December 2011


In September 2008, a private equity group led by Hammond, Kennedy, Whitney & Company, Inc. (“HKW”),  acquired a majority interest in FURminator, Inc., a Fenton, Missouri based manufacturer and marketer of pet grooming products.  The FURminator’s products include small, medium, large, cat, and equine deshedding tools, shampoos and conditioners, treats, and dog food supplements. Terms of the deal were not disclosed.  However, at the time, I put out some estimates here.

On December 9th, United Pet Group, Inc., a subsidiary of Spectrum Brand Holdings, Inc., announced they had acquired the business for $140 million.  Disclosed latest twelve months revenue for the company was  “at least” $40 million, putting the deal value at between 3.0x – 3.5x latest twelve months revenue — as eye-popping a multiple as we have seen in the pet industry, excluding food, over the past three years, and certainly something we expect other sellers and potential sellers to latch on to when establishing their valuation expectations.

When HKW and friends acquired the company, it was, in my opinion, a bit of a head-scratcher.   FURminator had established itself as the leading player in the deshedding tool market and its intellectual property position provided the company with a tangible source of competitive advantage.   However, it was not clear where the subsequent growth was going to come from.   How many $40 deshedding tools does one household need?  The product is virtually indestructible and the pet population was, at the time, not growing.   Notably, HKW did not have any pet industry experience and while my estimate of the value associated with the buyout transaction were, in hindsight, overstated, the group paid a healthy premium for the business.

So how did the buyout group generate such a handsome return?  Oddly enough, it was the recession.

While the pet industry fared well, on a relative basis, during the recession, the services segment was hit harder than consumables.  As consumers cut back on discretionary spending services were the first to go.   However, that did not mean that owners stopped washing and grooming their dogs.  Instead they just became do-it-yourselfers, driving sales of grooming products to the consumer market (relative to the professional market).  As the top brand in this space, FURminator benefited.

Additionally, the major pet retailers (Petco and PetSmart), in an effort to drive store traffic and control costs, began to consolidate vendors in late 2009.  During the 2007 – 2009 period, the number of product providers (both hardgoods and consumables) had increased markedly, reducing economies of scale in operations.  Further, brand proliferation made it difficult to provide consumers a uniform experience across store venues.  As central merchandizing groups took back control of the aisles, they shifted their product strategy to focus on core brands store brands/proprietary product.  As a result “tier two” players were waylaid.   After all, if you were only going to carry one brand of deshedding tool it was going to be FURminator.

The last leg of the stool was that the recession kicked off a wave of strategic M&A as corporations sought to purchase growth.   Within pet, the merchandising changes at Petco and PetSmart began to drive deals in the products space — Doskocil Manufacturing, Tagworks, Bamboo and Fat Cat, Spotless Group, among other deals.  United’s acquisition of FURminator is simply an extension of this trend.   These deals price attractively because of the operational synergies — rationalization of facilities, people, distribution.   Notably, United stated that once integrated the effective multiple they will be paying for FURminator is 6x – 7x EBITDA.  Given United’s ability to push the product into international distribution and their resources to assert  and defend FURminator’s intellectual property position means 3x revenue does not look overly expensive.

Beyond that, let’s hope the trend continues — 3x revenue valuations for everyone.

/bryan

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Despite its size, the pet industry, as a whole, is under analyzed.  That is not to say there is a lack of analysis, but rather a lack of diverse perspectives.  The reason for the homogenous set of  “points of view” is largely structural.   There are a handful of very big companies that drive the pet industry from the product side — Mars, Nestle SA, Procter & Gamble, Del Monte, etc.  However, we have limited transparency into the granular performance of their pet brands because they either have no reporting obligation (Mars) or their pet business is quite small relative to their overall income statement or balance sheet.  Notably Nestle, who controls some 30% of the pet food business, does not report  its pet food segment separately.  The same can be said about pet retail — Petco, Petsmart, Wal Mart.   The primary industry reporters — Packaged Facts, Mintel, IBIS — rely, largely, on the same survey methodology.

Given the above, you can understand why I was excited to get my hands on Todd Hale’s “State of the [Pet] Industry 2011”.   Todd is SVP, Consumer Shopper Insights for The Nielsen Company.  Simply put, I think Todd brings a different and unique perspective to the table.  Because his firm has access to unprecedented amounts of transaction data, he is best situated to look at the industry from a consumer standpoint, as opposed to from a product or individual retailer standpoint, and of equal significance, put pet consumer behavior in the context of consumer behavior in other retail environments.

With that as my long winded set up, here are some key takeaways from his presentation (all data credits to The Nielsen Company):

  • The Polarized Consumer.  We often talk about consumers in terms of median household income.   One can then analyze consumer behavior across stratified income bands.  This is really nothing new.  But what Nielsen scan data (actual product movement and basket purchases) provides is the opportunity to, on a rolling 52-week basis, analyze purchasing behavior within these income bands and compare the results to prior year periods.   This data does not need a +/- 4% confidence interval because it relies on actual transactions, as opposed to sentiment.  What Hale’s data shows is that the consumer population is very polarized.  While the wealthiest 20% of the consumer population have exited the recession, as evidenced by growth in shopping trips and shopping dollars, all other income bands have contracted.   This demonstrates the fragility of the retail industry and validates how important the premium demographic is to the health of all retail, not just pet.   Using the same methodology, Hale shows that that the affluent (those with household incomes in excess of $70,000) purchase 40% of the pet food and consume 42% of the pet services, despite making up less than a third of the consumer population.   As a result, it is easy to conclude that the pet industry remains as vulnerable as other retail categories.
  • Pet is En Fuego.  If you look across U.S. retail formats, as measured by store counts, value and convenience are winning.   The number of warehouse clubs, supercenters, dollar stores, supermarkets and convenience stores have all increased since 2005.  Only drug and mass merch have contracted.   However, when you dig into the specialty retail category, home improvement and pet have shown meaningful store count growth during this same period, with pet doors increasing 43% and home improvement moving 10.5% to the positive.  Further, pet is the only store category that has shown positive household penetration over the past 10 years, increasing from 30% to 32%.   In short, pet specialty industry has been star performer in the retail landscape over the past six years.
  • PetSmart is More En Fuego.  We have covered the performance of PetSmart on this blog in some depth.  Our historical analysis demonstrated that once PetSmart stopped focusing on topline growth and embraced a balanced scorecard (same store sales, product level gross margin, earnings per share) it quickly became the premier retailer in the pet industry.   Hale puts PetSmart’s performance in perspective across all retailers, noting that PetSmart has produce a 14 quarter “winning streak” of positive comp store sales.   Nordstrom came in second in the discretionary spending category at six quarters.  Among all other retailers (discretionary, value, club), only Sam’s Club and the “dollar” stores (Dollar Tree, Family Dollar, Dollar General) have comparable winning streaks, with only Family Dollar and Dollar General having higher average comp store sales since 2008 than PetSmart.  While the bar for domination of the pet specialty channel is in fact low, Hale’s data proves how impressive the company’s performance has been relative to all retailers.
  • Inflation is Hurting/Helping Pet.  Based on Nielsen scan data for the past two years, prices have risen across the board, with the exception of alcoholic beverages and pet food, though pet food prices increased over 4%  in 2011.  Pet care and pet treats also experienced inflation of 2% and 3% respectively in 2011.   While inflation is hitting consumers at times when incomes are down, price increases have helped the pet industry grow to new heights (sort of perverse).  Notably, Hale’s data shows more pet industry inflation than PetSmart has reported, meaning price increases at grocery and mass have been more substantial than in pet specialty.
  • Brands Hang Tough.   The recession kicked off a new chapter in the branded versus private label tug-of-war across consumer categories.   As Hale points out, private label brands hovered at 19% – 21.5% of unit volume from 2005 to the middle of 2008.  During the recession, store brand volume shot up and has remained at 21.5% – 23.5% post-recession.   Since 2007, store brands have grown 21% in dollar volume versus 3% for branded items.  Notably within pet, all major categories have a lower penetration of store brands than the product average, and private label penetration has fallen in pet care, food and treat over the past year.   This is logical given that store brand attachment falls as income rises, and the pet industry is driven (per above) by the higher income demographics.

In summary, Hale’s data provides us a different lens through which to view the pet industry.   The dominant perspective, to date, has been that of the product provider, and we are led to believe that the manufacturer dictates to the customer what he/she wants and consumes.  Hale helps us understand that the tail may in fact be wagging the dog — consumer behavior, and the ability of pet retailers to incent that behavior, may have been the more powerful force in driving the growth of the industry over the past five years.

/bryan