M&A: what is the state of play?

The pet industry enjoyed a positive and protected narrative in both the media and investment landscape for the period that spanned both the global economic downturn and COVID recession – between 2008 and 2021. That time was characterized by consistent industry growth, fueled mainly by pet humanization.

Upgraded pet care

At its core, growth in the past 15 years has been driven by an upgrade cycle in underlying pet nutrition, where a broad set of owners adopted pet food solutions that were higher quality. This was either because of their willingness and ability to pay, or in response to the marketing strategies of product providers.

Over time, that premium mentality spilled into other pet-related categories and – collectively – produced a rising tide that carried the industry. It then traveled from industrialized countries to the developing world, creating continuing confidence in the industry globally.

The early COVID period was a boon for the category. Pets were being adopted at accelerated rates. Owners stocked up on products and purchased solutions to support work from home.

Companion animals were providing their owners with physical and mental benefits during a dark hour in society. Investors followed, pushing industry deal volume to historic levels in 2021.

Post-pandemic reality

As the premium mentality gave way to inflation, and offices reopened, the industry found it harder to maintain its positive narrative. There is evidence of an absorption cycle in ownership growth, as owning a pet becomes more expensive. Recent category growth reflects price gains rather than volume.

The operators seeking transactions, as well as the investors looking for them, need to be guided by a new set of principles. For the pet care industry to succeed going forward, operators must first accept the reality that ‘more-of-the-same-only-better’ will no longer deliver comparable successful results.

The fact is that, in industrialized markets, humanization is no longer the primary growth driver. But the new – and younger – generations of pet owners do want their companion animal to live its happiest, healthiest and most mobile life. And their product purchases reflect that tendency.

This is known as the health and wellness growth driver, and the companies that have aligned their marketing strategies with this theme are likely to experience faster growth and higher margins. And, ultimately, to enjoy more value creation and investor interest.

Omnichannel leads to higher valuations

Based on syndicated retail data from NielsenIQ, pet-related e-commerce picked up almost 13% share points between 2019 and 2023. The COVID pandemic pushed online purchases out of necessity, and these gains were captured by brands selling directly online and by major e-commerce platforms.

Consumers learned during that time how convenience gives them little to no extra cost, while easing the burden of an additional shopping trip – without having to sacrifice brand choice. This behavior has proved to be long-term, reinforced by the generational shifts within pet ownership.

At the same time, dedicated online brands are finding joy in physical retail, as there is still a dedicated bricks-and-mortar pet consumer.

What we have gleaned from COVID and post-COVID transaction data is that a brand’s ability to implement an omnichannel strategy correlates with more closed deals and higher valuations.

Buyers looking for profitable growth

The pet industry is clearly in a maturity phase in industrialized markets. Innovation will continue to push the boundaries of the industry and create new entrepreneurial opportunities, especially in consumables, but the practical reality is that both financial and strategic buyers are underwriting based on profitability, and bidding as a multiple of income as opposed to revenue.

The sun has set on the ‘3 x revenue’ paradigm often cited by sellers.

While the main arbiter of applied multiples will be volume-based growth rates and profit realization percentages up and down the income statement, vertical integration will be increasingly critical to attracting strategic buyer interest.

If a company can leverage data to increase marketing efficiency, can prove supply chain durability, and succeeds with an omnichannel sales strategy, it will be awarded premium multiples relative to its peers and historical norms.

Emphasis on developed countries

During periods of economic and social uncertainty, investors exhibit a flight to quality. This is indicated by elevated deal volume in developed nations in comparison with emerging markets. These markets offer more transparency, liquidity and safety, often at the expense of growth.

In the years leading up to the pandemic, exposure to developing markets – mainly Asia – was viewed as positive. Where companies had succeeded in exporting and selling in these faster growth markets, a premium generally followed. Today, we see investors placing much more emphasis on capitalizing on channel and category opportunities in developed countries, before seeking to export brands to new markets.

Interest in services will re-accelerate

While the industry may be experiencing a relative malaise, conditions are expected to normalize in the coming year. A recent Morgan Stanley Alphawise survey suggests interest in new pet ownership has increased by 6% since 2022, primarily among younger generations.

Interestingly, younger owners tend to take their pet to the vet more often, despite relying on them less as a primary source of information around pet care. Return-to-the-office initiatives will particularly affect this group of pet parents, leading to an increased need for non-medical pet services, such as daycare and boarding.

There is a considerable list of veterinary service practice roll-ups – backed by institutional investors – waiting for exit markets to improve. When they do, this will create trades that, in turn, trickle down to small practices, which will then be worth more as ‘tuck-in’ acquisitions (when a large business entity completely absorbs a smaller one).

Increasing interest in pet services also offers major pet specialty retailers, like Petco, the opportunity to expand their offerings and to stay competitive among the emergence of challengers across various channels.