debt freeOne of the most frustrating aspects of following the pet industry is the lack of transparency we have into the operational results of bellwether companies that comprise the market.  With only a handful of pure-play public companies, and even fewer with meaningful analyst coverage, we are left to rely on publicly available market studies, which are often dated and/or at a cursory level, expensive third party research, or, more often than not, rumors and conjecture.  As evidence, approximately 25% of search terms that led people to this blog are related to market rumors (e.g. “Blue Buffalo acquired”) or data searches on private pet company performance (e.g. “Petco 2012 EBITDA”). However, the availability of cheap leverage to fund organic and acquired growth is providing us a rare opportunity to understand how some of these large private pet names are performing.

In October 2012, Moody’s Investor Services assigned a B3 rating (speculative) to a $250 million private bond issuance from Radio Systems Corporation, the privately held market leader in pet containment products and training systems.  The proceeds from the issuance went to replace existing balance sheet debt and purchase a putable equity stake valued at roughly $90 million.  According to Moody’s, the transaction would leave Radio Systems with a debt-to-EBITDA ratio of 4.7x.   The report also states that the company generated sales of $270 million for the twelve month period ended June 30, 2012.  So what can we glean from this disclosure?

  • Based on the company’s debt-to-EBITDA of 4.7x, this would imply Radio Systems had somewhere in the neighborhood of $50 million – $55 million in trailing EBITDA as of June 30, 2012.  Based on $270 million in sales for the coinciding period, this would imply an EBITDA margin of 18.5% – 20.0%, a good metric for a company of this size in this segment of the industry but certainly with room for expansion.
  • If we valued Radio Systems at an EBITDA multiple similar to the Sergeant’s Pet Care Products / Perrigo transaction or based on the public trading multiples of Garmin or Spectrum Brands, this would produce an implied enterprise value for Radio Systems of $500 – $550 million.
  • Finally, it appears safe to assume that TSG Consumer Partners, whose equity put is being acquired, will make a 3.0x return on its investment of $30 million made in 2006.  This returns Randy Boyd to full ownership of the company.

Moody’s rating of Blue Buffalo’s $470 million financing (rating B1) also provides us some salient insight into the company and its capital structure.  According to Moody’s, the proceeds of the transaction will go to fund a special dividend for the owners, including equity partner Invus Group.  While Moody’s did not peg a debt-to-EBITDA multiple for Blue Buffalo at the time of the transaction, it does state that “Moody’s expects that the company will be able to generate sufficient free cash flow to de-leverage rapidly, such that debt-to-EBITDA will be below five times in the next 12 months.”  The report also states that the company generated sales of $400 million for the twelve month period ended March 31, 2012.   So what can we glean from this disclosure?

  • If we assume the debt financing reflects the total leverage of Blue Buffalo, it is safe to assume that the company generated somewhere in the neighborhood of $80 – $90 million of EBITDA for the twelve month period ended March 31, 2012.  Based on $400 million in sales of the coinciding period, this would imply an EBITDA margin of 20.0% – 22.5%, a very good metric for a company of this size in this segment of the industry, especially one who is funding a national television advertising campaign.
  • Setting aside whether they were true or not, the rumors that were swirling around earlier this year that Blue Buffalo was entertaining sale dialogs with a starting price of $800 million, denotes an implied revenue multiple of 2.0x and an implied EBITDA multiple of +/- 10.0x, which do not appear out of line, maybe even light on the profitability side of the equation.
  • This confirms, what many people speculated, that Bill Bishop had sold a meaningful portion of the firm to a third party equity firm sometime within the last three years.  Invus, which has an evergreen fund structure, and therefore can hold positions for long periods, is a sensible partner.  Invus is also well credentialed in food, with historical investments in Keebler, Harry’s and Weight Watchers.

Finally, Petco Animal Supplies is again tapping the debt markets for $550 million in senior notes.  You might recall the company refinanced its balance sheet to the tune of $1.7 billion back in 2010, in part to finance a $700 million dividend to its owners, enabling them to repatriate 90% of their invested capital.  This time around, the notes along with balance sheet cash will be used to fund a $603 million distribution to shareholders.   I hashed out the Petco situation here before, but the most salient point that can be gleaned from Moody’s disclosure is that the company grew revenue from $3.0 billion to $3.3 billion from 2011 to 2012, a rate consistent with Petsmart for the same period, reflecting a greater equilibrium in the balance of power.

Net net, while much of the above might have been pieced together by an informed observer these conclusions were often difficult to corroborate because we lacked factual information.  One benefit of low interest rates, is we have gained some transparency in the process and therefore can substantiate some of the speculation rampant in the industry.

/bryan

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During the second half of 2011, the pet industry endured a brief hiatus from its uninterrupted growth trajectory.  Against a backdrop of macroeconomic uncertainty, the pet industry suffered as consumer sentiment deteriorated.  Stagnant unemployment, coupled with a housing market laboring to recover, left the industry with a post-holiday hangover.   As a result, expectations for 2012 were modest given the industry was in transition as historical growth themes from the 2007 – 2010 period waned.  This commentary was front and center in our Spring 2012 report.  What we did not accurately predict was how quickly Humpty Dumpty would be put back together again.

As we approach the bell lap for 2013, the pet industry appears poised to beat expectations for the year.  Pet population growth has accelerated, the housing market has improved, and consumer sentiment is trending up and to the right again.  This has been good for the pet industry, which saw both revenue and earnings accelerate. Coupled with investments in innovation and further evidence of traction for the Total Pet Health trend, the near term outlook looks much brighter today. Below is a summary of the macro trends I see currently impacting the industry.

  • Industry in Major Innovation Push. In recent versions of my report, I expressed a belief that the pet industry was laboring through a period characterized by a lack of innovation.  Limited investment during the recession resulted in fewer new product introductions in 2010 and 2011.  While the 2012 tradeshow season did not produce evidence of breakthrough renewal, there are signs the industry is addressing the issue.  Product company CEOs tell me they are investing heavily in R&D, retailers are promoting innovation through launch support, and equity backers are funding unique start-ups.  Where there is innovation there will be further consolidation.  Expect more excitement at Global Pet Expo 2013.
  • Ecommerce Gaining Momentum. One of the most discussed topics at SuperZoo was direct-to-consumer for the pet industry.  There is evidence, based on web traffic patterns, and partner engagement, that the category is moving online and that ecommerce leaders are growing rapidly. As Amazon experiments with same day delivery and online retailers find partnerships that provide access to pet prescriptions, we expect this solution set to grow in acceptance, taking share of independent pet specialty stores. Notably, PetSmart, who has commented that they are not seeing any market share erosion from online competitors, recently changed their management bonus program to tie ecommerce sales to compensation; recognition by the industry’s top retailer that ecommerce is a real competitive threat in pets over the long term.
  • Public Pet Companies Breakout, Again.  During 2H2011, core publicly traded pet companies lost momentum. Lacking a cohesive growth driver, earnings contracted and pet equities traded on company fundamentals with mixed results.  The industry malaise did not last long, as our comp group collectively produced 12.1% revenue growth and 16.7% earning growth in 1H2012.  As a result, core pet equities, as a group, have outperformed the S&P500 by over 15% in 2012.   While the expected names (PetSmart and MWI Veterinary Supply) continue to perform, it’s notable that others, such as Neogen Corp (23.7% equity return), Central Garden & Pet (40.4%) and Oil Dri Corp (11.2%), which have lagged in prior periods, have all produce double digit returns.  The broad advance is, in my opinion, a very positive sign for the industry.
  • Big Deal Potential.  Headline deals are important influencers of transaction dynamics within an industry.  Deals beget deals, as buyers and investors look to take advantage of market shifts caused by consolidation. While the pet industry has enjoyed a number of high profile transactions over past 24 months, these deals have been spaced in such a manner so as to limit our ability to glean anything meaningful from the associated transaction multiples. A single data point is not indicative of a trend.  However, when multiple deals express the same characteristics, it has a powerful impact.  With the recent Sergeant’s  Pet Care Products transaction, the pending Zoetis (Pfizer Animal Health) IPO, and potential deals for Central Garden & Pet / Blue Buffalo / Natural Balance Pet Foods, the industry may have a run that re-frames market valuation dynamics, similar to 2006 when the revenue multiples for premium consumable companies were established through the Milk Bone and Meow Mix transactions.

While we have never soured on the long term potential for the pet industry, what we are seeing in terms of a recovery and re-acceleration is remarkable.  It is our expectation that 2012 will turn out to have been better than expected, providing the industry an opportunity to breach its prior apex within the coming years.

As always, a full copy of my report is available by email.

/bryan

“For the times they are a-changin'” – Bob Dylan

The pet industry produced another solid year of growth according to the American Pet Products Association.   Total industry revenue increased 5.3%, to $51.0 billion in 2011 driven by growth in all major segments of the industry.   Sales benefited  from pet population growth, which returned after a two year absence, and price inflation in all categories.  Discretionary services produced the strongest growth rate at 7.9%.

During the past five years the industry has grown 20%, a remarkable rate under any conditions, but especially in light of the economic contraction experienced in 2009 – 2010.   Expansion was fueled by the “Humanization of Pets” movement.  The trend toward treating pets as family members shifted spend into higher priced categories such as premium food, driving growth in the absence of population expansion.  While this theme remains relevant, its influence has tapered as the product rotation it stimulated nears completion.  As evidence, premium food market share is flat over the past two years.  In contrast, private label pet food and supermarket channel share, both associated with value, have grown.   While a value focus will continue due to the domestic economic climate, it will not drive industry volume but rather shift mix.  Instead, I believe an accelerating focus on pet wellness and population growth will fuel the industry in 2012, albeit at lower growth rates than seen in the past few years.

While the concept of “wellness” and the pet population is not new per se,  I see it coming together in a new and integrated way, which I call “Total Pet Health”.  Previously wellness was about giving your pet “better” food, augmenting their nutrition with consumables that provided perceived benefits, and then taking your pet to the veterinarian and listening to their advice about dental health and weight management.   Today the concept of wellness is about empowering yourself to make the most informed decisions about your pets long term well being using all available resources, rather than relying on pseudo experts.  It is about making product decisions based on actual results, not marketing claims.  It is about selecting the best product for the need at the time rather than blindly associating with a brand.  Its about having a relationship with your veterinarian around preventative care and using insurance to control total cost of care.

To adapt to these changes in owner behavior, I expect to see pet brands morphing from product or service providers into wellness brands.   As an example, in July 2011, VCA Antech, the nations leading owner and operator of animal hospitals, acquired Vetstreet (d/b/a Vetinsight.com) a provider of client communications, pet education, and home delivery of pet medications and supplies.  Against a backdrop of strained relationships between pet owners and veterinarians driven by veterinary services price inflation, VCA took measurable steps to empower pet owners.  Vetstreet’s information solutions enable pet owners to educate themselves about pet health conditions, learn what tangible steps they can take to remedy those conditions at home, and understand what to expect if they do take their companion to the clinic in order to avoid unnecessary service or charges.  Through this transaction, VCA transitioned itself from being a perceived source of the problem to being a wellness solutions provider.

A summary of my Total Pet Health theme is below:

From a pet industry transaction standpoint, I expect slower growth will result in further consolidation.  While the pet industry saw substantive consolidation in 2011, it also saw renewal as growth remained robust.  Private placement volume within the industry accelerated in 2H2011.  However, in a slower growth environment it will be harder for emerging companies to gain scale.  Further, interest from institutional equity sources in highly competitive pet categories will logically recede absent lower valuations.  If capital is lacking innovation will also be limited.  To the positive, truly innovative companies should enjoy premium valuations – see United Pet Group’s acquisition of FURminator as a prime example of this reality.  These conditions point to transaction volume being oriented around consolidating segments – distribution, hardgoods, retail, and veterinary services – in the near term.

Despite a fundamental bias towards consolidation, I expect pet industry transaction volume to be modest in 2012 absent a major transaction on the consumables side.  When Procter & Gamble acquired Natura Pet Products in 2010 it sent shock waves through the industry, especially in light of the fact that P&G was rumored to be exiting of the pet sector.   While the industry has seen active M&A and capital markets since that time, it appears wanton for another marquee transaction to provide it stimulus and buzz.  The recent United Pet Group/FURminator transaction caught the attention of the product side of the industry, but consumables have been lacking a bellwether since Nestle Purina acquired Waggin’ Train in 2010.  Given the prospects for an industry growth taper, as well as downstream tax motivations, it seems plausible Blue Buffalo Company or Natural Balance Pet Foods, the two largest independent pet food companies, could trade in 2012.  If they do, expect a flurry of activity in their wake.

As always, my full report is available by request.

/bryan

One of the joys of the fall edition to my pet industry update is I have the benefit of hindsight.   While in an ideal world we would have real time industry statistics for the prior year delivered to us on January 2nd, that is not our reality.  In fact, we really don’t get a true beat on the prior year until May when all the industry data is crunched and available for public consumption, paying members first.  For some of you, this edition marks the first time you really get a glimpse into prior year results.   While this information may not be timely,  in relative terms, this year it is quite illuminating as it dispels a few industry myths, for the better.   Only through an objective look at the industry can it identify new ways to grow and thrive.

With calendar year 2010 statistics now available, we have a clear picture of how the pet industry performed exiting the recession.  While the industry grew in 2010, and at an impressive rate relative to the consumer economy, the recession clearly took a toll – the pet industry is not recession proof after all.  Notably, according to Packaged Facts: a) specialty retail lost share to discount stores, b) total food sales produced anemic growth (1.5% for dogs and -0.2% for cats), albeit growth, c) super premium food sales decelerated (growing 2.4% after years of double digit gain) and d) spending by higher income households contracted.  Non-medical pet services was the only major category to meet forecast.   Food,  pet products and health care all fell short of projected growth.

Stop. Pause. Breathe.  Yes, sometimes good industries have bad years.  And relative to the rest of the economy, this was no bad year.

That all being said, there are many reasons to feel positive about the forward outlook – sales of public pet companies produce strong second quarter comps, PetSmart increased full year earnings guidance 3%, and super premium food sales are again accelerating.  More importantly, industry consolidation has given way to renewal.

The pet industry entered into a natural consolidation phase coming out of the financial downtown.  As growth moderated, strategics looked to acquire revenue and leverage their existing cost structure to drive margin.   As a result, we witnessed an increase in consolidating transactions across all major industry segments.  While this consolidation phase is ongoing, we are also seeing significant acceleration in company formation and growth equity investments within the industry.  Superzoo featured dozens of emerging companies in consumables, food, and hardgoods.  Further, pet industry private placements have increased in 2H2011, after a near dormant showing through mid-year.  We view this as a healthy sign, which bodes well for long term transaction momentum within the industry.

On the retail front, PetSmart continues to deliver.  In 2009, PetSmart took on Wal Mart and won.  In 2010, it became transparent that PetSmart had also left Petco it is rear view mirror.  In the past 12 months, PetSmart grew revenue and EBITDA 7.3% and 10.1% respectively.  The most recent quarter was a continuation of the trend.  For 2Q2011, PetSmart posted impressive same-store-sales (5.0% versus a consensus estimate of 4.6%), a favorable mix shift (customers trading up and expanding their basket), and a strong increase in average ticket price ex-inflation.  Analysts are now calling PetSmart the “best run specialty retailer”.  The only negative is we continue to hear conflicting stories with respect PetSmart exclusives, reflected in decelerating hardgoods transactions.  One area where we see PetSmart as vulnerable is with respect to direct-to-consumer.

The post-recession retail landscape is undergoing fundamental change.  Progressive retailers are seeking to reign in their physical footprint and push customers to lower cost channels.  The pet industry has been slow to embrace ecommerce; the belief was that delivering 50 lb. bags of dog food was a money losing proposition. However, that belief is again being challenged.  In July, Amazon.com subsidiary Quidsi launched Wag.com, a major pet ecommerce portal leveraging Amazon.com’s logistics infrastructure.  During the same period, other major independent pet ecommerce players raised substantive amounts of capital.  An analysis of these sites yields the conclusion that while product costs at PetSmart.com and Petco.com are more favorable, total landed cost (product cost plus tax plus shipping) favors these alternative e-tailers.  The ability to eschew a poor customer experience at the pet majors and eliminate the risk of in store stock outs, will invariably push a segment of customers online.   While this has the potential to erode share from pet specialty we believe it will be a slow process.

Net net, the pet industry remains on solid footing and the outlook for the component sectors is in fact quite good in the long term.  However, until the economy begins to improve — as measured by  GDP growth, the unemployment rate, and housing starts — the industry will continue to post modest growth, by historical standards.   These market conditions provide innovative companies the opportunity to differentiate themselves from the pack.

As always, full report available via email.

/bryan

Within the capital markets, ecommerce is of the hottest areas for growth and private equity investors.   The favorable bias from the investment community stems from the belief that online vendors can provide consumers a more compelling shopping experience than premises-based alternatives.  More compelling in terms of selection, price, and convenience.   Ecommerce retailers in shoes, books, groceries, diapers, electronics, furniture and a host of other categories are taking a bite out of the pocket book of bricks and mortar retailers.  Further, the first ecommerce generation is growing up and their comfort with the online consumer experience coupled with their growing purchasing power is driving category growth.

That all being said, the pet industry has not been a central participant in ecommerce revolution.  The overarching issue was that 50 pound bags of dog food are not cost effective to ship to consumers.  Therefore a dog owner, who had to seek out a premise-based retail concept for his best friend’s staples was much more likely to satisfy as much of his pet basket through a trusted retailer offering a one-stop-shop environment.  And now you know what Petsmart’s stock price has done so well over the past three years.

In fact, the only pet segment that seems to have benefited from the ecommerce revolution is pet health.  The ability to eschew a vet visit in order to get flea and tick and other remedies enabled 1800-Pet-Meds to go public in 2004.   A number of start-ups attempted to leap into the void.  Most memorably was pets.com, funded in part by Amazon.com, which launched in February 1999.  After considerable success the company jumped the shark with its 2000 Superbowl advertisement.  The company was out of business by the end of the year.   Pet based ecommerce has been rather dormant since then with the pet majors doing just enough to limit the potential for new market entrants — until now.

On July 6. 2011, Amazon.com, through its subsidiary Quidsi, Inc., better known as diapers.com, which was acquired nearly 10 years to the day after the demise of pets.com, launched wag.com, a comprehensive ecommerce portal for all things pet.   As an example, wag.com offers 44 brands of dry dog food, ranging from the mainstream to the obscure.   The site will have over 10,000 products for dogs, cats and a variety of other small companion animals.   Of greatest significance, the site leverages Amazon’s warehouse and distribution capabilities and shipping rates, enabling them to offer free shipping on all orders greater than $49, no exclusions.  Notably, the food I give my dogs is cheaper through wag.com after sales tax than through my pet specialty retailer.  However, I have no intention of switching.

Wag.com is not alone in petstuffonline.com 2.0, one day after wag.com launched, Lightspeed Ventures announced it had invested $10 million in Petflow, LLC, manager of the petflow.com website.  Petflow is in fact the old pets.com.  Petflow raised $5 million in 2010 from Westwood Ventures, and is reportedly moving over 500,000 pounds of petfood a month.  Further, on June 29, 2011 Pet360, an information and ecommerce site for pets raised $18 million from Updata Partners and LLR Partners.  Pet360 operates petfooddirect.com and nationalpetpharmacy.com two of the more established ecommerce players in the pet space.

The winner is this new movement is the consumer, who benefits from more choice and greater access to specialty brands in a high convenience format.  The ability to access all your pet needs online without be burdened by unreasonable shipping costs should give the pet majors some heartburn.   The opportunity to eschew the poor service of a big box retailer as well as save time and travel expenses is also compelling.

The biggest question is can these sites make money.  The vast majority of site traffic, and therefore potential customers, will be driven to these properties through search engine optimization — the buying traffic through Google and friends based on paying for placement of a site when specific key word searches are entered (“pet food delivery” as an example).  As competition increases, so too does the cost of the most attractive key word alternatives.  Major ecommerce sites generally run at EBITDA margins of between 3% – 6%, leaving little room for real profits (Amazon is the gold standard at long term average of 6%).  Notably, CSN Stores, which runs over 200 ecommerce micro-sites (luggage.com, furniture.com, etc.), recently raised $165 million from five equity investors to expand its footprin.  It’s margin profile does not approach that of Amazon’s despite over $350 million in sales.   In short search engine and offline marketing will eat up a healthy percentage of these sites’ margin profile.

Then one must consider the fact that price and loyalty competition is surely to ensue as site and online vs. offline formats compete for market share.    Ecommerce provides customers the ability to get their product of choice at the lowest cost if they choose.  Most sites offer significant concessions to win a customer’s first order, with the hopes of locking them in long term, ideally through an automatic food reordering program.  As an example, you literally cannot buy something off petfooddirect.com without be offered some form of discount.  As product providers begin to assert themselves with respect to minimum advertised price, which enables product vendors to ensure that no one channel has an advantage over the other, these discounts will take a bite directly out of the sites operating margin.

Finally, the shipping dilemma remains a major hurdle.  Surely Amazon has the best logistics infrastructure, but eating the cost on delivery for a 50 pound bag of dog food in a competitive category is not sustainable long term.  These vendors must believe that pet food has enough margin to absorb most of this expense, and that over time they will be able to provide consumers with an increasing percentage of their pet purchasing basket, enabling them to operate profitably.  I suspect it will work for some, but not all.

/bryan

Despite a challenging economic backdrop, the pet industry was a star performer in the consumer economy in 2010.  With growth easily outpacing the broader economy, pet related companies were again the source of significant capital markets activity (both mergers and acquisitions and equity financings).

While the year will likely be best remembered for Procter & Gamble Co.’s acquisition of Natura Pet Products, it was only one of a significant handful of transactions that made headlines this year.   As I look forward to 2011, I expect to see a significant follow-on effect stemming from announced or closed transactions in the second half of 2010.  Further, as the broader economy continues toward recovery, deal velocity is expected to increase, especially in the pet space.  Notably, a number of meaningful pet transactions are known to be in process.

With the arrival of the new year, it is a natural time for us to take out our crystal ball and ruminate on what we see for the coming year.  As a long time follower of the pet industry, below are my predictions for the broader pet market in 2011.

  • Population Growth Returns.  After two years of stagnation, the pet population will return to growth in 2011.  During the recession, the pet industry grew as a result of food price inflation and the industry’s exposure to the premium consumer demographic.  With commodity prices in decline, forward growth will depend on population expansion.  While high levels of unemployment and low home ownership remain significant barriers, consumers will begin to add companion animals to their families as low cost food and health options become more widely available.
  • Premium Food Shake-Up Continues.   The impact of the Procter & Gamble / Natura deal will be felt in 2011.  I expect other major industry players to expand their portfolio to include ultra-premium and natural pet food properties in order to compete with a Natura portfolio that will likely move into the mass channel in 2011.  The most likely acquisition candidates include Blue Buffalo Company, Ltd., Merrick Pet Care, Inc., and Pet Guard, Inc., who have all been the source of sale speculation in the second half of 2010.  However, of concern are valuation expectations, which may dampen buyer interest.
  • Merchandising Changes at Mass.  PetSmart kicked off a new merchandising strategy in the second half of 2010.  The major pet retailer announced partnerships with Martha Stewart, GNC Corporation, and Fisher-Price, Inc., in an effort to attract store traffic and garner higher margin.  This strategy marks the return of centralized control over store direction that was widely dispersed prior to the recession.  I expect this strategy to be successful, and other mass channel pet retailers to seek their own partnerships in 2011 in an effort to compete with PetSmart’s first mover advantage.
  • Regulatory Pressures Increase.  The pet industry has enjoyed a long and relatively unimpeded run with respect to regulation.   While natural pet foods and supplements are regulated by the Food and Drug Administration (FDA)’s Center for Veterinary Medicine, consumers are not finding this sufficient to meet their needs.  As legislators move from focusing on the domestic economy to the tactical needs of their constituencies in 2011, I anticipate the pet industry will see increasing regulatory scrutiny with respect to product claims and supply chain management.
  • A Public Pet Platform.  The pet industry is undergoing a wave of consolidation across core market segments.   However, the industry lacks pure play public buyers given the size of the industry domestically.   The majority of public pet companies tapped the market in the mid-1990s, with PetMed Express, Inc. (d/b/a 1-800 PetMeds) the last in March 2000.  I expect this drought will end in 2011, with at least one major private pet company to enter the public markets.  My prediction is to see one of the major hardgoods companies to be the first to go.
  • Increasing Deal Velocity.  With over $400 billion in un-invested capital in the hands of institutional investors, I expect that transaction velocity will pick up across industries.  However, I expect the pet industry to garner more than its fair share.  During 2010, I witnessed an increased focus by consumer oriented growth equity and buyout funds in the pet industry.  I also saw major pet industry buyers become increasingly active. As valuations improve over the course of 2011, correlated with debt becoming more widely available, I expect to see capital markets and M&A transactions in the pet industry increase, potentially significantly, as owners seek liquidity and brands seek to capitalize on available market opportunity.

/bryan

For those of you who are not avid followers of the leverage buyout transaction market, or readers of the Wall Street Journal, it may come as news to you that on November 25th, while you were likely in a tryptophan induced stupor, a private equity consortium agreed to take Del Monte Food Co. private in a transaction valued at slightly more than $5 billion.   The buying group included Kohlberg Kravis Roberts  & Co., better known as KKR, of RJR Nabisco fame, among other notable transactions.   Both these fact will become important later.  KKR was joined in the transaction by Centerview Partners Management LLC and Vestar Capital Partners.   This fact has no relevance going forward however.

In and of itself a transaction involving Del Monte is hardly notable.   In fact, KKR was once the owner of Del Monte.   The company was one of many brands under the RJR Nabisco umbrella that was sold off, for nearly $1.5 billion, to pay down debt in the early 1990s.  The buyers later sold the business to Texas Pacific Group for $809 million in 1997.    In short, Del Monte has been around the transaction block and therefore news of a deal should not be “above the crease” material in and of itself.

Further, when you think of Del Monte you likely think of canned pineapple, or at least I do.   After all Del Monte is a sacred American brand in the field of shelf stable food products.  The company’s Consumer Products segment manufactures, markets, and sells branded and private label fruit, vegetable, tomato, and broth products under the  Del Monte, Contadina, S&W, and College Inn brands, among others.   The company sells its products through direct sales force and independent food brokers to grocery, club store, supercenter, and mass merchandiser customers; dollar stores, drug stores, convenience stores, military, food ingredients, and private label customers; and the foodservice industry.  Exciting I know.   Hang on, it gets more interesting; I promise.

Now consider a few things that I contend are not coincidences, and represent the real impetus behind the transaction:

1) In March 2006, Del Monte purchased The Meow Mix Company, LLC, a manufacturer and marketer of cat food and cat related products, from a private equity consortium for $705 million, or approximately 2.8x revenue.   In July of the same year, Del Monte acquired the Milk Bone Dog Food Business, maker of dog biscuits and chew treats, from Kraft Foods, Inc. for $580 million, or approximately 3.2x revenue.   All told $1,285 billion in deal consideration for approximately $433 million of pet related revenue.

2) As of May 2010, sales from the Pet Products business of Del Monte on a latest twelve months (LTM) basis were $1.75 billion, or 46.8% of total revenue.   More significant, Earnings Before Interest Taxes and Depreciation (EBIT) for the Pet Products business  on an LTM basis were $355.5 million, or 70% of total EBIT and 61.4% of total product EBIT (backing out corporate overhead).  In short Del Monte is a pet company from a profit standpoint.   Applying an 8.0x multiple to these profits yields a valuation of $2.84 billion or 57% of deal value. [post publishing note: In their analysis Deutsch Bank valued the pet business at 11.0x, which would mean the pet business constitutes over 75% of deal value]

3) In January 2010, KKR purchased Pets at Home Ltd., the largest pet retail chain in the United Kingdom for $1.55 billion.  Del Monte only derives 6% of total revenue from foreign markets.   In short, KKR has been bitten by the pet bug in a significant way, and its Pets at Home acquisition provides an immediate outlet to increase foreign sales of Del Monte brands.

Net net, this deal was not about canned goods, it was a bet on the macro pet market.  The Del Monte acquisition, when closed, would constitute the second largest consumer focused pet deal on record, after Nestle S.A.’s $12.1 billion acquisition of Ralston Purina Company in 2001.   What happens from here remains to be seen.  It’s hard to believe the buyout firms won’t separate the two businesses in an effort to unlock further value, but there’s no guarantee.   A standalone Del Monte Pet Products business could go public at a premium multiple in favorable market conditions.

/bryan