Outlook for Pet Industry M&A Strong
With little risk and recession-proof growth, the pet industry will continue attracting PE attention in 2013
The 2013 Global Pet Expo, which takes place in Orlando on Feb. 20 and lasts until Feb. 22, comes on the heels of an uptick in M&A throughout the pet care sector.
This was especially the case with private equity-backed companies. Petmate, for example, a Wind Point Partners portfolio company, toasted the end of 2012 by announcing that it acquired two pet toy companies, Canine Hardware and JW Pet Co., on Dec. 17. These were Petmate’s fourth and fifth pet company acquisitions. In 2012 other private equity groups acquired several pet product and distribution companies.
The pet industry gained the heightened attention of private equity investors as it grew at more than a 5 percent per year-over-year on average from 2007 to 2011 according to the American Pet Product Association (APPA), while the rest of the U.S. economy suffered one of its worst recessions in history. Remarkably, the pet industry has not had a down year in the last eight years. The pet industry has grown steadily from $17 billion in 1994 to about $53 billion in 2012 according to the APPA. Pet owners treat their companion animals as family and buy them food, treats and toys even in down times. The industry truly appears to be recession proof making it a seemingly safe place to invest.
Private equity firms have been snatching up pet industry companies over the last five years. There are at least 16 financial buyout groups that have invested in the pet industry and 11 of them have doubled-down having completed two or more investments in the industry. Five have made their first investments and are looking for add-ons or other stand-alone opportunities. These 16 firms have made 38 majority equity investments, two minority equity investments and one sub-debt placement. In addition, 23 more have stated their interest in the pet industry and have been looking for their first investment.
In 2012, Castor & Pollux was acquired by Merrick which is owned by Swander Pace Capital, and Thundershirt was acquired by Encore Consumer Capital which also owns Zukes.
Most of the private equity funds have purchased companies that make pet foods, treats or products which represent about 60 percent of the industry expenditures. However, AEA Investors and Halifax have ventured into pet distribution. A third private equity firm has been seeking an initial pet distribution company for more than a year to enter the fray.
Animal Supply acquired Lone Star of San Antonio on Nov. 8, Zeus & Co.’s Western Division on Dec. 17 and Summit of Greensboro on Jan 7, 2013, using private equity from the Halifax Group in Dallas. Earlier in the year Phillips Feed & Pet Supply acquired Mike’s Feed Farm Wholesale Distribution Co., K&W Distributing and Anjo Distributors using private equity from AEA Investors. There were at least four other mergers in pet distribution that fell apart because of worries about losing Procter & Gamble as a vendor. Lone Star didn’t have that problem because they hadn’t carried P&G products for years.
Phillips’ merger with Mike’s, K&W and Anjo creates a territory that stretches entire East Coast from Florida to Maine and includes portions of the Upper-Midwest. Animal Supply’s merger with Lone Star, Zeus and Summit creates a territory that covers the West Coast and stretches across the south central part of the country to the East Coast. Obviously the next move for either of these acquisitive companies would be to continue to stretch their territories toward each other.
In addition to all the private equity investment, strategic buyers are also very active. The more than a dozen very large strategic buyers include: Central Garden & Pet, United Pet Group, Mars, Del Monte, P&G, Nestle/Purina, Hills, Etc. and most have accumulated cash on their balance sheets during the recession.
On Sept. 13, Perrigo Company, a pharmaceutical company in Allegan MI, became the latest large strategic to enter the industry when it acquired Sergeants Pet Care Products for $285 million. Earlier this year United Pet Group bought FURminator at a premium valuation from the private equity firm Hammond, Kennedy and Whitney. In addition, there are more than 30 middle-market pet industry companies with $40 to $500 million in revenue that should also be considered strategic buyers.
Most transactions will fall in the 5.5 times to 7 times Ebitda range although higher multiples can be justified by strong brands, rapid growth, higher than normal margins and/or synergies with the acquirer. The specific terms of the Animal Supply acquisition of Lone Star and Summit were not disclosed in the press releases but it’s believed that Lone Star and Summit were valued at about a 6.5 times to 7 times multiple of Ebitda, and the owners used 10 percent to 20 percent of the proceeds to buy back stock in the merged entity for a "second bite of the apple".
The pet industry is highly entrepreneurial and has low barriers to entry. Based on an informal survey, there are hundreds of small boutique companies in the in the range of $1 million to $5 million in revenues, 100-125 in the $5 million to $10 million revenue range, 30 to 50 in the $10 to $50 million range, 20 to 30 in the $100-plus million revenue range. The opportunity for a transaction is greatest for those companies with revenues in excess of $10 million. However, according to Worldwise CEO Kevin Fick "opportunities also exist for companies with revenues of less than $10 million as add-on or bolt-on acquisitions and joint ventures with the large strategics and especially private equity backed companies like ours". Financing can also be obtained by the smaller companies that have high-growth potential.
If the investment activity wasn’t enough, the new administration is focused on raising taxes. The only questions are which taxes, when they will be increased and their effect on the economy. The capital gains rate increased from 15 percent to 20 percent and income taxes on those earning more than $400,000 and estate taxes increased Jan. 1.
Certain tax benefits may be extended for several months in order to legislate a more comprehensive tax code reform. However, after the reform the tax burden will probably further increase for dividends, corporate income and individual income. It has been empirically shown that significant additional taxes have a negative drag on the economy.
All of these suggest a very vigorous M&A market for the pet industry in 2013, the timing for owners considering a sale, partial sale, recapitalization or financing is sooner rather than later and the timing for investors is similar because the available pet industry assets to acquire is shrinking.
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