freddieThe fate of Champion Pet Foods has long been a source of speculation among industry insiders.  While most deal rumors in the industry spread like wildfire, over the past three years rumors about Champion have been without peer. Not a show goes by without speculation. We’ve heard, and have bought into at some level, various iterations — IPO, Canadian pension fund buyouts, Blue Buffalo/Mars/Nestle acquisition.  Knowledgeable people, including myself, have been hoodwinked many a time.  As such, when acquisition rumors hit the media in early July, the reaction was met by many with a shrug of the shoulders – “oh good, now we know.” However, should an acquisition of Champion by Nestle Purina PetCare in fact be consummated, it feels like there will be no winners.

Shortly after the Nestle rumor hit with pages of the Wall Street Journal, Champion issued a statement that could only be characterized as a “non-denial denial”.  There was no, “we are not for sale” but rather a “of course people should want to buy us.” If the rumor needed any credence, it was received.  What is most notable to me is that while a deal might happen, I am not sure anyone, even those on both sides of the transaction, want it to. To better assess this statement, let’s consider the transaction from all sides.

From Champion’s perspective, and those of its primary backers, a sale to Nestle would bring a financial windfall; of that, we can be certain. With a potential $2 billion price tag, we can only assume that Champion would be selling for a multiple that is aligned to recent sales of Blue Buffalo and Ainsworth.  While industry websites report Champion’s sales in 2017 at $170 million, we believe it to be significantly higher.  If you sell pet food in 80 countries, and are in the process of building a $200 million production facility (see details here) you better be selling a lot more kibble than that.  However, or greater importance is that historically Champion has pursued a moral high ground with respect to its formulation and production (see here) and its channel strategy.  When Pet360 and, later, Chewy were acquired by PetSmart, Champion exited both platforms, supporting the independent retailers in their battle with major pet specialty and leading online sites they control.  Champion grew on the backs of independent pet retail, greatly benefiting from this channel’s reduction in exposure to Blue Buffalo through various brand dilutive events.  As such, a sale to Nestle would seem antithetical to much that Champion stands for.  Further, a financial windfall for the sellers seems available through a myriad of other avenues that don’t involve a perceived selling out.

On the other side of the coin is Nestle’s pet food subsidiary.  If you have been following closely, Nestle’s core food business, like many of its peers, has been under siege.  Large food companies, as a class of competitors, have been struggling to adapt to changing demographics and consumer preferences and the associated evolving channel dynamics.  Activist investors are pressuring these companies to evolve their brand portfolios faster and seek mergers to rationalize costs.  Against this backdrop, Purina has been performing.  If you dig deep in the back of Nestle’s Half-Yearly Report 2018 (page 28), you will notice Purina was a top performing segment, generating 3.8% growth in the first half of the year.  Now consider what handcuffs Champion as a premium seller might extract in a transaction — No PetSmart, Petco or Chewy? No FDM? No formulation changes? No management changes?  If you are Purina management, you are likely to inherit a business at very high price tag that is unlikely to realize the necessary return profile to be attractive in the near to medium term.  The deal appears to be a Daniel Loeb pet food aisle clean-up special, as opposed to a good organic M&A idea.  For Purina management, you can sense the apathy from afar, especially if the deal curtails your ability to pursue transactions for which you have a higher degree of conviction.

Finally, let’s consider the independent retailers. Many operators in this class of retail have benefited greatly from the growth of Orijen, Acanca, and, to a lesser extent, Heritage, as well as Champion’s conviction to this channel, at the expense of growth.  Champion provides these retailers a recurring high price point sale opportunity.  Many of them have become reliant on the company’s product offerings at multiple premium price points, and, in turn, Champion benefited from these retailers recommending their product and scaling back on Blue Buffalo considering its politics.  While we don’t know what constraints might be a byproduct of any deal negotiation, these retailers could potentially lose exclusivity to one of the backbones in their pet food merchandising mix.  A blow of this magnitude will reverberate across the channel.

When a brand seeks to take the moral high ground in a product category, it is lauded, and it often should be.  However, capitalism never stops calling, and when you take outsiders money you eventually take the next call. I’m not privy to Champion’s financials, but it would seem they possess a myriad of options outside of this contemplated transaction. If consummated, its repercussions, mostly negative, will be felt by all directly and indirectly involved.  In turn, consumers will get more jaded about what we expect from the companies we rely on to keep our companion animals healthy and happy.  Emerging brands will in turn inherit those expectations and the cycle will begin anew.

/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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fence jumperOn April 18th, PetSmart announced the acquisition of Chewy, Inc., owner and operator of the chewy.com website.  On April 21st, Tuffy’s Pet Food, a brand of KLN Family Brands, announced that it was terminating its partnership with Chewy in what was termed a “show of support for the independent pet specialty channel.”  As a result of the move, KLN received considerable positive press, and likely bolstered its standing among independent retailers.  The first mover often enjoys the disproportionate amount of the spoils.

While it is unlikely that anyone predicted Tuffy’s would be first to find the exit, let alone do it so quickly, undoubtedly the buyer and seller had to assume that there would be customer loss associated with a transaction of this nature.  The issue really was not whether Tuffy’s was going to stay or go, but whether widely distributed brands who generate a meaningful portion of their sales online would continue with the platform.  Other likely defectors were going to come from brands that call Petco home, and therefore have no existing distribution in PetSmart. There was established precedent here.  When PetSmart acquired Pet360, several brands opted out of the platform.

To the informed, this put the focus on Champion Petfoods, Fromm Family Foods, and Merrick Pet Care.  The later because it continued to be a Petco exclusive, even after its acquisition by Nestle Purina.  At issue for the former two was the fact that Chewy represented a significant customer, and likely its fastest growing.  On July 10th, both Champion and Fromm disclosed, through different mechanisms, that they had in fact exited their relationship with chewy.com due to their individual commitments to the independent pet specialty channel.  The Facebook pages of both brands lit up with comments expressing both adulation and disdain for the move.  Rumor is that Chewy was encouraging platform loyalists to express their displeasure online.

Reaction to the news was quick to fill up my inbox, suggesting that this was an unforeseen circumstance and would likely lead down the path of a write-down for PetSmart on its acquisition.  Given that both brands defected when PetSmart acquired Pet360, I suggest that this circumstance was likely known, or at the very least contemplated, from the outset.  If not, someone was negligent in doing their due diligence.  More than likely this impacts Chewy’s ability to earn any contingent consideration tied to revenue or customer retention.  Potentially it hastens Ryan Cohen’s path to exiting the business he founded and that made him wealthy, assuming he is only sticking around to get the last dollar out of the deal.

In sorting out the winners and loser of these decisions, there is less clarity than one might expect.  The impact would, to a large extent, depend on what you believe the physical and emotional substitutes are for the end customer.  If the customer is tied to the brand, the beneficiaries will be the independent retailers as the brands intended it to be.  These brands are staples of the independent channel and vital to their competitive advantage. However, if cost and convenience trump (no pun intended) brand loyalty, Chewy has the potential to transition pet owners to other premium and super premium brands that remain in their stable, including their own product set American Journey. Many of the comments on the Facebook pages of Champion and Fromm suggest customers are considering a switch, but that may be motivated by the catalyst above. I would also argue that Phillips Feed Service’s acquisition of Petflow looks better by the day. They should see owners transition to the petflow.com platform, as they are competitive on price with chewy.com, but it might also motivate independent pet stores to adopt their Endless Aisles solution set, seeking to step into the Chewy void for these brands.  However, if Champion and Fromm use this shake-up as an opportunity to begin directly selling their product to end customers, the end results may not be known for some time.

It is natural to seek to look at the above situation and try and paint Chewy and/or PetSmart as “the bad guy”.  However, I would argue that a healthy chewy.com is good for the entire pet industry offering consumers additional choice in the form of an alternative sales channel, and pushing back on price in an industry that has experienced considerable price inflation post-recession.  Without Chewy, the price of Champion and Fromm products is likely to increase, at least online, and that is not a favorable outcome for pet owners no matter how you slice up the pie.

/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.