What We’re Hearing: Market is Slowing but Long-term Outlook Remains Favorable
One of the industries that saw the most growth through the pandemic was undoubtedly the pet sector. Surges in pet ownership, high levels of disposable income, and trends towards the humanization of pets and customization of home environments to pets were among the driving forces that led to a boom in pet-industry M&A activity and valuations over the last few years.
The natural question is whether such fervor is sustainable. We recently discussed the topic with a number of the most active investors in the industry to garner their predictions.
Overview
Our investor conversations were full of mixed commentary about the past year’s deal volume and quality. Some of the variation hinged on market subsector.
Overall, it appears that high-quality deals have declined compared with the record-setting activity in 2021. Historic inflation has squeezed discretionary spending. At the same time, rapid interest rate hikes have compressed buyers’ leverage capabilities, while public market volatility and industry saturation also exerted impacts.
Despite these challenges, investors seem aligned behind the belief that long-term tailwinds for the industry will ultimately beat out current macroeconomic headwinds.
Worth noting, however, buyers have recently become more selective about their preferred subsectors than they may have been during 2021’s competitive frenzy. Although the humanization of pets has generally put innovative pet health at the forefront of deal activity, strategic viewpoints regarding the most attractive targets of acquisition differ from investor to investor.
Supplements & Pet Food Subsectors
Supplements & Manufacturing Considerations
On the heels of major acquisitions, including NaturVet, Pet Honesty, and Zesty Paws, the more established pet supplement brands continue to drive strong investor interest.
Low barriers to market entry as a non-manufacturing company, however, have led some investors to a more wary stance on lower scale brands without a defensible competitive moat. Additionally, concerns about quality control and regulatory risks are being raised in some corners with regards to new brands that are outsourcing their manufacturing.
Established brands with strong channel diversification and manufacturing capabilities, on the other hand, remain highly prized. Among the factors playing in their favor, these companies are typically less susceptible to supply chain disruptions, quality control issues, and price volatility. Targets with manufacturing facilities can also offset brand-specific risk through private label manufacturing, even during periods of slower brand growth.
CBD Considerations
CBD offerings in the pet supplement space elicited diverse opinions. Some investors consider the market to be a Wild West environment and fear that regulatory bodies could become more involved in evaluating and enforcing issues. In fact, some investors cited regulatory risk as a broad concern for the supplement market, beyond CBD products.
Other buyers take a more optimistic view of CBD applications for pets and prefer the category’s less crowded competitive environment, as compared to a fairly saturated pet food and treat market.
Growth Sustainability Concerns
A common concern among buyers is the high level of marketing spend many brands deploy to grow or maintain market share. This issue has been especially prevalent for supplement businesses coming to market, given the relative lack of a moat compared with other pet categories.
Investors noted during our discussions that it’s not uncommon to see strong topline growth from branded pet opportunities, but they were also quick to clarify that not all growth is viewed equally. In many cases, growth trends can be attributed to substantial marketing budget, prompting concerns about growth sustainability and true brand equity.
Market Advantages
Top-tier buyers are typically looking for brands leveraging patents, diversified product lines, exclusive supplier/retailer relationships, and other strategies to establish a moat in a crowded space. Many buyers are also interested in diversifying their own pet portfolios by investing in emerging categories, such as human-grade raw pet food and bespoke diet and supplement plans.
Within the pet food category, which has remained popular among private equity and strategic buyers alike, innovative premium categories tailored to high-spending pet owners—offerings such as freeze-dried and air-dried raw, refrigerated fresh, and personalized meal options—are likely to stand out in upcoming years.
Durable Categories
Investors also remain interested in durable categories, such as accessories, toys, and confinement products. Critical in attracting interest is a demonstrated ability to develop competitive differentiation and achieve continued growth beyond the pandemic period, during which many pet durable product brands saw a COVID-related performance bump.
Services Subsector
Investors are now regaining interest in pet services, which declined during the pandemic. As many pet owners have returned to work, providers in such categories as pet boarding and grooming are back in vogue. Televet services are also being targeted for buyer portfolio diversification.
Veterinary practices continue to see significant consolidation from private equity-based strategic buyers. Investments in veterinary clinics have allowed investors to enter the pet space with a model that is generally viewed as more predictable and lower risk than branded products.
Conclusion
Investors in the pet space continue to express optimism about the industry’s long-term prospects. The question of which subcategories offer the most room for growth remains a matter of keen debate.
Expect for well-established brands, manufacturers, and service providers with a strong growth history to attract highly competitive processes, while lower scale and more speculatory models face greater market scrutiny than they may have during the pandemic.
AUTHORED BY:
Bobby Motch | Head of Sponsor Coverage | Class VI Securities, LLC
As head of Sponsor Coverage, Bobby is responsible for managing financial and strategic sponsor engagement, developing sponsor-related content, and managing Class VI’s Buyer CoPilot program. Prior to his role as Head of Sponsor Coverage, Bobby was responsible for executing and closing transactions and supporting Class VI clients through financial analysis, modeling, market outreach, industry research, and valuations.
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