retail


happy faceThe pet industry, for all its interest and fanfare, is a data starved segment of the consumer landscape.  The industry lacks for data solutions that would provide a dynamic understanding of industry, channel, and company level performance.  Instead, operators and investors are left to rely on summary level government reporting, annual data releases from industry associations, specialized proprietary data reporting from industry participants, and select data points from publicly traded companies, that when put together provide a general understanding of industry growth and direction.  As the pet industry further expands into the food, drug, and mass channel data should improve, but this will take time.

As we wait for APPA data to be released at Global Pet Expo in March, we thought it might be useful to use the other available data sources to paint an industry picture ahead of the tradeshow season.

  • Growth:  The pet industry continues to grow at levels in excess GDP (2.3% in 2017).  Pet related Personal Consumption Expenditures, measured by the Bureau of Labor Statistics posted 6.5% growth in 2017, driven by 9.7% growth in Services PCE.  Product PCE growth was more muted at 4.2%.  The industry experienced a deflationary trend in pet food of 1%. Services inflation continued at just short of 2%.  The variance in PCE versus APPA growth figures has been expanding, meaning the data sets are getting less correlated, for reasons that are unclear. However, based on the underlying PCE data it is safe to assume that growth was steady in 2017, but it is unlikely that we returned to 4%+ growth.  Continued deflationary pressure in pet food is a long-term headwind, which services inflation could constrain pet population growth for cash starved Millennial pet owners.
  • Economic Tail/Head Winds: Growth in the pet industry is, in our experience, tied to three economic factors.  First is employment.  People who are employed are more likely to have income to afford a companion animal and a living situation that would allow for pet ownership.  Currently, unemployment is at a structural barrier, which has been good for pet ownership growth over the past 12 – 18 months.  However, it seems the industry is getting as much benefit from the employment situation as one can expect. Unemployment has also declined due to people leaving the workforce, meaning the benefits of full employment on the pet industry in recent years is somewhat overstated.  Second, is disposable income.  The cost of owning a pet continues to increase. According to the APPA Pet Ownership Survey 2017 – 2018, the annual cost of owning a dog is greater than $1,500.  Some surveys put the lifetime cost at over $25,000.  To afford these costs, pet owners need disposable income. Yet growth in disposable income has been tepid over the past over the past 24-months. The recently passed tax reform should benefit income trends, but potentially at the expense of inflation. Psychologically income trends should be healthy for pet ownership as consumers tend to overlook cost inflation in the near term. Third, is home formation.  When a family unit purchases a home, it is often a catalyst for purchasing a companion animal.  Low interest rates and sustained economic growth have led to a strong demand for housing, despite concerns about affordability given current home prices.  Home formation trends should continue to benefit the industry, though rising interest rates may cause home formation trends to taper.
  • FDM Growth: The launch of Blue Buffalo in the mass and grocery channel is a game changer for the industry.  A myriad of other brands are launching outside the pet specialty channel, such as Nutro in Walmart, and we expect PetSmart and Petco will be offering a competitive response in their next reset.  The issue is that PetSmart and Petco cannot offer brands the same growth trajectory they have enjoyed in the post-recession period.  Quite simply, consumables availability has become ubiquitous; consumers are simply choosing a transaction venue based on convenience weighted cost.  The consumer relationship is with the brand, not the retailer.  Even with only six months of Blue Buffalo exposure, which has slightly underperformed and been aided by significant discounting and promotional spend, in 2017 pet consumables growth in FDM is estimated to have exceeded that in pet specialty — 2% compared to 1.5%.  This bodes well for growth among brands with existing FDM shelf space, though the ability to hold that space going forward is going to become increasingly competitive.
  • Ecommerce Growth Continues:  In 2016, industry analysts, based on very limited information, estimated that ecommerce penetration in the pet industry would eventually grow to 20%.  At the time penetration was estimated to be +/- 5%.  According to Amazon, they estimate ecommerce penetration in the pet space will reach 18% in 2018, meaning the industry will almost certainly breach 20% and do so in 2020.  Amazon recently stated that they viewed the industry as a “unique and highly valuable category” and they intend to make growing their online sales of pet products a 2018 business priority.  Additionally, the proliferation of direct-to-consumer pet food brands (Ollie, JustFoodForDogs, etc.) and sales platforms (Petnet, PetCube), many of whom are now venture backed, will give the broader sales channel additional tailwinds. We also see aging pet parents as a further opportunity to grow pet ecommerce. As consumers get mobility constrained they are increasingly turning to online venues for product acquisition. We believe they will do so with their pet spend, especially pet medications. The unanswered question is how MAP pricing might impact online channel sales.  Ecommerce has grown substantially based on its pricing advantage.  As that narrows, it would logically impact purchase intent unless it offers convenience benefits that outweigh the alternatives.

For the past two years, we have talked about an industry in flux.  While we believe the industry continues in a state of transformation, we think we are through the most volatile phase of the change cycle.  The truth is there is some stable thematics — steady growth aided by modest tailwinds, customer first retail, and dissolving incumbent paradigms.  Companies that can build a salient customer value proposition and innovate stand to do just fine against this continually evolving backdrop.  Those that rely on historical paradigms as a means of competitive advantage seem more likely to get run over.

/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.

 

 

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spinoffI enjoy the holidays as much as the next person.  Every year I seem to make some new friends during the party circuit that accompanies each Yuletide.  This year was no exception.  However, who those friends were was a departure from historical norms. All my new pals had one thing in common — they were PetSmart bondholders.

My firm does not engage in sales or trading of public equity or debt securities, nor do we provide any research products tied to specific companies or offerings, so for a critical mass of hedge fund managers to end up at my doorstep was a bit of a surprise.  All of them wanted to know if I thought PetSmart would spinoff Chewy.com.  To better understand why that was such a pressing question some context is required.

When PetSmart acquired Chewy in April 2017, they financed the purchase with a combination of debt ($3.25 billion) and equity. The debt component include two tranches of publicly traded notes (first and second lien).  The price of the debt began to slide within one month of the close, and picked-up steam when Blue Buffalo jumped the channel in August followed closely by the departure of PetSmart’s CEO. A third quarter earnings miss added fuel to the fire (EBITDA down 34% year-over-year).  The company’s second lien notes have traded as low as the mid-50s, while the first lien note have traded as low as the mid-70s, a healthy discount to par.  The notes were among the worst performing junk debt issuances of 2017.  However, what caused PetSmart bondholders to worry most was the fact that the covenant package tied to the debt would allow the private equity syndicate to separate Chewy from PetSmart for its own benefit, and to the detriment of creditors.

The primary motivation of private equity investors is first and foremost financial gain.  That is not to say they do not provide a direct or indirect public good, but rather I would never put it past this class of investors to pursue what was in their own best interest.  While separating Chewy from PetSmart might be theoretically viable under the terms of the bonds, we think the carve-out has more risk than reward.

While Chewy remains the market leading ecommerce property in the pet space, its value proposition is eroding.  Post-closing of the transaction, a small number of notable brands exited the platform, dealing the company a topline financial hit. The transaction also accelerated a movement within the retail community for the implementation of MAP pricing policies.  While MAP can be hard for smaller brands to enforce, it appears that most companies are making reasonable efforts to communicate and enforce these policies.  Of greater significance is the fact that Chewy was losing money at the time of the sale, meaning it would need more cash to sustain its growth.  Separating from PetSmart would result in the loss of significant purchasing leverage, meaning even further losses.  Absent a major cash infusion, Chewy would need a public float to perpetuate the business model.  Public comps with this business model trade at 1.0x – 2.0x revenue, much lower than the multiples paid for the banner.

The net of all this is that I do not see a full separation as a likely outcome.  At the very least it would lead to years of expensive litigation. Rather, I believe the private equity syndicate will use the threat of a spinoff to renegotiate with bondholders if and when needed.  If a spinoff does occur, expect it to involve less then 50% of Chewy, such that the entity can continue to be consolidated for financial reporting purposes and enjoy the benefit of PetSmart’s purchasing power to offset losses.

/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.

 

 

 

 

 

aisleEarlier this week, Blue Buffalo released its 2Q2017 financial results.  While the numbers are always interesting, analysts were looking for further clarity on the company’s FDM launch and its anticipated impact on full year results, as well as insights as to where the brand is migrating and how it might offset dilution associated with a multi-channel strategy.  In short, the quarterly results were only the appetizer and the FDM launch narrative the main course. Reactions from the call seem to fall squarely into two camps — satisfied or bewildered.  The stock was up 6.6% on the day, which tells you which camp Wall Street fell into, but off its high during the trading session.  The stock had been up a double digit percentage during the session.

The quantitative metrics made for a mixed bag.  The company delivered in line EPS despite a – 2.5% topline miss.  Management attributed the miss to inventory delevering at major pet specialty accounts.  Organic sales growth was +2.8% (+3.3% in dry and +0.7% in WTO) driven by +1.8% mix gain and +0.9% inflation.  Sell through was ~ 7% representing sequential growth over 1Q2017.  Notably pet superstore sell through declined ~ 6% versus sell-in and was down ~ 11% year-over-year.  In contrast ecommerce growth was robust leading to a total sell through growth rate of ~ 30% in the channel. Gross Margin was also up +235 bps year-over-year, driven by supply chain efficiencies and lower input costs.  This appeared to be +125 bps over consensus.  The company affirmed full year guidance for both top and bottom line. The long short is Wall Street likes earnings and in combination with margin gains, it was enough to look past the sale miss.  The narrative appeared something akin to the following — “We will make it up in FDM!”

Management elaborated on its FDM launch, stating the four retailers it has partnered with represent between 8% – 9% of the pet food market on a dollar basis.  This expands Blue Buffalo’s addressable market by ~ 20%.  The company’s products will now be available in an additional 6,000 doors. Given that FDM over indexes on cat and wet/treats, management believes this unlocks some potential for growth in WTO.  Based on some early looks at the product set in Publix, it appears FDM will be selling 25 lb. bags of Life Protection Formula for a price consistent with a 30 lb. bag on Chewy.com. Blue Buffalo is targeting a high single digits/low double digits share in its FDM accounts.  Said differently, they are targeting 8% – 10% share within the retailers that account for 8% – 9% share of the pet food market.

The most notable aspect of the call, was the fact that Blue Buffalo did not speak to PetSmart or Petco before announcing the launch, which had been in the works for close to a year.  Thus, there was no way for them to weigh the competitive response from their major pet specialty retail partners. Management’s response to analyst queries was akin to, “we are hoping for the best.”  Whether it was coincidental or contributory, PetSmart CEO, Michael Massey, resigned today (see press release here).  My sense is that Blue Buffalo did not want to alert these retailers ahead of their pending category resets.  This would have likely led to greater near term shelf losses as the superstores increase shelf space for their premium private label offerings.  Blue has demonstrated they understand the timing game and are playing it to their advantage.

And the pace of change for the pet industry keeps accelerating…

/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.

 

 

 

 

 

 

 

 

 

 

 

blue dogOver the past year, we have covered, at length, the transitional phase that the pet industry now finds itself in.  We have encouraged market participants to question everything they have come to know as the “status quo” for the industry and assess the likelihood that it will continue to prevail over the next three, six, twelve months and beyond.  For those who have dismissed the potential for wholesale industry change, we have pointed to the current political environment as a proxy, where the historical standard for how business gets done has descended into a state of entropy.  While the pet industry’s state of change has not reached the point of chaos, many traditional barriers have in fact fallen and are not likely to be seen again.

And another one goes…

Yesterday, Blue Buffalo began informing customers that it has begun distributing a subset of the BLUE Life Protection Formula (LFP) to select mass and grocery retailers.  Product will begin showing up on the shelves of Target, Kroger, Meijer, and Publix in August.  The company stated, “We have decided that broadening the distribution of LFP, our entry-level natural pet food line, is the natural evolution of our go-to-market strategy.”  The company intends to focus on smaller bag sizes and more mainstream formulations in its FDM solution set.  The company’s other lines will continue to be pet specialty exclusives.  See the full letter here.

To some this will come as a surprise.  After all, the pet industry has relied on well-maintained channel boundaries wherein brands choose to focus on and remain loyal to either pet specialty or FDM as a means of garnering retailer support.  Within these buckets there are soft boundaries between independent pet specialty and major pet specialty and between mass grocery and natural grocery.   When a big brand jumps the turnstile it is a BIG DEAL.  However, in this case it appeared to be inevitable.

When Blue Buffalo went public in 2015, pet superstores accounted for approximately 70% of the company’s revenue and was growing at over 7%.  Fast forward to 2017, and pet superstores are expected to account for less than 55% of total company sales and their growth rate will contract over 6%.  This trend line is not expected to change, with further contraction contemplated going forward.  To offset the challenges within its core channel, Blue Buffalo launched other growth initiatives focused on the veterinary channel and international markets. We viewed these as simply stop-gap measures while the company waited for the right time to make its move to mass.  That time has apparently arrived.  However, it arrived in a somewhat unanticipated way.  Our assumption was that the company would partner with Walmart, but instead it chose Target and conventional grocery.  This leads us to believe that a Walmart launch will be a 2019 event.  Blue Buffalo will wait until its Target and grocery channel account sales anniversary and then launch in other mass accounts, providing them four years of baked in growth optics based on mid-year launches.  That is public company behavior hard at work.  As of this writing the stock is down ~ 2% on the news, but don’t expect it to stay that way.

Now that Blue Buffalo has made its move, the question is what is the competitive response.  Just last week Champion Petfoods and Fromm Family Foods were showered with praise from independent retailers due to their willingness to move off Chewy.com in light of its acquisition by PetSmart.  Just a week later they now are faced with a different decision as they both could undoubtedly enjoy a national roll out at PetSmart, Petco, or both if they are willing to embrace that opportunity.  Other brands that are likely to benefit include Chewy’s own American Journey, which could easily transition to an online/offline brand.  Nulo is another prime candidate given its performance in PetSmart and the emergence of its Freestyle line in independent pet specialty.  Brands like Nulo, who effectively straddle the inner channel boundaries, are likely to welcome the news of a Blue FDM launch.

From a retailer perspective, one has to believe that Blue Buffalo shelf space will decline in the near term, if only as a psychological feel-good moment.  The pet specialty channel has a strong reliance on Blue Buffalo, so it’s ability to have a meaningful response is, to a large extent, muted.  Some back of the envelope math would suggest that nearly 25% of Petco and PetSmart food sales are in Blue Buffalo products.  The likely answer will be less retailer financed marketing support, though Blue Buffalo can take up that spend through national ad campaigns.  Notably, the company intends to begin tagging commercials for its pet specialty exclusive lines with “available at your favorite pet specialty store”.  Independents may have greater perceived influence by curtailing product recommendations, but that only works if they can effectively steer potential customers into alternative brands. Many retailers have found that converting Blue Buffalo customers is harder than it looks.

Finally, we come to the leading FDM brands.  It’s natural to assume that Freshpet, Rachel Ray, and I & Love & You should be concerned.  After all, there is only so much space available for the pet category within these retail environments.  However, each of these companies have forms of differentiation that they can rely on be it form factor or brand attributes, so Blue Buffalo’s ability to drive traffic to the channel may in fact benefit them as consumers begin to rethink the role of their grocery retailer in fulfilling a critical mass of their pet spend basket.

Every day, the pet industry looks less like a behavioral outlier, and more like its human industry peer group.  The change the industry has undergone over the past 12 months is dramatic, but a new end game is starting to come into focus.  That should excite companies with innovative products, salient marketing messages, and strong execution capabilities.  To the victor go the spoils.

ETA: PetSmart bond prices have declined almost 4% since the announcement.

petm

/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.

 

sbmIf you have not seen the digital age in pet coming, it’s arrival has now been fully announced.  In the past year, a remarkable number of meaningful events have happened to punctuate it’s arrival.  Many of those events were likely to have gone unnoticed at the time, but in aggregate its hard to ignore.  Notably the past last year was book-ended on one end by Mars acquisition of Whistle Labs (March 31, 2016) and the merger of A Place for Rover and Dog Vacay (March 29, 2017) on the other end.  In between we have witnessed the rise of Chewy.com at the expense of Petco, PetSmart, and even Amazon; Phillips Feed Services acquisition of Petflow for the purpose of arming independent retailers for the digital pet race; and a total $154 million dollars invested in 46 pet-tech deals.

Pet-Tech-Annualnew

Historically, it has been easy to dismiss the digital pet movement as a novelty act, confined to products whose addressable market was small and whose value proposition was narrow.  It’s true that many of the first generation products were poorly designed or over engineered, and generally expensive.  Further, the arrival of pet tech was slowed by the inability of core pet retailers to sell the solution set.  Simply stated, Petco and PetSmart were not well set up to educate consumers on why they needed to own a $200 smart feeder or a $150 remote treating system.  Further, technology retailers, such as Best Buy, knew very little about the category and were therefore unable to effectively merchandise a pet technology set.

Despite these impediments, it’s hard to argue with the results of the market leaders.  Whistle Labs was acquired by Mars for $117 million, representing a high single digit multiple of revenue.  As we detailed in our last post, Chewy.com has achieved over 50% market share in online sales and anticipates 2017 sales of $1.5 billion. Finally, A Place for Rover (Rover.com) was valued at more then $308 million its $40 million Series E financing closed in October 2016.  Rover also announced that it acquired its primary domestic competitor Dog Vacay in a stock-for-stock transaction. In our discussion with other pet technology companies many of them appear poised to deliver strong growth and financial results in 2017.

The collective impact of these digital pet companies and their ascendancy in terms of industry importance can no longer be ignored.  While the negative comps produced by both Petco and PetSmart in 2016, and the recent deterioration of their leveraged loan valuations, can be attributed to a variety of factors, it’s hard to argue that the rise of Chewy.com and the lack of traffic drivers attractive to the Millennials, and subsequent generations, such as pet technology products, has been a key contributor.  The fact that the vast majority of pet food brands are available online, making their availability more commoditized, and not an influencer of store visits, is exacerbating the problem.  Further, Rover and DogVacay have served to disrupt the discretionary services segment of the market, for whom Petco and PetSmart (both boarding and grooming), along with VCA Antech (boarding) and Banfield Animal Health (boarding),  are the most established players.  Prior to the take private, PetSmart generated $750+ million in services revenue annually, accounting for ~ 12% of revenues.

The ability of incumbent players to catch-up digitally is limited.  Earnings based companies are hesitant to acquire companies without an established track record of profitability given their valuation paradigms consist of multiples of EBITDA or contribution margin.  Mars benefited from its private nature when considering the acquisition of Whistle.   A subset of major players we have spoken to are waiting around for these companies to stumble in hopes of acquiring them at bargain prices.  While companies like Chewy.com have “scraped paint” in the past, we see this strategy as unlikely to succeed in the near to medium term.  Those who are called to action, but partially paralyzed by their valuation paradigms will seek to partner.  Whether creating these bridges will be enough to move the needle or insulate them from risk remains to be seen.

/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.

 

blue dog 2Over the past five years, interest in the potential and performance of the online channel for pet products has become an increasingly hot topic.  The narrative around pet ecommerce has been fueled, in part, by a change in ownership demographics, but more significantly by the lack of transparent data regarding the size of and growth rate in the channel.  Quite simply, no one knows how much pet food is sold online or how fast the channel is actually growing, and therefore everyone is free to speculate.  The loss of PetSmart as a public reporting entity only further exacerbated this reality.

What we have known for some time is that online is taking share and its growth is a key driver of malaise within major pet specialty.  Whether you source your information from Packaged Facts, IBISWorld, or Euromonitor, all three entities have online pet products sales in the U.S. growing at between 10% – 15%.  Further, according to Packaged Facts 2016 National Pet Owner Survey, 46% of pet owners buy products online, an increase of 5% from 2015. Thus, the intent from a consumer perspective continues to rise.  Additionally, Blue Buffalo, widely believed to be the top selling pet food brand online, CEO Billy Bishop commented, in the company’s most recent earnings call, that the shift to online is occurring much faster than anyone at Blue Buffalo anticipated.  Couple this with the fact that during FY16, Blue Buffalo’s share of sales outside of major pet specialty increased from 33% in Q1 to 41% by Q4 primarily behind the sharp increase in ecommerce.

No entity has been more responsible for shaking up the pet retail world than Chewy.com.  In November 2016, we got our first real glimpse into the organization when a Bloomberg article detailed that the company anticipated that it would generate $880 million in sales for the calendar year.  Further, it projected 70% growth in 2017, bringing the company’s topline to $1.5 billion.  A recent Miami Herald article pushed that number to $2 billion. According to a recent survey by 1010data, Chewy.com has approximately 51% share of the online pet products market including autoship revenues.  This contrasts with Amazon at 35%, also inclusive of autoship.  Chewy also leads in subscription pet food sales at 10.2% versus 7.6% for Amazon.  PetSmart garners 7.9% of the market when you consolidate its own banner (2.2%) with sales of its Pet360 (5.7%) acquisition.  Petco clocks in at 3.1%, while Wal Mart (< 1%) barely registers. Finally, Chewy employs 200 full time portrait artists who churn out 700 oil paintings a week for unsuspecting customers.

Chewy, which has never turned a profit and has been funded by $261 million of equity, raised over five rounds, and $90 million of debt, is in the process of upping the table stakes.  The company recently launched its American Journey house brand of dry kibble.  American Journey, which comes in seven flavors, currently costs $39.99 for a 25-lb. bag before autoship discount.  This is $8 – $10 less than a comparable sized bag of Blue Buffalo on the site.  Notably, American Journey is made by one of Blue Buffalo’s co-packers. Additionally, Chewy launched Tylee’s, their human grade fresh/frozen pet food brand aimed squarely at the increasing band of upstarts seeking to deliver human meal equivalents for your pet. The company is also said to be working on a public offering slated for 2018.

The question of whether Chewy.com can be stopped has been answered. It’s most recent financings ($75 million of equity from BlackRock and $90 million in debt from Wells Fargo) suggest that investors are looking past the profitability profile and instead focusing on the growth history and the potential IPO valuation.  Mutual funds targeting a pre-IPO stake are likely accessible should the company need additional funding. The more intriguing question is whether there is a transaction alternative that might be more attractive to Chewy shareholders than a public offering.  As Chewy.com Chairman Mark Vadon, who co-founded Zulily, can attest, being a public company without earnings is not all that it is cracked up to be.  We rule out an Amazon combination for a myriad of reasons.  This leads us to Petco or PetSmart as the most logical destination.  While somewhat counter-intuitive on the surface, if Chewy.com could extract more value in a combination than an IPO, why not consider it?  Given the weak comps we have been hearing coming out of Petco and PetSmart, a combination with Chewy.com would solve a myriad of problems.  Chewy would gain access to cash flow and hundreds of local warehouses, while Petco or PetSmart would be able to rationalize its store base and gain the pole position in pet omni-channel.  It might not be as far-fetched as we think.

/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.

 

 

thAnxiety about ecommerce in the pet industry is not a new phenomenon.  I’ve had it for a while; it seems to come in waves.  Often the “worry” is overcome through the most limited acceptable response from a market participant, just sufficient enough to satisfy my concerns. Most recently, my unease related to the future of Chewy.com, the leading independent ecommerce player in the industry.  My fear was that should Chewy be cut off from the capital markets, it could lead to a meltdown given its operating profile and cash burn, setting the online component of the industry back for a decade, from which it may not recover.  Thankfully, for the moment, my concern has been assuaged with the announcement of the company’s most recent funding, a $75 million investment from investment management firm Blackrock.

Pet ecommerce is a bit of an enigma, wrapped inside a riddle, wrapped inside a conundrum.  The conundrum — the perceived potential for cannibalization of four wall retail revenue — started it all in my opinion (others will quibble here, but to do so would merely be a digression).  For years, Petco and PetSmart buried their head in the sand about the potential for ecommerce in the pet industry. As the dominant retailers in the category, their view was akin to “why promote it, if you don’t want it to happen?”. The number three and four retail players possess a limited to non-existent ecommerce capability set as well.  The riddle was how to get a 25 – 40 lb. bag of dog food to a customer’s door without going broke in the process.  The failures of those who tried to solve the riddle, before the needs of customers were sufficient to want it or the infrastructure was available to make it happen, only served to reinforce the conundrum.  The cost problem has been addressed in a variety of ways ranging from infrastructure partnerships, to rising consumer demand, to subscription services, to more effective cross selling of higher margin products to online consumers.  The enigma remains how much ecommerce is influencing the pet industry and the trajectory of its largest retail players.

Depending on what you believe, online sales of pet products accounts for 6% – 10% of industry sales, or $4 – $6 billion.  Again, depending on your source, online sales for pet products is growing at 12% – 20% and enjoys the highest sales penetration of any home care category in the U.S.  However, the U.S. trails both the UK and China in terms of sales penetration of pet food online.  Of these estimated sales, we now know Chewy.com makes up $880 million of them, according to a Bloomberg article where the notoriously secret company disclosed details of it’s most recent funding, a $75 million equity financing from Blackrock.

To date, Chewy.com has raised $236 million (or $248 million depending on your source) in equity from a variety of institutional investors.  There is no complete data source that can reconcile that number — mapping the who, the when, and the how much.  However, we do know investors have migrated from traditional venture capitalist (Volition Capital and Greenspring Associates) to mutual funds whose investments often are a precursor to an IPO (T. Rowe Price and Blackrock). These fund have been necessary to fuel the company’s hyper growth, which has been driven by aggressive customer acquisition and rock bottom pricing for customers.  You don’t go from $0 to $880 million in online revenue in five years without a significant war chest and a willingness to buy customers at essentially whatever cost is required

However, on the way to becoming a pet industry unicorn, Chewy.com’s world began to morph.  First, Jet.com added the category and began to compete aggressively for customers driving up acquisition costs for all the major players and driving down profits for price matching entities as Jet sought to undercut the market when possible. With Jet’s acquisition by Wal-Mart, this issue may abate over time in the name of its parent company’s earnings and ROI requirements. Second, the major physical retailers began to quietly fight back, threatening punitive action for brands that would not enforce MAP online.  While MAP would be a net positive of Chewy’s margin profile, it would likely have come at the cost of growth, a necessity to access the capital markets.  Finally, was the issue of the most recent election cycle.  As Chewy sought to fund its business it was likely going to be pushed towards foreign markets or an IPO, as a trade sale at an attractive price appears unlikely unless you view the business as a capability acquisition and not a category play. Based on the trade and capital markets forecasts for the incoming political regime, there are concerns about slowing foreign investment in U.S. companies against a back drop of changing trade policies and the potential for the IPO window to close as a result of a market contraction.  While neither of these may come to pass, the concerns are real.  This makes the most recent announcement by Chewy to be welcome news, in my opinion, for all independent pet ecommerce players.

Should the public capital markets continue to be inviting, expect an S-1 sometime in 2017 for Chewy.com.  Further, cross off another of our anticipated transitional events for the pet industry in 2016 – 2017 (see here).

/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.

 

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