dylan“The times they are a-changin” – Bob Dylan

Industry analysis is easy when everything is moving up and to the right.  When market conditions are such that a rising tide does not float all boats, it is harder to draw conclusions that are applicable to a broad set of market participants.  The pet industry now finds itself in an operating environment where company execution will most likely determine the winners in this phase of the cycle.

The  pet industry has hit a transformative moment.  The humanization movement, though it continues to be cited regularly, has achieved its point of arrival — pets are treated like members of the family.  Kids today only know of pets as their equal.  As a result, there are no longer large cohorts of pet owners who are available to upgrade.  At the same time, younger generations now represent the largest segment of pet owners, and they think and act differently than their parents generations.  However, they also lack the same disposable financial resources, meaning they have to make tradeoffs today.

These realities are changing the power paradigm in the category.  The pet consumer is in the ascendancy at the expense of all others who participate in the supply chain.  Today the pet owner is able to choose among channels and brands based in their personal values.  Effectively product access has been commoditized. Consumers are now able to dictate to manufacturers what attributes they seek, not vice-versa.  In the future this paradigm will move across the sub-categories within in pets to redefine who wins and who gets left behind.

When market dynamics shift with significant force, it usually leads to elevated levels of industry consolidation. The 2015 – 2016 period was the greatest period of consolidation the industry has witnessed, and we expect that will continue.  With that as a backdrop, we present our pet industry capital market themes for the Spring of 2017:

  • Major Pet Specialty Franchises Struggling. It was not long ago that PetSmart and Petco could do no wrong. The major pet specialty chains were posting SSS comps that were the envy of retail analysts; the gap between the two biggest pet retailers and the balance of the industry seemed vast and unbridgeable. How quickly things can change. Over the past three years, major pet specialty has watched its franchise erode. Independent pet retailers out-serviced them; FDM retailers poached manufacturers and offered customers a better cost value proposition; and ecommerce providers out-priced and out-“convenienced” them. In 2016, we estimate that PetSmart comped down 3% – 4% (mature stores) and that Petco comps were flat to down 2% (mature stores). With their loan packages trading below par, both companies are under pressure to innovate. Petco’s turnaround strategy appears focused on private label and house brands.  PetSmart is focusing on ecommerce, as evidenced by its acquisition of Chewy. What is clear is that there is no silver bullet for what ails them. Expect things to get worse, before they get better as brands begin to feel pressure to find other sources of growth and as Petco and PetSmart refine their respective strategies.
  • Treat Acquisitions are Focused on Sustainable Competitive Advantage. The treat space has been actively consolidating as manufacturers compete for the discretionary portion of the pet owner’s shopping basket. However, what is rapidly changing is the attributes these consolidators are seeking in their acquisition targets. Deep customer relationships built through an emotive brand are now the table stakes.  Buyers want some form of competitive advantage that has greater barriers to justify prevailing multiples. The acquisition of Salix Animal Health (Spectrum Brands) and Whimzees (WellPet) are examples of this in practice. Other major pet treat IP players, including Petmatrix, are most likely to get snapped up by the large industry players. This will in turn create an opportunity for private equity to acquire mid-stage brands and invest in building these attributes.  The phrase “innovate or perish” has never been truer than in the treat space today.
  • Digital Pet Age Has Arrived. Historically, pet industry incumbents have been dismissive of the potential for category disruption through technology innovation. Major pet retailers were not well situated to sell the solution set; legacy pet ownership generations, the Baby Boomers, did not understand it; market leaders were not organized to innovate into the category. As a result, Chewy, A Place for Rover, Bark Box, Whistle, and their peers rose up to fill the market void, creating substantial shareholder value as pet ownership dynamics shifted to favor the digital generations. In 2016, $154 million dollars was invested in 46 pet-tech deals, a pace that has been increasing since 2012. Even in its nascency the pet tech movement is showing signs of making a lasting impact. As Millennials further outpace Baby Boomers in terms of pet ownership, digital will gain more momentum in the pet category. This realization will leave strategic buyers who have not made a tech play scrambling to play catch-up.  This trend augers well for acquisition valuations in this sector of the market.
  • Expect M&A Transaction Velocity to Remain High. Since 2014, transaction bias in the pet industry has been towards M&A. 2015 – 2016 was the greatest period of industry consolidation as measured by transaction volume. As company’s reposition themselves to compete in a rapidly changing landscape, we expect elevated M&A activity to continue in 2017. Market leaders will seek to plug remaining portfolio gaps while small and midsized players will be looking to exit at the tail end of the cycle. While acquisitions may be plentiful, there will also be a flight to quality with differentiated assets – brand, scale, channel (direct or proprietary) – garnering premium valuations, while those lacking it face commodity multiples. If the U.S. implements tax reform, volume should spike across asset classes providing private equity a unique opportunity to buy into the category.  Financial buyers will be banking on these assets to carry them through the next recession.

As always, our full pet industry report is available by request.

/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.

 

 

dog-bowlBeing early, wrong, or both is no fun, at least not in the case of making industry predictions (traders will also say early is also wrong).  And when it comes to our views on the waning of the pet food upgrade cycle many people have made us aware that we were either early or wrong (or both!).  However, when you make market predictions based on limited information you are going to be wrong, sometimes with regularity (see my view on the inability for private equity to acquire PetSmart here, as just one notable example where I have missed the mark, but at least I correctly predicted that they would not combine with Petco, see here), and we are okay with that.  That said, here I am not sure we were either wrong or even that early in this case.

In 2013, we began to beat the drum about the deceleration of the pet food upgrade cycle (for those of you scoring at home you can see comments here and here).  Our view was that basic economic realities were fundamental headwinds — stagnant wage growth, slowing pet replacement, growth in small dog ownership, and continued food price inflation.  We then pointed to PetSmart comps going flat to negative, and fully negative ex-inflation, for most of 2014, had to be a sign this cycle was on life support.  However, all of these factors were explained away by other data — accelerating pet product Personal Consumption Expenditures in 2015 (Bureau of Economic Analysis), recovering pet adoptions in 2015 (PetPoint), accelerating pet food spend in 2015 (APPA), growth in alternative form factor pet food (GfK), mismanagement at PetSmart (pick your favorite equity analyst), and the successful Blue Buffalo IPO.  In short, for every fundamental premise we had on the offer, there was a data set that one could point to bolster their thesis.  The issue was that the evidence used to perpetuate the myth that the upgrade cycle was alive and well was easy to debunk, but nobody want to hear it, and they still don’t.

Fast forward to today, and we now see increasing direct evidence that supports our thesis.  First, last month The J.M. Smucker Company trimmed its full year earnings forecast on the basis of declining sales of pet food for the quarter, down 6%. While there was a positive spin around the narrative (difficult comps due to prior year sell-in, strong new brand sales prior year), it is concerning.  The company expects weakness to persist throughout the balance of the year.  Second, our survey of private mid-market pet food marketers ($100+ million in revenue) indicates that the malaise Smucker’s is experiencing is not isolated, though the magnitude is greater.  Most of the company’s we surveyed offered full year views of 0% – 2% growth domestically. Finally, Tractor Supply, which does a significant percentage of its business in livestock and pet supplies (44%), trimmed its quarterly earnings forecast and full year outlook for the second time this year.  The company now expects same-store-sales for the quarter to be flat to down 1% after being up 2.9% in the prior year period. While we may not think of Tractor Supply as the prime destination for the premium pet food consumer, they do sell a considerable number of premium brands – Blue Buffalo, Merrick, Natural Balance, and Wellness, among others.  The company pointed to slowing growth in the C.U.E. (consumables, usables, edibles) business. Translating the semantic hieroglyphics, this means their pet and animal products business, including pet food.  We suspect Tractor Supply is not alone.

What is more important here than being right or wrong as it relates to the state of pet food, is what will the implications be for the capital markets of the death of the cycle.  We do not believe that slowing pet food sales, premium or otherwise, is going to hamper capital formation. There remain multiple heuristics of emerging brands garnering footholds to grow their business rapidly to $25 – $50 million in sales with limited capital investment.  The scarcity of these businesses, coupled with the amount of institutional capital chasing these opportunities, means that growth equity investments in pet food, distinct from treats, will remain robust.  Of greater significance is whether this will jump start a new M&A cycle.  While large strategic acquirers tend to have a negative M&A bias during period of weak financial performance, it might just be such that they will uses these events to recognize the need to buy into niches that represent the future of the industry.  This could push multiples, which have been waning, albeit, at the margins over the past three years to begin to trend up.  Further, the fact that broader M&A statistics indicate we are almost certainly at the end of this M&A cycle, might cause more sellers to come to the table.  Watch closely for M&A volume in this segment to tick up over the coming year.

/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.

 

 

 

 

mockingjayEarlier this month, Petco Animal Supplies and PetSmart stores in Topeka, Kansas, and adjacent Lawrence, Kansas, removed from their shelves Hill’s Science Diet and Ideal Balance products.  Store managers have been telling customers that the brands is not coming back on shelf.  Notably, Hill’s Pet Nutrition, a subsidiary of Colgate Palmolive, is headquartered in Topeka.

Consider the above action a shot across the bow in the dynamically evolving landscape of pet food retail.  To better understand the future, and what this gambit might mean, one must begin with a look at the past.

Hill’s Pet Nutrition was founded in 1907. The company started in the rendering business.  By 1930, the company had evolved into packing company, producing animal feed, dog food, and horsemeat for human consumption in Norway, Finland, and Sweden.  In 1948, Dr. Mark Morris contacted Hill’s seeking a producer for Canine k/d, his brand of healthy scientifically engineered pet food.  In 1968, Canine k/d was made available to veterinarians as Hill’s Science Diet.  The brand evolved into a broad line of prescription and breed specific solutions available through veterinarians and pet specialty retailers.  In 1978, Hill’s became part of the Colgate family through a merger of Hill’s parent company.  In 1999, Hill’s sales reached $1 billion.

What is particularly significant was the fact that Hill’s was at the forefront of the healthy pet food revolution, albeit with a scientific approach. Further, long before there was Blue Buffalo, Hill’s, along with Nutro, was one of the biggest drivers of customer traffic to pet specialty retailers on the market.  Thus, for Petco and PetSmart to declare war on Hill’s is, for lack of a better term, A BIG DEAL.

The makings of this feud can be traced back five years.  Beginning in 2011, Hill’s pet food sales began to stagnate.  The company, whose products evoked images of white lab coats and engineers, found itself on the wrong side of a change in consumer preference, and therefore purchase intent.  Instead of favoring science based nutrition solutions, pet owners began to favor products whose ingredient panels best mirrored their own diet.  White lab coats were replaced by images of roasted turkey, market vegetables, and whole grains.  Natural triumphed over engineered.

Hill’s, being part of a large consumer packaged goods firm, was not content to let its franchise slip away. The company tried to change with the market, launching Science Diet Nature’s Best, a naming convention approaching the absurd.  Not surprisingly the disconnect remained.  Hill’s responded with the launch of Ideal Balance, its “natural” solution, but was slow to win back customers. While Hill’s revenues had grown to $2.2 billion in 2015, this number represented essentially flat growth between 2011 – 2015.  To maintain sales, Hill’s embraced the internet as a channel.  In 2015, Hill’s represented 7.5% of online pet food sales, taking the third position behind Blue Buffalo (12.3%) and Wellness (9.0%).  It attained that position by turning a blind eye to the price discount pet food retailers where charging for its solution set, thereby drawing the ire of Petco and PetSmart.  And you understand why we-are-where-we-are.

One has to surmise that Hill’s knows quite well what it is doing and the consequences of its actions. My understanding is they have recently put pressure on major online retail sites to enforce their MAP policy based, in turn, on pressure from Petco and PetSmart. However, if Hill’s cannot get back in the good graces of its top premise based retailers, prepare to find Science Diet and Ideal Balance at big box store near you.  The likes of Target and Wal Mart would welcome Hill’s and its customer base with open arms. Whether this is a brilliant move by Colgate or the straw that breaks the brands back remains to be seen.

Of greater interest is what this means for Blue Buffalo.  A big box Hill’s is not going to be a welcome site for the veterinary community who drives the disproportionate sales of prescription diets and is a big influencer of Science Diet sales.  Blue Buffalo has staked the next leg of its growth stool on its veterinary line of products.  If Hill’s defects, that will create a fracture in the relationship between the company and the veterinary community that Blue Buffalo could be poised to exploit.  That’s not to say it won’t have fierce competition for that mind share from the likes of Royal Canin and Purina, but thirty days ago that market looked much tougher to crack.

Let the games begin.

/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.

 

 

 

phoenisThe pet industry stands at the precipice of a tactical sea change.  The industry entered into this transitional phase in 2014 and is expected to remain there through 2017.  The industry entered into this state as a result of slowing growth and macroeconomic headwinds.  The historical catalysts for growth — Baby Boomers as the driver of industry spend, pet food upgrade cycle, premise based retail — have waned.  However, the future change drivers — pet ownership among Millennials, grain-free and alternative form factor pet food, ecommerce, connected pet — are individually not yet sufficient to resurface the landscape. Yet we expect, after another year of gestation, these trends, will set of the next phase of industry growth, market share shift, and strategic acquisitions.

As we muddle through the tail end of this transitional phased, here are trends we are keeping an eye on in 2016:

  • Industry Offers More Upside Opportunity than Downside Risk. Despite the slowing sequential growth rate for the industry and the limited innovation in consumables, we believe the industry stands poised to outperform in 2016. Our premise relies on three factors. First, the acceleration in pet adoptions experienced in the 2H2015 will have a knock-on effect on pet spending in 2016 as these new owners generate a full year of expenditures and trade up to premium solutions. This adoption spike is consistent with the 2012 – 2013 period where growth was 4.5%, albeit from a smaller base. Second, while the pet food upgrade cycle may be running on fumes, a proliferation in food additives, convenience offerings, and premium cat solutions will provide the industry with a growth impetus. Finally, we view the macro economic stability for employment, wage growth, and consumer sentiment as remaining favorable through the balance of 2016.
  • Expect Transaction Velocity to Remain High. 2015 was a return to normalized transaction velocity levels for the industry after a two year hiatus. We expect transaction velocity will remain high in 2016 as consolidation themes continue and sellers try to take advantage of the tail end of the capital markets cycle. What will change is the types of deals that are getting done. In 2014 and 2015, the industry was the subject of a large number of headline grabbing transactions involving key industry names – Big Heart Brands, PetSmart, Petco, MWI Veterinary Supply.  Absent a sale of Champion Petfoods, we expect most of the velocity to be among companies valued at less than $250 million. Notably, the M&A rumor mill was at peak decibel levels at Global Pet Expo. However, the number of companies pursuing deals pursuant to organized processes appears lower, meaning the number of potential deals that could get done pursuant to one-off dialogs is elevated.
  • Consumables Lines Blurring in New Ways. Five years ago, the thought of a pet treat business being able to bridge into pet food was unthinkable. Today there exist a myriad of treat brands which have developed a trusted connection with consumers in the pet specialty channel that might allow them to make that leap. Notably, several of these brands launched food solutions at Global Pet Expo to very favorable retailer response. While it is unclear if and how quickly these solutions can scale, it speaks to the fact that the delineation between food and treat brands continues to decrease.  As premium pet food companies find market share gains harder to come by, we expect they will seek to expand sales volume through increased treat offerings and acquisitions of treat companies. Further, treat company valuations will benefit from buyers factoring in potential product line extensions into food, though not all brands will benefit.
  • Ecommerce Landscape Changes Ahead. Sales of pet products continues to grow online fueled by price based competition and increased convenience. The impact of growing online sales can been seen acutely in the comps of Petco and PetSmart prior to their representative transactions. However, the pain has spread to the independent channel as well, as more brands have embraced ecommerce as a driver of growth and customer acquisition. In response, retailers are putting pressure on manufacturers to enforce MAP policies or, in some cases, choose sides. However, many of the brands caught in the battle among retail formats are not well equipped to do either. Assuming that Chewy.com continues to find fuel for its growth, and that Jet.com continues to find brands willing to embrace its platform, this problem will grow. Pressuring brands will not solve the problem. Rather, the winners in retail will be those who deliver the best consumer service experience as measured by selection, price, and convenience. Independent retailers will need to develop capabilities that enable their customers to shop online and get accelerated delivery, presenting an opportunity for distributors to fill this void.

 

As always, a complete copy of our 2016 industry report is available by email.

/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.

 

dwarfEarlier this week it was announced that Mars Petcare had acquired Whistle Labs, designer and marketer of activity monitoring and asset tracking solutions for small companion animals.  The deal was valued at $117 million (or $119 million depending on the source of information).  Whistle had raised $25 million in outside capital, including $21 million in two institutional rounds, including a $15 million Series B round in January 2015, led by Nokia Growth Partners.  The Series B also including participation from, among others,  Melo7 Tech Ventures (the equity fund of Carmelo Anthony, NBA superstar) and QueensBridge Venture Partner (the equity fund of Nasir Jones, world famous rapper).  The post-money on the Series B was reported to be $26.65 million, meaning these investors made a ~ 4.5x cash-on-cash return on the sale and triple digit internal rate of return based on the short duration.

When Whistle launched its solution set the market was bifurcated between activity monitoring and asset tracking.  The asset tracking side was being addressed largely by companies that were re-purposing technology that had been deployed in more traditional markets, such as logistics, automobile tracking, or human tracking (yes these do exist).  However, these companies did not necessarily recognize the emotional engagement aspects of the pet space, and did little to build community.  The network costs of these businesses were high, and the user base was small.  Given that the initial hardware purchase was subsidized, these businesses lost money, sometimes large amounts of it.  Further, there was no effective retail channel for this class of products as the major pet specialty retailers were not well situated to sell a $200 device with a monthly subscription attached thereto or explain the value proposition effectively to customers, and therefore the market was slow to emerge. Traditional channels, such as consumer electronics and mobile phone centers, were no more effective at attracting pet owners let alone articulating the purchase rationale.  It did not help that most of these solutions had large form factors and minimal visual appeal.

In contrast, Whistle brought to market an activity tracker with a high level of aesthetic appeal at a much lower cost.  Of significance, gone were the monthly subscriptions.  The problem was the market wanted asset tracking as the linkage between the activity monitor and the benefits use case was just not obvious to pet owners.  In short, there was data but not much to do with it and sharing it was cumbersome.  Much like the early human activity tracking sector, the real value of these devices did not emerge until the ecosystem and community aspect developed. Whistle would use part of its Series B financing to acquire Snaptracs, the Qualcomm based asset tracking solution that it spun out in 2013.  Using their industrial engineering acumen, Whistle combined the two solution sets into a best of breed offering and the business began to accelerate.

About the time of the Series B, Whistle began collaborating with Mars on the use cases of its device.  The challenge became how do you balance the venture capitalists agenda — drive brand, drive sales, drive community — with the Mars agenda around linking the data to wellness outcomes and product sales.  In the end, we believe Mars acquired Whistle to enable its agenda to become central to the future of the business.  Given that the lifetime value of a subscriber was high as the revenue was recurring, shareholder value increased exponentially.

While the acquisition and the prevailing purchase price will certainly give momentum to the connected pet space, the perceived rationale is somewhat vexing to rationalize.  Connected pet solutions that have been funded and launched into the market over the past few years have focused more on emotive connections (remote viewing, remote treating, automated feeding) than wellness outcomes, and here we have an acquisition rationale that we believe is tied more to healthcare outcomes than humanization. That is not to say the deal won’t be effective in catalyzing more investment and further M&A; the return profile will ensure that happens.

This deal very much validates the space, and we have been on record suggesting more large consolidators get into connected pet since 2013, when we marketed the Snaptracs business for sale.  We believe other large players will have to take notice and find avenues to take a position in connected pet. Further, we think the Mars acquisition rationale is specific to them and does not require a pivot by other operators to enhance their focus on wellness.  Mars is unique in that it is the only enterprise that has both veterinary hospitals and branded companion animal consumables, and therefore could view Whistle in a unique way and justify the purchase price as a result. It does help that they are a very large private enterprise and do not have to kowtow to outside shareholders.

One of the key themes we witnessed at the most recent Global Pet Expo was a proliferation of solutions aimed at connecting owners to their pets wherever they were resident at the time — the home, the grooming salon, the daycare or dog walker, the boarding facility. etc.  Expect the Whistle deal to give them all more conviction and attract a host of new entrants seeking to capitalize on the market opportunity. Ultimately, pet owners stand to benefit most.

/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.

 

 

beakersHistorically, the discourse around pet food delivered in alternative form factors (fresh/frozen, freeze-dried, dehydrated) has focused on the merits, or lack thereof, associated with feeding your pet raw protein. Lost behind the countless articles delving into the pros and cons of raw, has been the growth in both size and importance of this sub-category, and the value it has created for those who invested early in this category.

According to GfK point-of-sale data from the pet specialty channel for the 12 months ended August 2015, alternative form factor pet food was, in approximate terms, a $175 million market.  Based on these same figures for the prior year period, this represents 50%+ growth for the category.  When you add to this annualized IRI MULO data for fresh/frozen pet food sold in the mass market and apply an adjustment to GfK’s estimate of dehydrated pet food, which we know to be low, and the total market is approaching $750 million, growing at 30% – 35%.  While relative to dry kibble, this market is in fact small, it is meaningful, and in combination with its growth rate, cannot be ignored by the large strategic buyers in the space.

Validation of this notion began to accelerate in 2H2014 when Agrolimen SA, a Spanish privately-held producer of food and other consumer goods, quietly acquired a controlling stake in Nature’s Variety, the market leader in freeze-dried raw pet food, from Catterton Partners.  This was followed closely by the successful initial public offering by Freshpet, Inc. (NASDAQ: FPRT), which currently trades at 2.3x Revenue despite some challenges in the roll-out of their refrigerator program among several large retail accounts.

After a brief fallow period, further validation arrived in the form of Nestle SA’s acquisition of Merrick Pet Care. While Merrick’s market entry into the freeze dried raw space (Backcountry), was nascent, the fact that they had an in-market offering was clearly a benefit to the deal.  Around this same period, Stella & Chewy’s, LLC, a portfolio company of Stripes Group,  and the market leader in freeze-dried raw sold in the independent pet store channel, transitioned into a new 164,000 square-foot facility in Oak Creek, Wisconsin, funded by a debt package sourced by the company in early 2015.  On January 7, 2016, the company announced it had hired a highly seasoned consumer industry executive to run the company and recruited pet industry executive Mark Sapir as Chief Marketing Officer.  Sapir most recently served as VP of Marketing & Innovation at Merrick.  Finally, on January 8, 2016, it was disclosed that WellPet, LLC, a portfolio company of Berwind Corporation, and the owners of the Old Mother Hubbard (which had been previously owned by Catterton) and Eagle Pack Brands, had acquires Sojourner Farms, LLC, doing business as Sojos. Sojos is number two or three player in the dehydrated pet food space.  In addition to providing validation of both the freeze-dried raw and dehydrated solution set, it also provides further evidence that larger players in the consumables space will buy smaller brands, especially if those brands resonate with premium customers who shop independent pet specialty.

So what does this all mean? I believe there are two conclusions that can be drawn. First, that the alternative form factor pet food market is a real sub-category and mid-sized to large players need to pay attention to it, because consumers are buying into the category, and have a response for how to compete within it or counter its proliferation going forward. The category is no longer a novelty, something that market leaders can simply write off or ignore.  Second, it’s going to result in more transactions as strategics buy into the space in an effort to deliver a competitive response. The winners of this coming-of-age will be the entrepreneurs who pioneered the category and the private/growth equity firms that supported them.  With a limited set of properties available, it could send valuations, which have been trending down, back towards the upper end of the historical multiple range.

/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.