Companion Animal Category Offers Opportunities for Durable Performance
Many private equity professionals heading back into the office are losing a major employment benefit that no one is talking about—lost time with beloved pets. Pandemic-era Zoom calls anecdotally proved out my theory that most PE professionals are pet owners. So, if you are reading this, you likely either have a dog, a cat, or both. Maybe even multiples of each, and over the past 18 months, they were probably even more important to you than multiples of EBITDA.
The money you spend on pet food, treats, supplies, and healthcare, at times, astounds you, but you never hesitate. After all, this is love—maybe the deepest love you have ever known—and you are aware it is fleeting. Between brushing your companion animal’s teeth, reading scientific research on pet food ingredients, and keeping them on the daily supplement regimen you could never quite keep yourself on, you take comfort in knowing your efforts will hopefully extend your time together.
Seeking to capitalize on the macro environment you are now acutely aware of, you might desire to merge your personal and professional loves. Finding a pet company to buy or invest in is now your North Star. If history is any guide, your journey will start in one of two places: food or veterinary services, because you view both as having recurring revenue streams.
This is when your ambition may hit you squarely between the eyes. Your favorite food brand is already equity-backed. Same with your go-to treat brand. The one your colleague raves about? Already acquired. Veterinarians are ghosting you, but don’t take it personally—a dozen of your colleagues and peers have called them this week, too.
Through some connections, you meet a rapidly scaling, digitally native brand. Unfortunately, you soon have the very unpleasant experience of water coming out of your nose when they tell you their valuation expectations. That cat litter robot you learned about on Instagram suddenly seems more interesting. Carrying on, you participate in a banked process for a supplies business playing in several growing segments with a broad sourcing strategy. You will stretch for the platform and multiple down through tuck-ins. But today, you must come home to be consoled by your pet when your 10x bid does not even get you a management meeting. Finally, reality comes crashing down on you. After putting in more effort than a member of the Working Group at the Westminster Dog Show, you have battle scars but no IRR to show for your ambition.
If any of this sounds familiar, you are not alone. But I come bearing good news! Your luck may soon change.
This year, the U.S. pet industry will eclipse any historic deal volume threshold ever posted. All signs point to a substantial increase over 2020, which is significant even with the weaker comp due to the pandemic. Private equity and equity-backed strategics will absorb most of the deal volume, and below are the primary drivers of this reality:
The Stars Don’t Align for Large Public Strategics in Consumables. Large public strategics in the pet category are either feeling no pain or have too much to handle. Take, for example, Nestlé. While Nestlé PetCare saw market share erosion in almost all pet-related categories in 2020, the division posted 10.2% organic growth globally during the same period. Moreover, while Nestlé has made pet acquisitions in the last two years, none of them involved U.S. consumables assets, despite the many opportunities laid before them.
In contrast, The J.M. Smucker company needs to demonstrate to the market that it can ring the value out of what it has bought and divest what is not working. That process has led it to better recognize its core competencies, which does not open the aperture for acquisitions. Mars is playing a global game like Nestlé and has shown little interest in U.S.-centric opportunities primarily focused on the right 20% of the bell curve.
The net result is that name brands such as WellPet, Natural Balance, Nulo, and Stella & Chewy, among others, all end up in the hands of private equity.
Private Equity is the Game in Town for Supplies. Supplies have also been a significant driver of M&A volume, but large strategic players in this category are, again, largely dormant. For example, Spectrum Brands has acquired in Europe but not in the U.S., and Hartz Mountain has not acquired anything in the last ten years. Private equity-backed platforms have been active, but several are late in their gestation cycles and more likely to be looking for exits, which provides market entrants a unique opportunity to compete for and win deals.
Further, larger funds can vacuum up these platform exits, as Clayton, Dubilier & Rice did with Radio Systems Corporation in 2020. Subsequently, Radio Systems has made seven acquisitions within its Invisible Fence line of business. For companies that are seeking a 2021 exit for tax purposes but are running into supply chain challenges—both in terms of product availability and landed cost due to rising manufacturing rates in China and increased logistics expense—buyers who can see through the noise have a potential value opportunity.
B2B Opportunities are Increasingly Attractive. As industries mature, business-to-business opportunities emerge and present an attractive alternative to taking brand or singular company risk. Why bet on a brand when you can play the category through manufacturing, ingredients, or services? While prominent industry players are actively deploying capital to build facilities in lieu of M&A, much of the industry remains reliant on third-party production.
Private equity funds saw this writing on the wall years ago, but opportunities remain, especially in emerging categories like supplements and alternative form factors in consumables, such as freeze-dried. While the core elements of the industry have been significantly professionalized, a meaningful portion of third-party production remains in the hands of entrepreneurs.
Stretching on Value Has Never Been Easier. Value creation in the pet industry has been robust over the past five years, despite limited growth in the U.S. pet population. From 2016 – 2020, Cascadia’s index of public equities in pureplay pet companies outperformed the S&P 500 by 236%. Many companies in the 2016–2018 vintage that took capital at unprecedented multiples returned it many times over. In short, the brave were handsomely rewarded.
With the pandemic further solidifying the role companion animals play in our physical and mental well-being, we are witnessing an acceleration in pet ownership and population trends, accompanied by rising wages. For those concerned about the risk of an economic contraction, the companion animal category offers one of the best opportunities for durable performance. Further, lenders are frothing to back profit-generating pet businesses, especially if future acquisitions are part of the growth strategy. Put simply, the risk seems well worth it.
I will acknowledge that all glitters does not turn to gold. However, the pet industry has delivered handsomely during this investment cycle despite headwinds related to ownership, demographics, and real wage growth to support spending. With tailwinds lining up for accelerated growth and large strategics focused squarely on their own knitting, now seems like your time to pounce.
P.S. Your pet would like a fifty-basis point deal origination fee and working capital set aside for treats.
About the Author
Bryan Jaffe is a Managing Director in Cascadia Capital’s Food, Beverage, and Agribusiness practice with deep domain expertise in companion animal, food and beverage, and consumer products. Bryan helps build client relationships by focusing on M&A mandates, recapitalizations, restructuring, and equity private placements for consumer-facing companies.