m8bA common refrain in the pet industry is that to predict the future of the consumables category, you need only to look back on the prevailing human trends three years prior. Today, I would argue that this rule-of-thumb applies more broadly, to a cross section of pet industry categories, than previously appreciated. As an example, the rise of ecommerce in the pet industry follows a similar trajectory to a number of human categories that were thought to be “Amazon proof”.  This is why I think pet industry participants should be paying attention to recent funding deals for Freshly, Inc., whose $77 million Series D was led by Nestle, USA, and Chef’d, LLC, whose $17.6 million Series B was led by Campbell Soup Company.

Both Freshly and Chef’d are in the business of delivering fresh food to your door step.  In the case of Freshly, these are fresh prepared meals, which require minimal intervention to get them from the packaging to the plate.  Chef’d delivers personalized meal-kits, which you then prepare at home, in as little as 10 minutes.  As a side note, I’ve never completed a meal kit from any company in under an hour, but maybe that says more about my cooking skills than anything else. Notably Chef’d partners with culinary and media personalities to create menu inspirations.  That said, what these companies deliver is less interesting than who is financing the growth of their business.

Large human food companies have significantly increased their investment activity in emerging food brands over the past 24 months.  Major industry players have set up dedicated investing units to source and evaluate opportunities.  The human food industry has largely outsourced its research and development function to start-ups who are seeking to capitalize on emerging consumer trends.  These companies become investment or acquisition targets if their solution set demonstrates the ability to resonate with a large enough audience and if their production processes can scale.  However, this pattern has, to-date, largely been confined to product companies.  Freshly and Chef’d are direct-to-consumer distribution companies cloaked in a product orientation.

The pet industry has its Freshly and Chef’d corollaries.  Companies like JustFoodForDogs and The Farmer’s Dog, have both recently received major cash infusions from financial players.  There are numerous others competing for this emerging space — Ollie Pet, NomNomNow, PetPlate, to name a few.  Yet, I believe the investment trend illustrated by the Freshly and Chef’d transactions tells us more about the real value of scale direct-to-consumer businesses such as A Place for Rover and Bark & Co., than the potential for fresh food delivery in the pet category, whose future we also think is bright.

What the pet food and products manufacturers have in common with their human counterparts is their core means of distribution are under siege by small retailers who provide better service and/or in-store experience as well as by the internet.  As such, any opportunity to get directly to the end customer is highly coveted, and therefore of great value. Within the pet category, there are a very limited set of players that have proven their ability to directly access a critical mass of pet owners.  Therefore, as large manufacturers look for direct-to-consumer exposure they will be left with a choice of ascribing a very high value to an asset with breadth or taking a calculated risk on an upstart.

What these large strategics are looking for is the ability to build a relationship directly with a consumer that is tied solely to the product or offering, and that exists outside of that buyer’s relationship with any retailer, physical or digital. If they own the customer they can look to monetize him or her in a variety of ways, capturing more the the margin along the way. We believe this trend to be applicable to both product and service providers in the pet category.

The question then becomes what would a tie-up between a Mars/Purina/J.M. Smucker Company and a Rover/Bark & Co. mean for the acquired entity.  Would consumers have the same affinity for their Bark Box if it only included treats from the buyer organization, or is the lack of affiliation that part of the value proposition?  We don’t know the answer to that question, but if we follow the story of Freshly and Chef’d going forward, we may well find out.

/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.

 

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.