions are such that a rising tide does not float all boats, it is harder to draw conclusions that are applicable to a broad set of market participants.  The pet industry now finds itself in an operating environment where company execution will most likely determine the winners in this phase of the cycle.

The  pet industry has hit a transformative moment.  The humanization movement, though it continues to be cited regularly, has achieved its point of arrival — pets are treated like members of the family.  Kids today only know of pets as their equal.  As a result, there are no longer large cohorts of pet owners who are available to upgrade.  At the same time, younger generations now represent the largest segment of pet owners, and they think and act differently than their parents generations.  However, they also lack the same disposable financial resources, meaning they have to make tradeoffs today.

These realities are changing the power paradigm in the category.  The pet consumer is in the ascendancy at the expense of all others who participate in the supply chain.  Today the pet owner is able to choose among channels and brands based in their personal values.  Effectively product access has been commoditized. Consumers are now able to dictate to manufacturers what attributes they seek, not vice-versa.  In the future this paradigm will move across the sub-categories within in pets to redefine who wins and who gets left behind.

When market dynamics shift with significant force, it usually leads to elevated levels of industry consolidation. The 2015 – 2016 period was the greatest period of consolidation the industry has witnessed, and we expect that will continue.  With that as a backdrop, we present our pet industry capital market themes for the Spring of 2017:

  • Major Pet Specialty Franchises Struggling. It was not long ago that PetSmart and Petco could do no wrong. The major pet specialty chains were posting SSS comps that were the envy of retail analysts; the gap between the two biggest pet retailers and the balance of the industry seemed vast and unbridgeable. How quickly things can change. Over the past three years, major pet specialty has watched its franchise erode. Independent pet retailers out-serviced them; FDM retailers poached manufacturers and offered customers a better cost value proposition; and ecommerce providers out-priced and out-“convenienced” them. In 2016, we estimate that PetSmart comped down 3% – 4% (mature stores) and that Petco comps were flat to down 2% (mature stores). With their loan packages trading below par, both companies are under pressure to innovate. Petco’s turnaround strategy appears focused on private label and house brands.  PetSmart is focusing on ecommerce, as evidenced by its acquisition of Chewy. What is clear is that there is no silver bullet for what ails them. Expect things to get worse, before they get better as brands begin to feel pressure to find other sources of growth and as Petco and PetSmart refine their respective strategies.
  • Treat Acquisitions are Focused on Sustainable Competitive Advantage. The treat space has been actively consolidating as manufacturers compete for the discretionary portion of the pet owner’s shopping basket. However, what is rapidly changing is the attributes these consolidators are seeking in their acquisition targets. Deep customer relationships built through an emotive brand are now the table stakes.  Buyers want some form of competitive advantage that has greater barriers to justify prevailing multiples. The acquisition of Salix Animal Health (Spectrum Brands) and Whimzees (WellPet) are examples of this in practice. Other major pet treat IP players, including Petmatrix, are most likely to get snapped up by the large industry players. This will in turn create an opportunity for private equity to acquire mid-stage brands and invest in building these attributes.  The phrase “innovate or perish” has never been truer than in the treat space today.
  • Digital Pet Age Has Arrived. Historically, pet industry incumbents have been dismissive of the potential for category disruption through technology innovation. Major pet retailers were not well situated to sell the solution set; legacy pet ownership generations, the Baby Boomers, did not understand it; market leaders were not organized to innovate into the category. As a result, Chewy, A Place for Rover, Bark Box, Whistle, and their peers rose up to fill the market void, creating substantial shareholder value as pet ownership dynamics shifted to favor the digital generations. In 2016, $154 million dollars was invested in 46 pet-tech deals, a pace that has been increasing since 2012. Even in its nascency the pet tech movement is showing signs of making a lasting impact. As Millennials further outpace Baby Boomers in terms of pet ownership, digital will gain more momentum in the pet category. This realization will leave strategic buyers who have not made a tech play scrambling to play catch-up.  This trend augers well for acquisition valuations in this sector of the market.
  • Expect M&A Transaction Velocity to Remain High. Since 2014, transaction bias in the pet industry has been towards M&A. 2015 – 2016 was the greatest period of industry consolidation as measured by transaction volume. As company’s reposition themselves to compete in a rapidly changing landscape, we expect elevated M&A activity to continue in 2017. Market leaders will seek to plug remaining portfolio gaps while small and midsized players will be looking to exit at the tail end of the cycle. While acquisitions may be plentiful, there will also be a flight to quality with differentiated assets – brand, scale, channel (direct or proprietary) – garnering premium valuations, while those lacking it face commodity multiples. If the U.S. implements tax reform, volume should spike across asset classes providing private equity a unique opportunity to buy into the category.  Financial buyers will be banking on these assets to carry them through the next recession.

As always, our full pet industry report is available by request.

/bryan

Note: This blog is for informational purposes only. The opinions expressed reflect my view as of the publishing date, which are subject to change. While this post utilizes data sources I consider reliable, I cannot guarantee the accuracy of any third party cited herein.

sbmIf you have not seen the digital age in pet coming, it’s arrival has now been fully announced.  In the past year, a remarkable number of meaningful events have happened to punctuate it’s arrival.  Many of those events were likely to have gone unnoticed at the time, but in aggregate its hard to ignore.  Notably the past last year was book-ended on one end by Mars acquisition of Whistle Labs (March 31, 2016) and the merger of A Place for Rover and Dog Vacay (March 29, 2017) on the other end.  In between we have witnessed the rise of Chewy.com at the expense of Petco, PetSmart, and even Amazon; Phillips Feed Services acquisition of Petflow for the purpose of arming independent retailers for the digital pet race; and a total $154 million dollars invested in 46 pet-tech deals.

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Historically, it has been easy to dismiss the digital pet movement as a novelty act, confined to products whose addressable market was small and whose value proposition was narrow.  It’s true that many of the first generation products were poorly designed or over engineered, and generally expensive.  Further, the arrival of pet tech was slowed by the inability of core pet retailers to sell the solution set.  Simply stated, Petco and PetSmart were not well set up to educate consumers on why they needed to own a $200 smart feeder or a $150 remote treating system.  Further, technology retailers, such as Best Buy, knew very little about the category and were therefore unable to effectively merchandise a pet technology set.

Despite these impediments, it’s hard to argue with the results of the market leaders.  Whistle Labs was acquired by Mars for $117 million, representing a high single digit multiple of revenue.  As we detailed in our last post, Chewy.com has achieved over 50% market share in online sales and anticipates 2017 sales of $1.5 billion. Finally, A Place for Rover (Rover.com) was valued at more then $308 million its $40 million Series E financing closed in October 2016.  Rover also announced that it acquired its primary domestic competitor Dog Vacay in a stock-for-stock transaction. In our discussion with other pet technology companies many of them appear poised to deliver strong growth and financial results in 2017.

The collective impact of these digital pet companies and their ascendancy in terms of industry importance can no longer be ignored.  While the negative comps produced by both Petco and PetSmart in 2016, and the recent deterioration of their leveraged loan valuations, can be attributed to a variety of factors, it’s hard to argue that the rise of Chewy.com and the lack of traffic drivers attractive to the Millennials, and subsequent generations, such as pet technology products, has been a key contributor.  The fact that the vast majority of pet food brands are available online, making their availability more commoditized, and not an influencer of store visits, is exacerbating the problem.  Further, Rover and DogVacay have served to disrupt the discretionary services segment of the market, for whom Petco and PetSmart (both boarding and grooming), along with VCA Antech (boarding) and Banfield Animal Health (boarding),  are the most established players.  Prior to the take private, PetSmart generated $750+ million in services revenue annually, accounting for ~ 12% of revenues.

The ability of incumbent players to catch-up digitally is limited.  Earnings based companies are hesitant to acquire companies without an established track record of profitability given their valuation paradigms consist of multiples of EBITDA or contribution margin.  Mars benefited from its private nature when considering the acquisition of Whistle.   A subset of major players we have spoken to are waiting around for these companies to stumble in hopes of acquiring them at bargain prices.  While companies like Chewy.com have “scraped paint” in the past, we see this strategy as unlikely to succeed in the near to medium term.  Those who are called to action, but partially paralyzed by their valuation paradigms will seek to partner.  Whether creating these bridges will be enough to move the needle or insulate them from risk remains to be seen.

/bryan

Note: This blog is for informational purposes only. The opinions expressed reflect my view as of the publishing date, which are subject to change. While this post utilizes data sources I consider reliable, I cannot guarantee the accuracy of any third party cited herein.

 

blue dog 2Over the past five years, interest in the potential and performance of the online channel for pet products has become an increasingly hot topic.  The narrative around pet ecommerce has been fueled, in part, by a change in ownership demographics, but more significantly by the lack of transparent data regarding the size of and growth rate in the channel.  Quite simply, no one knows how much pet food is sold online or how fast the channel is actually growing, and therefore everyone is free to speculate.  The loss of PetSmart as a public reporting entity only further exacerbated this reality.

What we have known for some time is that online is taking share and its growth is a key driver of malaise within major pet specialty.  Whether you source your information from Packaged Facts, IBISWorld, or Euromonitor, all three entities have online pet products sales in the U.S. growing at between 10% – 15%.  Further, according to Packaged Facts 2016 National Pet Owner Survey, 46% of pet owners buy products online, an increase of 5% from 2015. Thus, the intent from a consumer perspective continues to rise.  Additionally, Blue Buffalo, widely believed to be the top selling pet food brand online, CEO Billy Bishop commented, in the company’s most recent earnings call, that the shift to online is occurring much faster than anyone at Blue Buffalo anticipated.  Couple this with the fact that during FY16, Blue Buffalo’s share of sales outside of major pet specialty increased from 33% in Q1 to 41% by Q4 primarily behind the sharp increase in ecommerce.

No entity has been more responsible for shaking up the pet retail world than Chewy.com.  In November 2016, we got our first real glimpse into the organization when a Bloomberg article detailed that the company anticipated that it would generate $880 million in sales for the calendar year.  Further, it projected 70% growth in 2017, bringing the company’s topline to $1.5 billion.  A recent Miami Herald article pushed that number to $2 billion. According to a recent survey by 1010data, Chewy.com has approximately 51% share of the online pet products market including autoship revenues.  This contrasts with Amazon at 35%, also inclusive of autoship.  Chewy also leads in subscription pet food sales at 10.2% versus 7.6% for Amazon.  PetSmart garners 7.9% of the market when you consolidate its own banner (2.2%) with sales of its Pet360 (5.7%) acquisition.  Petco clocks in at 3.1%, while Wal Mart (< 1%) barely registers. Finally, Chewy employs 200 full time portrait artists who churn out 700 oil paintings a week for unsuspecting customers.

Chewy, which has never turned a profit and has been funded by $261 million of equity, raised over five rounds, and $90 million of debt, is in the process of upping the table stakes.  The company recently launched its American Journey house brand of dry kibble.  American Journey, which comes in seven flavors, currently costs $39.99 for a 25-lb. bag before autoship discount.  This is $8 – $10 less than a comparable sized bag of Blue Buffalo on the site.  Notably, American Journey is made by one of Blue Buffalo’s co-packers. Additionally, Chewy launched Tylee’s, their human grade fresh/frozen pet food brand aimed squarely at the increasing band of upstarts seeking to deliver human meal equivalents for your pet. The company is also said to be working on a public offering slated for 2018.

The question of whether Chewy.com can be stopped has been answered. It’s most recent financings ($75 million of equity from BlackRock and $90 million in debt from Wells Fargo) suggest that investors are looking past the profitability profile and instead focusing on the growth history and the potential IPO valuation.  Mutual funds targeting a pre-IPO stake are likely accessible should the company need additional funding. The more intriguing question is whether there is a transaction alternative that might be more attractive to Chewy shareholders than a public offering.  As Chewy.com Chairman Mark Vadon, who co-founded Zulily, can attest, being a public company without earnings is not all that it is cracked up to be.  We rule out an Amazon combination for a myriad of reasons.  This leads us to Petco or PetSmart as the most logical destination.  While somewhat counter-intuitive on the surface, if Chewy.com could extract more value in a combination than an IPO, why not consider it?  Given the weak comps we have been hearing coming out of Petco and PetSmart, a combination with Chewy.com would solve a myriad of problems.  Chewy would gain access to cash flow and hundreds of local warehouses, while Petco or PetSmart would be able to rationalize its store base and gain the pole position in pet omni-channel.  It might not be as far-fetched as we think.

/bryan

Note: This blog is for informational purposes only. The opinions expressed reflect my view as of the publishing date, which are subject to change. While this post utilizes data sources I consider reliable, I cannot guarantee the accuracy of any third party cited herein.

 

 

asiaOn January 9, 2017, Mars, Inc., owner of the Banfield Pet Hospital veterinary group, the largest pet hospital chain in the nation (~900 units), agreed to acquire VCA, Inc., the markets number two player (~760 units), in a deal valued at $9.1 billion.  The deal represents a 31% premium to the prevailing stock price, just prior to the transaction, and reflects an acquisition multiple of just over 19.0x LTM EBITDA, generally in line with other top tier animal health company acquisitions (15.0x – 20.0x).

VCA’s equity had experienced strong appreciation in the year leading up to the transaction, rising ~32%.  The company was enjoying renewed momentum in its hospital business in 2016 with comps growing 6.3% in 2Q2016 after posting a gain of 7.6% in 1Q.  However, 3Q2016 comp growth of 5.4% was viewed as a sign of deceleration against a back drop of a $0.02 EPS miss. The company’s equity had rebounded to near peak levels before the transaction was announced.

As part of the announcement, Mars indicated that VCA would continue to be led by Bob Antin and will operate as a separate business unit. Antin holds a 3.12% equity stake in VCA, which is valued at ~$240 million in the transaction.  It is our expectation that the two hospital chains will be merged at some point to realize the clear operating synergies between the organizations.  Antitrust is not the reason the businesses are expected to be kept separate in the near term.  There are approximately 26,000 pet hospitals in the U.S. and Banfield and VCA operate under different service models.

The business logic of the deal is hard to question.  Key reasons for the acquisition include the following:

  • Economies of Scope. While VCA and Banfield operate under different service models, they are vying for the same customer.  By owning the two biggest banners in the space, Mars can begin strategically thinking about how to rationalize current and future locations to maximize performance within its portfolio.  The data available to them for strategic planning purposes alone should be invaluable. The combined expertise should enable Mars to bring the highest quality of animal care to the largest addressable market.
  • Economies of Scale. Setting aside, for now, the clear potential to consolidate back office operations, the deal comes with ample potential scale benefits.  One of the most attractive aspects of VCA is its lab business, Antech Diagnostics.  While Antech is already the reference lab for Banfield, they also drive meaningful volumes for IDEXX (in-house diagnostics and consumables) and ABAXIS (hematology).  Some of this business is expected to flow to Antech over time.  Additionally, the two organizations have distinct distributor relationships, with VCA linked with Henry Schein and Banfield working with MWI.  We would expect this business will soon be up for grabs.
  • Acquisitions. While we expect Mars will be out of the hospital acquisition game for a short period, given that there is 90% of the market still to capture and roll-ups continuing to happen, we expect they will be back in the market as a buyer within 12 months.  However, the combination will remove a meaningful source of price inflation in the market, where VCA and Mars have historically gone head-to-head for attractive deals, thereby driving up price. Unless someone else fills this void, I would expect sellers would lose leverage as private equity is unlikely to be a competitor in a rising interest rate world.
  • Shifting Exposure. As the largest veterinary asset in the Mars portfolio, Banfield presents some unique problems in that its growth is largely tied to unit growth at PetSmart.  PetSmart was previously a 21% owner of Banfield’s parent, Medical Management, Inc.  Mars repurchased PetSmart’s interest in the company in late 2015, in a deal that has largely gone under the radar. The majority of Banfield hospitals operate inside PetSmart locations.  In contrast, VCA clinics are standalone operations.  With PetSmart box growth rate waning, gaining additional exposure to the standalone clinic market diversifies risk for Mars.

While the transaction between Mars and VCA may make very good business sense, it remains to be seen how consumers will benefit.  Most of the marketplace discussion has been about the potential for limited choice and rising prices, as opposed to better service and value for consumers.  As Millennials grow in terms of pet ownership, they may also view this as a further “corporatization” of the veterinary market and seek service elsewhere. Only time will tell.

/bryan

Note: This blog is for informational purposes only. The opinions expressed reflect my view as of the publishing date, which are subject to change. While this post utilizes data sources I consider reliable, I cannot guarantee the accuracy of any third party cited herein.

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I recently had the opportunity to speak at the First Annual Pet Food Investor Forum, sponsored by Susquehanna  Financial Group. The conference was primarily geared towards public equity analysts and it was interesting to see this class of market observers collectively hone in on a few key questions that were affecting the public equities in the pet food sector. Among those questions, one that came up with the greatest frequency was the prospects for Blue Buffalo to penetrate the veterinary channel.  The array of speakers were almost universally asked to proffer our views on this issue, as it is central to the next leg of the Blue Buffalo growth story.

Since Blue Buffalo announced its intentions in the professional channel, I’ve held the belief that it was likely going to struggle to gain penetration quickly. My view was grounded on two basic premises, neither of which speaks to the quality of their solution set, of which I have no knowledge.  The first is that this channel has some very strong incumbents, who have a long history with the channel and its practitioners. The vets I have spoken to suggest that is going to be hard to overcome given how hard it is to create access. Second, was that building sales in the veterinary channel takes time and requires fundamental research that Blue Buffalo might have a hard time producing quickly, unless they had started this process long before the commercialization efforts came to light. Blue has obviously overcome significant hurdles in its history to become a near $5 billion market cap company, and there is reason to believe that if you give them a long enough time horizon that they will make inroads. I only see it as a question of magnitude.

However, last week something caused me to begin to rethink my paradigm.  Lawyers in the State of California, on behalf of California, Minnesota, Georgia, and North Carolina filed a class action lawsuit against the major players in prescription pet food (Mars, Nestle, Hills) and a subset of their primary distributors of their prescription products (Banfield, BluePearl Vet, PetSmart).  The lawsuit contends, among other things, the following, (a) there is nothing unique in the ingredient deck of prescription pet food to differentiate it from non-prescription pet food, (b) the marketing, labeling and sale of these products is deceptive, and (c) the defendants are engaged in anti-competitive practices to sell these solutions at above market prices to consumers.  If you want to read the full complaint it is here.

While I am not a lawyer or a Holiday Inn Express customer, at first blush, it would appear this case is good for Blue Buffalo’s potential franchise in the veterinary channel.  If the plaintiffs were to win their case, it would likely open up the channel to competition, giving Blue Buffalo a seat at the table. Further, if successful, the case could erode the brands of incumbent players in channel, driving faster penetration and sales of Blue Buffalo’s prescription solutions through consumer requests. That said, Blue Buffalo would also have to deal with any implications of the lawsuit given it operates in the category. However, when one digs deeper, it becomes apparent that this case is far from a done deal.

Let’s first deal with the issue as to whether prescription diets should be allowed to be labelled as such.  It is correct that prescription pet food diets do not contain controlled substances and are not manufactured under purview of the FDA. However, they are formulated for specific conditions and feeding them to an otherwise healthy pet is likely, over time, to have consequences. This is what allows the manufacturers to call them “prescription”.  This is merely a labeling issue, and if changed would not make feeding them under general conditions advisable. Further, I don’t think this makes them deceptive by definition. The marketing of these solutions generally indicates they were formulated to specifically treat a condition, not that they contain a drug. These products recommend you only feed them under the supervision of a veterinarian, in case they don’t address an issue that needs addressing or there are negative side effects of feeding them. Personally, I don’t see how labeling them prescription harms consumers and in fact the prescription protocol is, in most cases, necessary to protect pets from self-diagnosis by their owner and improper application. That all being said, these products could be labeled differently and if we adhere to a standard that the label prescription only covers controlled substances a change should be made. Whether that impacts anything beyond that does not, on the surface appear to be all that damaging.

The question of whether they are “different” is where things start to get muddy.  What defines a prescription diet is the inclusion of certain vitamins and minerals that are scientifically proven to help address a specific condition — kidney, cancer, obesity, skin, digestive, etc. The claim that these ingredients could be found in other pet food products sold without a prescription does not make them the same. The notion that pet food is pet food because all of the ingredients are generally available does not hold water in my view. If it did, pet food would only be sold in flavors, formulations and brands would not matter. I suspect lawyers from the manufactures cited in the cause of action have parsed these issues for their clients many times. We also know that brands matter in this category, Blue Buffalo’s success being a prime example of that.

Finally, I can’t speak to anti-competitive behavior, as I don’t know what goes on behind the scenes, but the pricing claims make me smile.  The cost of pet food has escalated significantly post-recession (40% on average on a per pound basis since 2011 according to GfK) without much of a peep from lawyers, despite the fact that class action lawsuits in the pet category have escalated significantly.  The prices of of most Hill’s Prescription Diet dry dog food solutions in 25 lb. bags runs between $80 – $85 online, approximately $3.25/lb.  This translates to approximately $2.40 per 1,000 calories, while higher than premium kibble at $1.75 – $2.25, this is significantly less than dehydrated ($5 – $8), premium cans ($7.5 – $10), frozen raw ($10 – $11) and premium freeze dried ($11 – $18).  If there is outrage around the price, it should be kept in context. When combined with the notion that these solutions are in fact different, these claims lose some of their veracity.  For me, you would have to believe that the veterinarians are coercing their clients into buying these solutions because they have no other choice and then providing them no other means of access than to pay the price for which they are selling them. However, these solutions are available online and transactions are facilitated through prescription verification providers such as Vetsource.  This feels much like a contact lens parallel.  Are there drugs in contact lens? Ponder that.

The net of all this is that it will spur dialog about labeling of these solution sets, and consumers who have purchased these products may end up with coupon books or rebates from manufacturers, but I don’t see that as providing a meaningful recasting of the competitive landscape for the prescription pet food.  And while Blue Buffalo should be a beneficiary in the near term, it is unlikely this provides them the runway they need to rapidly penetrate the channel.

/bryan

Note: This blog is for informational purposes only. The opinions expressed reflect my view as of the publishing date, which are subject to change.  While this post utilizes data sources I consider reliable, I cannot guarantee the accuracy of any third party cited herein.

thAnxiety about ecommerce in the pet industry is not a new phenomenon.  I’ve had it for a while; it seems to come in waves.  Often the “worry” is overcome through the most limited acceptable response from a market participant, just sufficient enough to satisfy my concerns. Most recently, my unease related to the future of Chewy.com, the leading independent ecommerce player in the industry.  My fear was that should Chewy be cut off from the capital markets, it could lead to a meltdown given its operating profile and cash burn, setting the online component of the industry back for a decade, from which it may not recover.  Thankfully, for the moment, my concern has been assuaged with the announcement of the company’s most recent funding, a $75 million investment from investment management firm Blackrock.

Pet ecommerce is a bit of an enigma, wrapped inside a riddle, wrapped inside a conundrum.  The conundrum — the perceived potential for cannibalization of four wall retail revenue — started it all in my opinion (others will quibble here, but to do so would merely be a digression).  For years, Petco and PetSmart buried their head in the sand about the potential for ecommerce in the pet industry. As the dominant retailers in the category, their view was akin to “why promote it, if you don’t want it to happen?”. The number three and four retail players possess a limited to non-existent ecommerce capability set as well.  The riddle was how to get a 25 – 40 lb. bag of dog food to a customer’s door without going broke in the process.  The failures of those who tried to solve the riddle, before the needs of customers were sufficient to want it or the infrastructure was available to make it happen, only served to reinforce the conundrum.  The cost problem has been addressed in a variety of ways ranging from infrastructure partnerships, to rising consumer demand, to subscription services, to more effective cross selling of higher margin products to online consumers.  The enigma remains how much ecommerce is influencing the pet industry and the trajectory of its largest retail players.

Depending on what you believe, online sales of pet products accounts for 6% – 10% of industry sales, or $4 – $6 billion.  Again, depending on your source, online sales for pet products is growing at 12% – 20% and enjoys the highest sales penetration of any home care category in the U.S.  However, the U.S. trails both the UK and China in terms of sales penetration of pet food online.  Of these estimated sales, we now know Chewy.com makes up $880 million of them, according to a Bloomberg article where the notoriously secret company disclosed details of it’s most recent funding, a $75 million equity financing from Blackrock.

To date, Chewy.com has raised $236 million (or $248 million depending on your source) in equity from a variety of institutional investors.  There is no complete data source that can reconcile that number — mapping the who, the when, and the how much.  However, we do know investors have migrated from traditional venture capitalist (Volition Capital and Greenspring Associates) to mutual funds whose investments often are a precursor to an IPO (T. Rowe Price and Blackrock). These fund have been necessary to fuel the company’s hyper growth, which has been driven by aggressive customer acquisition and rock bottom pricing for customers.  You don’t go from $0 to $880 million in online revenue in five years without a significant war chest and a willingness to buy customers at essentially whatever cost is required

However, on the way to becoming a pet industry unicorn, Chewy.com’s world began to morph.  First, Jet.com added the category and began to compete aggressively for customers driving up acquisition costs for all the major players and driving down profits for price matching entities as Jet sought to undercut the market when possible. With Jet’s acquisition by Wal-Mart, this issue may abate over time in the name of its parent company’s earnings and ROI requirements. Second, the major physical retailers began to quietly fight back, threatening punitive action for brands that would not enforce MAP online.  While MAP would be a net positive of Chewy’s margin profile, it would likely have come at the cost of growth, a necessity to access the capital markets.  Finally, was the issue of the most recent election cycle.  As Chewy sought to fund its business it was likely going to be pushed towards foreign markets or an IPO, as a trade sale at an attractive price appears unlikely unless you view the business as a capability acquisition and not a category play. Based on the trade and capital markets forecasts for the incoming political regime, there are concerns about slowing foreign investment in U.S. companies against a back drop of changing trade policies and the potential for the IPO window to close as a result of a market contraction.  While neither of these may come to pass, the concerns are real.  This makes the most recent announcement by Chewy to be welcome news, in my opinion, for all independent pet ecommerce players.

Should the public capital markets continue to be inviting, expect an S-1 sometime in 2017 for Chewy.com.  Further, cross off another of our anticipated transitional events for the pet industry in 2016 – 2017 (see here).

/bryan

Note: This blog is for informational purposes only. The opinions expressed reflect my view as of the publishing date, which are subject to change.  While this post utilizes data sources I consider reliable, I cannot guarantee the accuracy of any third party cited herein.