On 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.
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.