unicornOn Wednesday, as anticipated, Blue Buffalo, the pet industry’s most prominent unicorn, filed to raise up to $500 million in a public offering (see form S-1 here).  The company intends to trade on the NASDAQ under the “BUFF” ticker symbol.  J.P. Morgan and Citigroup are the lead underwriters. BUFF reports generating $918 million in revenue in 2014 ($940 million for the latest 12 months ended March 31, 2015). The company estimates it holds a 6% share of the total pet food market and 34% share within its competitive set, which it defines as the Wholesome Natural market segment.

A number of items that are notable from the S-1:

  • The company’s growth strategy lays out a thinly veiled plan for ubiquity in product access, noting that Blue Buffalo currently feeds only 4% of dogs and 2% of cats.  Growth will come from 1) building U.S. market share by expanding the availability of Blue Buffalo products, which we assume means a move into mass, 2) entering into therapeutic diets, and 3) select international opportunities (Canada, Mexico, Japan).
  • Blue Buffalo products tend to over index with younger households (Gen X and Gen Y) as well as younger pets (ages 0 – 1), providing some belief that it will increase market share as these owners age by capturing them early in the lifecycle.  Approximately 4% of Blue Buffalo sales occur online, versus 2% of the total market according to Blue Buffalo, which makes sense given the demographic where the brand is resonating strongly.
  • The business has delivered impressive growth over both the recent and longer term time horizon.  Revenues increased from $190 million in 2010 to $918 million in 2014, representing a compound annual growth rate (“CAGR”) of 48%.  During this same period Operating Income grew at an 86% CAGR from $15 million to $179 million.  Operating Income margins have increased from ~ 8% in 2010 to nearly 20% in 2014.  While future growth rates are projected to taper, it appears to be more associated to with the “law of large numbers” catching up with the business, as opposed to any change in fundamentals.
  • Management plans to continue its movement towards vertical integration as it relates to production. The company notes that in-sourcing a substantial portion of its product manufacturing, whether at the existing Heartland plant (which is expected to produce 50% – 60% of Blue Buffalo volume) or to future owned facilities, will yield significant cost savings. The Gross Margin profile of the business is healthy for this category, at around 40%, but has not shown much in terms of scale benefits. That said, that fact is not all that surprising given the level of production outsourcing and variable cost of protein inputs.
  • The company is building a dedicated sales force for the veterinary channel.  Blue Buffalo views veterinarians as key influencers and believes it can develop a set of differentiated products that will create disruptive results in this channel.
  • The company incurred $2.9 million of legal expenses in 2014, which are costs related primarily to the litigation with Nestle Purina.

The filing highlights the reason BUFF has not pursued an M&A exit.  Historically, the high water mark for pet food M&A has trended at 3.0x Revenue.  However, if Blue Buffalo were valued at $3 billion, that would imply the company was worth 15.5x Adjusted EBITDA of $193.2 million, which feels considerably light for the leading independent natural pet food brand. Consider Freshpet, which is smaller, unprofitable, and has not produced as impressive growth, trades at over 6.0x Revenue. While we don’t see Freshpet as the perfect comp those who are not close to the industry are naturally going to make that comparison. Our expectation is that a public Blue Buffalo will be valued closer to $5 billion, too big a piece of cheese for even the largest industry mouse to swallow. That valuation assumes that the company can detail a tangible plan to grow outside its core channels and in lower cost products, improve its gross margin profiles, and deliver higher level of surety around its product inputs.

/bryan

Note: This blog is for informational purposes only. The opinions expressed reflect my view as of the publishing date, which are subject to change.  While this post utilizes data sources I consider reliable, I cannot guarantee the accuracy of any third party cited herein.