May 2010


If you follow the pet trades, or place close attention to what food you put in your dogs belly, you probably are aware that, last week, Procter & Gamble (NYSE: PG) purchased Natura Pet Products, a privately held producer of holistic and natural pet foods.   If not, let me bring you in on the not so secret combination.

The transaction, which was kept very low key inside the trade puts P&G squarely on the front lines of the battle for the premium pet consumer.  Natura possess a well respected portfolio of premium brands, including California Naturals, Innova and Evo.  In the name of full disclosure, I feed my dogs Evo, among other things.

For some the transaction was curious for P&G.  The company possess a small pet business relative to the overall size of the consumer mother-ship.   Many people were betting that the company would go in the other direction, possibly divesting Eukanuba and Iams.   Instead, P&G is trying to catch a bigger wave in the pet world and ride the premium pet food movement to higher profits and therefore an improved equity price.    However, P&G is but one constituency that stands to win, lose or draw from this transaction.  Below we analyze them all.

Winners

  • Consumers.  No one wins more than consumers in this deal.   However, this comes with a caveat; it assumes that P&G keeps the formulations and authenticity in tact.  Given the history of such actions in the consumer space this is a reasonably big leap of faith (Ben & Jerry’s anyone).  Let’s assume they do for arguments sake (and for the record I think they will, because it would not be that hard or cost prohibitive).  Consumers win when P&G pushes high quality pet foods into the mass channel making them more widely available.  Further, their ability to produce at scale economies will make them more accessible from a cost standpoint.  Even I might go to Petco to save $10 on a bag of Evo.  Well, at least I would think about it.
  • Independent Pet Specialty Brands.   Love ’em, hate ’em, Natura brands had cache in independent pet specialty.   The safe assumption is that P&G is going to move the brands in to mass, opening up precious shelf space in independent pet specialty, which is space constrained.   Brands like Honest Kitchen, Orijen, Ziwi Peak, Mulligan’s Stew,  and others stand to gain share within this channel as boutiques and  independent chains retrench from Natura brands due to channel conflict.
  • Nature’s Variety/Castor & Pollux.  Congratulations, you just became the number one acquisition targets in natural and holistic pet food in the specialty and natural channel respectively.   I can feel the smile from Catterton Partners and Highland Consumer Partners all the way from the east coast.

Losers

  • Independent Pet Specialty.  As much as I love this channel, this is not a favorable turn of events for them, in my opinion.  Natura offered many independent pet specialty stores a one stop shop solution for wellness oriented food products.  Further, these brands have strong affinity that may follow the brands to mass.   Further, if these products do exit pet specialty stores will likely have to take some risk on one or more brands whose staying power is as yet unknown.  There will be a lot of shelf and floor space to negotiate over.

Draw

  • Pet Mass.   One would think that Petco and Petsmart would go into the “winners” category as they will get their hands on a well known series of brands consistent with where they are trying to take their image and focus.    Given how easy it would be to market the brand portfolio within mass (grains are bad for your dog, these have no grain), one would think that would be the case.  However, this is Petco and Petsmart we are talking about.  I suspect they will find ways to under monetize their pending asset.
  • Proctor & Gamble.  Only time will tell how this deal turns out for P&G.  I suspect they paid a modest premium on what many believe is a $150 million revenue business, but given the mixed performance within the portfolio it is unlikely that they had to break the bank.   In mass they will go head-to-head with Wellpet, Castor & Pollux, Solid Gold, Blue Buffalo and others, in what has suddenly become a crowded field.   One has to believe their muscle — capital, branding acumen, retail relationships, etc. — will help drive the business to the next level, but only time will tell.

/bryan

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Rewind 18 months and the outlook for the private equity world looked rather bleak.    Debt financing was drier than the Sahara in July,  the economy was pulling down the financial performance of portfolio companies causing defaults at alarming rates, and limited partners were actively looking at ways to pull commitments to avoid over allocation to the alternative asset class.   You didn’t need to be Goose to see that “this is not good Maverick”.   Further, you did not have to roam far within the financial services community to find someone who thought the party was over.

As a general rule, the investment banking community has never been overly sympathetic to the private equity cause.  There is not a private equity pro who does not believe that every banker is pining for their job.   However, in the run up to the financial meltdown, equity investing had become a hustle game resulting from too much liquidity in the system.  Private equity pros lived on the road in search of “proprietary deal flow”.   They would willingly drop in on any banker that would take a meeting.  It was tough not to have a least a little sympathy as purchase price multiples reached unprecedented levels making it hard to believe fund IRRs were going to make these guys more wealthy than their predecessors.   Further, private equity, was driving deal volume, and therefore banker bonuses, accounting for nearly a third of all domestic M&A transactions in 2007.

Today, and with the benefit of a little hindsight, it is clear that the demise of private equity was grossly exaggerated.  In fact the financial buyer community has rebounded quite nicely.  While financial buyers do not enjoy the  full economic advantage that they did 24 months ago — really cheap  limited or non-recourse debt — they are well situated for success and the market appears to be coming back to them.  Consider the following:

  • Survival of Mega Buyouts.  When the economy began to unravel many thought that the mega-LBOs of the prior 24 months would unravel, leaving private equity with a tremendous black eye.   Considering that mega buyouts, while only 5% of deal volume, accounted for 61% of private equity investment in 2008 and 2009, it was safe to assume that as they go, so goes the industry.  That said, save for the demise of Chrysler, the mega-buyouts have withstood the brunt of the storm.  Yes it is true that banks have had to work with many of these credits out of self interest, but this does not account for the  mere trickle of private equity backed bankruptcies that we are currently seeing.   Likely more applicable is that private equity purchased significant amounts of debt on the open market, at a discount, to preserve equity value in their portfolio companies.  As the economy stabilized they benefited from the rising prices for this debt, thereby juicing returns.  While there have only been two $1+ billion deals announced in 2010, the fact that any can get done shows that there are “green shoots” on the private equity transaction landscape.
  • Credit Returns.  While credit may not be as abundant as it once was, certain classes of companies are enjoying access to leverage at attractive rates within favorable structures (e.g., covenant lite, PIK toggle, etc.).    Companies that generate more than $10 million of annual EBITDA are the prime beneficiaries of banks loosing their clutches on credit.   Facing competition for these credits from the high yield market, banks are increasingly willing to loan to companies perceived to be “safer”.   Garnering 3.5x – 4.0x leverage appears to be straight forward, while we have even seen a 6.5x stapled financing (senior plus subordinated debt)  on a consumer non-cyclical company.   Debt drives private equity’s ability to pay, as every dollar they can borrow is a dollar they can kick in as equity, assuming a 50%/50%  debt/equity split.    Given that the majority of LBO deals involve companies that breach (in a good way) this EBITDA hurdle, one would expect to see private equity deal volume spike as a result.
  • Deal Stats Trending Favorably.  For the third straight quarter, private equity deal activity posted a gain both in terms of number of transactions and dollars deployed.   Private equity completed 300 investments totaling $14 billion.  This is up from 238 deals for $13 billion in 4Q2009.  Notably, 1Q2010 saw the first deal greater than $2 billion completed since the prior year period — CPP/TPG/Leonard Green acquisition of IMS Health ($5.2 billion).

Private equity is also enjoying the benefit of overreaching strategic buyers.   Strategics, possessing flush balance sheets, and lacking competition in the M&A markets have failed to embrace sellers in a way that casts them in a favorable light.  Instead they have assumed a very conservative approach, as evidenced by the increasing use of earnouts, the expanding size of deal escrows, and the elongation of transaction timelines.    Net net, private equity in its core market is alive and well.

/bryan