fishySpeculation is fun.  Speculation about others is more fun.  The pet industry loves speculation.  Given the insular nature of the industry, it’s often all we have to rely on.  So when Procter & Gamble Co. (“P&G”) announced 2Q2013 earnings (P&G is on a June 30th fiscal year end), and made nary a mention of their Pet Care division a reputable pet author set the blogosphere abuzz pondering the implications of this “over site”.

The fate of P&G’s pet portfolio, which features the Iams and Eukanuba pet food brands, has been the subject of speculation for years.  That speculation has roots in a 2007 disclosure that P&G had hired the Blackstone Group to review strategic alternatives for its Folgers, Pringles, and Duracell brands.   After being a net buyer of assets from 2000 – 2005, P&G was preparing to be a net seller in an effort boost its earnings growth and enhance focus.  At the time, a divestiture of Pet Care was dismissed in favor of new management in an effort to turn around the flagging division, which in combination with the Snack group, had experienced a contraction of over 30% (revenue and earnings) between 2006 and 2007.

Speculation about P&G Pet Care end game died down after the company sold the Folgers Coffee brand for $3.3 billion in 2008 and its pharmaceuticals group for $2.2 billion in 2009, before launching a stock buyback program of up to $8 billion.  In the interim the Snack and Pet Care division had recovered its growth trajectory, even if the slope of the curve was modest.

And then P&G stunned the pet market through its winning bid for Natura Pet Products in 2010. The transaction, which likely cost them $500+ million was not the behavior of a net seller of pet related assets.  Natura was believed to be doing $200 – $250 million in sales before the acquisition. However, when P&G agreed to sell The Wimble Company (aka Pringles) to Diamond Foods for $2.35 billion in 2011 (a deal which fell through over some improper payments to walnut growers before the asset was sold to the Kellogg Company in 2012), speculation about the fate of Pet Care returned to the surface.  When Bill Ackman, an activist investor with a penchant for identifying under valued brands, made his largest ever investment in a company, the simmer became a boil, which continues today.

That said, P&G’s failure to discuss its Pet Care business on an earnings call does not have any veiled meaning.  The reality is that when Wimble was sold, Pet Care was reclassified into the company’s Fabric and Home Care reporting unit.  Pet Care as a separate P&L was no longer relevant given that Pringles made up 50% of the Snack and Pet Care divisions revenues.  Further, the fact that Pet Care on its owned is dwarfed in sales by ever other P&G revenue division by at least a factor or 8x means it was unlikely to get the same executive airtime in earnings conference calls.  In fact, the division has only received fleeting mention in ant of the three prior earnings calls.

The reality is that Pet Care does not have many places it could go even if P&G wanted it off the balance sheet.  Collectively the brands likely generate $2.5 billion in revenue meaning a market valuation of +/- $5 billion.  Most of the companies who could afford that figure would likely be facing anti-trust scrutiny if they tried to acquire the business, so it would have to be an adjacent market buyer or a foreign market entrant.  A second option would be to sell the business to a private equity firm.  However, I don’t think the numbers work.  Assuming, generously, 20% EBITDA margins and the ability to borrow 6x EBITDA to finance the deal, a financial buyer would still need to pony up approximately $2 billion in equity.  Not many firms have that sort of dry kibble.  Further, this would be akin to the Del Monte take private with half the revenue and a third of the profitability.  Pet food is not a great margin business once marketing costs are factored into the equation.  A third option would be to spin the business into a public company, a la Pifzer / Zoetis.  While having a pure play pet food comp would be nice, the transparency would make the brands vulnerable on a number of fronts.  I don’t know what a public listing would otherwise accomplish.

Net net pet industry pundits must accept that it’s not always about pet care when it comes to global brands.

/bryan

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