arrowAs most of you are well aware, the pet industry is in fact quite large.  Depending on how you measure industry size, the pet industry is the fourth largest consumer segment of the U.S. economy (excluding health care).  And where there are large market opportunities, logically, they are capital inflows from investors, both public and private, seeking to create wealth from changing dynamics in those markets.   As an example, if you were an investor in PetSmart’s public shares over the past five years, you have enjoyed a handsome return from the specialty retail chains’ ascendency, as consumers spent more on their pets as part of the broader humanization trend.

Pet companies have also received a considerable amount of interest from private equity funds seeking to capitalize on the growth trends inherent in the industry.  While I do not have purview into every equity funds predilections, I have yet to come across a consumer oriented growth equity or buyout fund that does not have an interest in the pet space.  Many of them long to replicate the success of Eagle Pack Pet Food, Old Mother Hubbard and Banfield Pet Hospitals.  This “professionalization” of the industry has been a thematic I have waxed on about at length in my prior reports.

However, despite the size of the opportunity and the amount of available capital seeking that very opportunity, private equity transaction volume in the pet industry has in fact been quite limited.  To put this in perspective, according to the Pitchbook platform, there were 364 private equity transactions completed in 2012 that involved consumer facing companies.  Of that deal volume, the pet industry made up just over five percent of private equity deal volume with 19 reported transactions.  The is a decline from the past three years, where pet industry transaction volume made up just over seven percent of total consumer transaction volume.  The chart below tracks the trend over time (source: Pitchbook).

GraphThrough April 2013, there have been six reported private equity investments in the pet industry, putting the industry trend at risk for a second consecutive deceleration.  So what gives?  A few thoughts based on my experience.  First, the interest of private equity in the industry does not align well with the size of its participants.  As a general rule, private equity firms target companies with at least $5 million in Operating Income, with a strong preference for more.  That is not to say that growth equity and buyout deals don’t get done involving pet businesses of every size, but the core interest from these investors is in companies with a strong track record of profitability.  The pet industry has a limited number of companies that fit this mold, with most businesses being bigger or well below that threshold.  Second, there is an active consolidator market in the industry which is a headwind for private equity firms to get a deal done.  If a seller can get a better valuation from a strategic, they will often bypass the private equity market all together and wait to do a strategic sale. Finally, the interest of private equity in the space tends to be disproportionately oriented around pet food and veterinary clinics. A lack of opportunities in these segments has increased focus on retailers, distributors and, more recently treat companies, but a historical sector bias has certainly limited deal volume.

I remain long term bullish on private equity and the pet industry, but, as evidenced by the above, the relationship between the two has some inherent complexity.  However, as private equity gets a track record of success in a broader segment of industry sectors look for the industry to embrace outside equity more fully.  Deals beget deals.

/bryan

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