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Briefing IPO report... Zoetis (ZTS) Fundamental Grade: B

Zoetis (ZTS), the world's largest animal health business and a spin-off from Pfizer (PFE), is set to price its 86.1 million share IPO next week in the $22-25 range. Based on the mid-point of that range, Zoetis is expected to have a market cap of around $11.8 billion and it should raise around $2 billion before fees.
The IPO will be entirely made up entirely of Class A shares. After the offering, Pfizer will hold zero Class A shares but will have 413.9 million Class B shares. Both classes of shares will have identical rights and voting power on all matters submitted to stockholder vote, other than the election of directors where B shares will have 10x the voting power. ZTS expects to pay a quarterly dividend of $0.065 per share which computes to an annual yield of approximately 1.1%. JP Morgan, BofA Merrill and Morgan Stanley are the lead underwriters.

What They Do
Zoetis, formerly known as Pfizer Animal Health, is a supplier of animal health medicines and vaccines for both livestock (66% of revenue) and companion animals (34%). Its products are sold in more than 120 countries across eight core species and five major product categories. To get a sense of how large Zoetis is, consider that its products account for about one-fourth of all animal health medicine approvals made by the FDA and one-fifth of all animal health vaccine approvals granted by the USDA.
Its sales breakdown by geography is as follows: US (41%), Europe/Africa/Middle East (25%), Canada/Latin America (18%), Asia/Pacific (16%). A big part of Zoetis’ growth strategy is to further penetrate emerging markets. Based on its diverse product portfolio and regional/local focus, ZTS believes it has further opportunities to expand in emerging markets by reaching new customers, by introducing more products and by supporting the adoption of more sophisticated medicines and vaccines. Furthermore, Zoetis believes that the consolidation of livestock producers in certain emerging markets will drive adoption of Zoetis’ products.

Animal health industry
Livestock health and production are essential to meeting the growing demand for animal protein of a global population that is increasing its standard of living, particularly in many emerging markets. Also, livestock health is critical to assuring a safe food supply by reducing the outbreak of infectious diseases. The cost to livestock producers of medicines and vaccines is small relative to other costs such as feed. And these products help protect producers' investments by treating and preventing diseases in herds and flocks before they become widespread, thus improving economic outcomes for producers. As a result, demand for animal health products has typically been more stable than demand for other production inputs. As for the companion animal market, growth is being driven by increases in disposable income, higher rates of pet ownership, companion animals living longer etc.
There are significant differences between the animal health medicines and vaccines and human health businesses. For example, R&D is faster, less expensive and more predictable. R&D for animal health generally requires fewer clinical studies, fewer test subjects and is conducted directly in the target species. As a result, decisions on efficacy and safety can be made more quickly. Another difference is that generic competition in the animal health industry is less than in human health. The reasons for this include the smaller average market size of each product, the importance of direct distribution and the primarily self-pay nature of the business.

Financials
Taking a quick look at the financials, the company is profitable with strong margins. For the nine months ended September 30, revenue came in at $3.16 billion, which was up about 2% YoY. While the top line growth is pretty modest, Zoetis posted pre-tax margin of 21.9% when you back out restructuring charges, which is quite strong. Probably the main negative is the balance sheet. On a pro forma basis, Zoetis will have long term debt of $3.64 billion vs. shareholders equity of just $1.1 billion for a LT-debt-to-cap of 77% which is quite levered.

Conclusion and Briefing.com Grade: B
In sum, there are a number of positives with this IPO. Zoetis is the largest player in the animal health space, they are geographically diverse with a strong position in emerging markets and they have very strong margins. On the flip side, they have a lot of debt and the top line growth is pretty modest. Also, this is a huge company with a large offering size so we’d be surprised to see it pop one way or the other.

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