“For the times they are a-changin'” – Bob Dylan

The pet industry produced another solid year of growth according to the American Pet Products Association.   Total industry revenue increased 5.3%, to $51.0 billion in 2011 driven by growth in all major segments of the industry.   Sales benefited  from pet population growth, which returned after a two year absence, and price inflation in all categories.  Discretionary services produced the strongest growth rate at 7.9%.

During the past five years the industry has grown 20%, a remarkable rate under any conditions, but especially in light of the economic contraction experienced in 2009 – 2010.   Expansion was fueled by the “Humanization of Pets” movement.  The trend toward treating pets as family members shifted spend into higher priced categories such as premium food, driving growth in the absence of population expansion.  While this theme remains relevant, its influence has tapered as the product rotation it stimulated nears completion.  As evidence, premium food market share is flat over the past two years.  In contrast, private label pet food and supermarket channel share, both associated with value, have grown.   While a value focus will continue due to the domestic economic climate, it will not drive industry volume but rather shift mix.  Instead, I believe an accelerating focus on pet wellness and population growth will fuel the industry in 2012, albeit at lower growth rates than seen in the past few years.

While the concept of “wellness” and the pet population is not new per se,  I see it coming together in a new and integrated way, which I call “Total Pet Health”.  Previously wellness was about giving your pet “better” food, augmenting their nutrition with consumables that provided perceived benefits, and then taking your pet to the veterinarian and listening to their advice about dental health and weight management.   Today the concept of wellness is about empowering yourself to make the most informed decisions about your pets long term well being using all available resources, rather than relying on pseudo experts.  It is about making product decisions based on actual results, not marketing claims.  It is about selecting the best product for the need at the time rather than blindly associating with a brand.  Its about having a relationship with your veterinarian around preventative care and using insurance to control total cost of care.

To adapt to these changes in owner behavior, I expect to see pet brands morphing from product or service providers into wellness brands.   As an example, in July 2011, VCA Antech, the nations leading owner and operator of animal hospitals, acquired Vetstreet (d/b/a Vetinsight.com) a provider of client communications, pet education, and home delivery of pet medications and supplies.  Against a backdrop of strained relationships between pet owners and veterinarians driven by veterinary services price inflation, VCA took measurable steps to empower pet owners.  Vetstreet’s information solutions enable pet owners to educate themselves about pet health conditions, learn what tangible steps they can take to remedy those conditions at home, and understand what to expect if they do take their companion to the clinic in order to avoid unnecessary service or charges.  Through this transaction, VCA transitioned itself from being a perceived source of the problem to being a wellness solutions provider.

A summary of my Total Pet Health theme is below:

From a pet industry transaction standpoint, I expect slower growth will result in further consolidation.  While the pet industry saw substantive consolidation in 2011, it also saw renewal as growth remained robust.  Private placement volume within the industry accelerated in 2H2011.  However, in a slower growth environment it will be harder for emerging companies to gain scale.  Further, interest from institutional equity sources in highly competitive pet categories will logically recede absent lower valuations.  If capital is lacking innovation will also be limited.  To the positive, truly innovative companies should enjoy premium valuations – see United Pet Group’s acquisition of FURminator as a prime example of this reality.  These conditions point to transaction volume being oriented around consolidating segments – distribution, hardgoods, retail, and veterinary services – in the near term.

Despite a fundamental bias towards consolidation, I expect pet industry transaction volume to be modest in 2012 absent a major transaction on the consumables side.  When Procter & Gamble acquired Natura Pet Products in 2010 it sent shock waves through the industry, especially in light of the fact that P&G was rumored to be exiting of the pet sector.   While the industry has seen active M&A and capital markets since that time, it appears wanton for another marquee transaction to provide it stimulus and buzz.  The recent United Pet Group/FURminator transaction caught the attention of the product side of the industry, but consumables have been lacking a bellwether since Nestle Purina acquired Waggin’ Train in 2010.  Given the prospects for an industry growth taper, as well as downstream tax motivations, it seems plausible Blue Buffalo Company or Natural Balance Pet Foods, the two largest independent pet food companies, could trade in 2012.  If they do, expect a flurry of activity in their wake.

As always, my full report is available by request.

/bryan

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