skullOne of the challenges in forecasting is failing to recognize the inherent frictions in the market.  For over two years I have been predicting a major IPO for the pet industry against the backdrop of expanding public company market multiples.  My initial thesis was that PetSmart’s market valuation heuristics would compel Petco to consider a listing.  Two dividend recaps later, the private equity owners of Petco seem happy to milk their cash cow with no public offering in site.  Natura? Sold.  Sergeant’s Pet Care? Sold, and probably too small anyway.  Pets at Home? Sold. Radio Systems? Private bond offering. Hartz Mountain? Recapped. Blue Buffalo? Crickets.  During this same period, a number of pet related public companies have been taken private (Del Monte, you see a food company while I see a pet company, and International Absorbents, as examples). So net net the market had experienced entropy where I predicted order.

There is a saying that “100% of shots not taken result in goals not scored”.  While I had taken my shots, it resulted in the same outcome — a bagel.  However, next week I get a consolation prize when Pfizer spins off its Animal Health Division into a new corporation, Zoetis Inc., listed on the New York Stock Exchange.  Zoetis engages in the discovery, development, manufacture, and commercialization of animal health medicines and vaccines.  The company derives 65% of its revenue from the livestock market and 35% from the companion animal space.  The company’s name is derived from zoetic, meaning “pertaining to life”.

Zoetis is a big business by pet industry standards, having generated over $4 billion in revenue and over $1 billion in EBITDA for the twelve month period ended July 1, 2012.   Post spin, the company will be the largest standalone manufacturer of animal health products globally, with roughly a 19% market share.  Vaccines and medicines for animals represents a $22 billion market globally according to Pfizer, of which approximately 30% represents veterinary vaccines for companion animals.  The U.S. market for these products is expected to grow at annual rate of 5.8% over the next five years, slightly higher than the total domestic vaccine market whose growth, over the same period, is projected at 5.3% according to Transparency Market Research. Notably, Zoetis grew approximately 30% in 2010 (in part due to the acquisition of Wyeth, whose animal health division, Fort Dodge, generated over $1 billion in revenue at the time of the transaction), 18% in 2011 and 4% over the first half of 2012.  Pfizer estimates that the public company value of Zoetis could be as high as $12.5 billion, or approximately 12.0x estimated 2012 EBITDA.  After the spin off Pfizer will own 80% of Zoetis.

Yes, the Zoetis IPO is essentially an overdue backdoor validation of my thesis – it’s not a products or consumables company or a specialty retailer, it’s an animal health empire.  Further, Zoetis was nurtured inside the womb of one of the largest global phrmara companies and not built from the ground up.  That said, the cloud has a silver lining:

  •  Yes, someone had to go first.  Often times a sector IPO leads to others, assuming it gets a warm market reception.  Given that Zoetis is a cash cow, it should be welcomed with open arms by retail investors.
  • The pro-forma valuation of Zoetis is healthy.   The company is expected to trade at a significant premium to core human pharma names, consistent with my belief that the companion animal health care market has strong tail winds and a large opportunity set ahead.  Notably, the valuation does a lot to validate the price paid for Perrigo’s acquisition of Sergeant’s, which I estimated at 10.0x EBITDA.
  • The pet market is lacking for public companies that focus solely on the industry.  Having greater transparency into industry related valuations is good for capital recruitment and exit market dynamics.

In closing, it’s notable that Pfizer spent nearly two years considering alternatives for Zoetis.  So while I predict other pet IPOs, I don’t suggest holding your breath until the next one.