Vice President: Ivan Petkov
Associate: Riccardo Vittorio Perego
Analysts: Vraj Agarwal, Adam Hrehovcik, Simon Sandewall, Rhea Bhasin
Deal Overview
Introduction
Dechra Pharmaceuticals, a UK-based veterinary drugmaker, will be taken private by EQT, a renowned Swedish private equity firm, through its EQT X Fund. The deal is poised to be one of Europe’s largest take privates of the year, valued at approximately £4.5 billion (S.A., 2023). Dechra’s board of directors unanimously recommended EQT’s offer of £3.875 per share, giving the company an equity value of £4.5bn (Kelly, 2023). The price represents a 44 % premium to Dechra’s closing share price on April 12 — before EQT’s interest became public — but is less than the private equity group was initially willing to pay (Kirchfeld, 2023), following a profit warning from the pharma company last month. EQT will own 74% of Dechra upon completion of the deal (in its EQT X Fund), with its co-investor, the private equity arm of the Abu Dhabi Investment Authority, holding the rest. (Bloomberg, 2023)
Dechra Pharmaceuticals acquisition will be operated through “Freya Bidco Limited”, a specially formed company operated by EQT and Luxinava S.A (LSE, 2023). The acquisition will be implemented by a courtsanctioned scheme of arrangement. The take-private offer was recommended by Dechra board of directors, advised by Investec, who considers the acquisition to best benefit the interest of shareholders and the company (growth & investment).
Blackstone Inc. and Goldman Sachs Asset Management are leading a £1.25 billion direct lending deal to support the take-private of Dechra, as per Bloomberg News. Blackstone and Goldman Sachs are committing £400 million each to the transaction (LSE, 2023).
Overall, the acquisition of Dechra by EQT represents a strategic move by EQT (Nair, 2023) to capitalize on the growth potential of the veterinary pharmaceuticals market which maintains strong fundamentals but was hampered by macro headwinds, providing attractive valuations. As per its statement, EQT aims to support the company's future development and value-creation initiatives while leveraging its expertise and resources in the growing sector.
The offer comes at a challenging time for the animal health market. In the US and Europe, wholesalers that buy Dechra’s medicinal products have been cutting the amount of stock they hold, which has hit the company’s profit margins. Of course, the completion of the take-private is conditional on shareholder support and approval from antitrust regulators. If approved, it would complete later this year or in early 2024 (Reuters, 2023).
Business Overview
Dechra Pharmaceuticals
Dechra Pharmaceuticals PLC is a company engaged in the development, manufacturing, and sale of veterinary pharmaceuticals and related products. Its operations are divided into three segments: European Pharmaceuticals, North American Pharmaceuticals, and Pharmaceuticals Research and Development (Dechra, 2023). The company offers a wide range of products for various veterinary needs from medications to overall animal care. Dechra distributes its products through wholesaler and distributor networks.
EQT
EQT is a global private equity firm with a core mission on value creation and sustainable growth. EQT manages a portfolio of market-leading businesses with significant growth potential. The company works closely with portfolio companies to drive operational improvements, strategic initiatives, and value creation (EQT, 2023).
EQT manages a series of funds such as EQT VIII, targeting investments in Northern Europe and North America, and EQT IX, focusing on European and North American markets. These funds provide the necessary resources and expertise to drive value creation and deliver strong returns for investors.
Rationale
EQT is looking to further expand its portfolio in the pet industry through the acquisition of Dechra. Medical advancements, surge in pet ownership and greater emphasis on the well-being of pets will accelerate the growth of the pet industry (Nair et al., 2023). Given the evolving and growing pet market, Dechra, as an estabilished veterinary business with operations in 26 countries, is a perfect jigsaw fit into EQT’s portfolio (City A.M., 2023). EQT has previously acquired IVC Evidensia which is another global leader in veterinary care. Additionally, EQT is also previously invested in ManyPets (a pet insurer) and Zooplus (an online pet food and accessories retailer) (Kelly et al., 2023).
Secondly, EQT aims to further expand Dechra globally and enter new markets as pet ownership becomes more popular, especially in certain regions within Asia Pacific. Finally, EQT also plans to grow Dechra inorganically in the future through further acquisitions by pumping additional investments into its business. Given the evolving customer needs in this sector, congeneric inorganic growth will allow Dechra to expand its product range quickly, leverage new gaps in the market and meet the needs of a wider range of customers. Additionally, horizontal acquisition opportunities in the future feed directly into its vision to expand globally (Nair et al., 2023).
Industry Analysis
The global pet care market was valued at $235.32 billion in 2022 and $246.66 billion in 2023. At a CAGR of 5.92%, the market size is expected to grow to $368.88 billion by 2030. The worldwide sales for the pet market since 2016 and projections up to 2027 express a steady growth (Roberts, 2022). Greater emphasis on pet welfare and the further diversification in the product range offered as new toys, wearables and food flavours are introduced in the market has primarily fuelled the growth in the recent years.
The coronavirus pandemic increased the demand for pets to accompany individuals, especially during long isolation periods, which subsequently increased the demand for hygienic food and pet care products. As pet owners become more cautious about the general health and diet of their pets, the industry can leverage the opportunity to research and introduce new healthier food and lifestyle products to the market. Obesity, in particular, is a common health concern amongst many pet owners. The demand for vegan food has also started to emerge in the market providing further opportunities for market growth.
Several customers are increasing their yearly expenditures on pet-related products supporting the rise in business cost that naturally arises from introducing new premium products/services and infrastructure such as grooming and manufacturing facilities. However, the rising product costs has also sparked affordability concerns for some pet owners. Around 53% of the total pet cost is associated with food and 15% with veterinary products.
In terms of region, North America holds the largest market share ($79.54 billion) in 2022 and is anticipated to be the leading region for the next few years (Fortune, 2023). In US, dogs were the most common type of pets in 2022 (owned by 44.5% of households) followed by cats (owned by 29% of households) (Megna et al., 2023). Asia Pacific is witnessing the fastest growth as the middle-class population increases and established businesses such as Mars Incorporated and Nestle S.A expand into the region increasing the popularity of a range of new pet products (Fortune, 2023). USA had the biggest contribution (of 38%) to Dechra’s revenue while UK and Germany each generated 9% of the total revenue in 2022 (Dechra, 2022).
Millennial and Generation Z are more likely to own a pet in their lifetime compared to the previous generations. Additionally, they are more cautious about the health and general well-being of their pets presenting a plethora of product/service opportunities including behavioural training, doggy day care, specialised pet food and regular health check-ups (Grand View Research, 2022).
Company Analysis
Dechra Pharmaceuticals PLC is the largest veterinary drug manufacturer in the UK that ranks consistently within the 20 largest animal health companies in the world by revenue. However, it is important to note that the animal health market is highly fragmented, which is evident in Dechra’s market share, which was 1.43% as of June 2020. Company’s products are distributed to 63 countries, but 40% of its revenue comes from the US and Canada alone. Other major geographies for Dechra are France, Germany, the Netherlands or the UK. Apart from Europe and North America, Dechra has only 11% of its revenue from the rest of the world. This is not in line with the overall portion of global demand from the rest of the world, which is estimated to be around 30%. Dechra has therefore significant growth opportunities in markets in Latin America, Asia-Pacific, or Middle East. One of the reasons for Dechra’s strong reliance on Europe and North America is that there has been a significant increase in consumer spending on pets in these regions in the past few years, which incentivised Dechra to focus more on these markets instead of geographical expansion.
Dechra’s products are divided into four categories. Companion Animal Products are developed for dogs and cats, Food producing Animal Products for poultry, pigs and cattle, Equine for horses, and Nutrition products are also designed for dogs and cats. The Companion Animal Products contribute to 74.6% of the revenue. Part of Dechra’s long-term strategy is to boost its sales in the other product categories. However, the growth in these categories lagged behind the growth in Companion Animal Products sales in 2022. One reason for this situation is the inherent market unpredictability. This holds true especially for the Animal Food Production sector, which experienced significant setbacks last year because of the outbreak of diseases like avian influenza and African swine fever.
In the future, Dechra’s growth should be driven by the pipeline delivery, geographical expansion, and inorganic growth in form of acquisitions. Over the last few years, Dechra was focused on increasing the number of drugs in development which should translate to consistent flow of new products in the future. This should ensure stable revenue growth. Furthermore, acquisitions can help increase both the scale of the business but also its geographical presence by providing easier access to new markets while widening company’s portfolio.
Among the key risks of the company is the trend of veterinarians, creating buying groups with the objective to consolidate their purchasing power. This could lead to higher sales volumes, but it will also likely reduce profit margins of the company which is concern of many. Product development and regulatory risks can also slow down or completely cancel launches of new products due to changes in regulations or pipeline delays. Lastly, there is significant competitor risk in the form of other companies launching products against Dechra’s products after the expiration of patents or exclusivity periods.
Financial Analysis
Dechra has a current market capitalisation of £4.1bn. Comparing this to the value of the transaction of £4.5bn means that the deal will happen at a significant premium of over 9% in comparison to the current stock price. Looking at the deal from a longer-term perspective, the transaction price includes a premium of 44% to Dechra’s closing share price on April 12, which is the last day before EQT’s interest in the takeover of Dechra became public.
Source: (Financial Times, 2023)
Dechra’s revenue is forecasted to grow at 7.7% (Simply Wall St, 2023), which can be compared to growth of 12.1% from 2021 to 2022. This was the key driver behind the growth in net income to offset Dechra’s lower profitability. However, the earnings are expected to grow at 24.4% a year (Simply Wall St, 2023). This is an increase in the trend from the average earnings growth of 14.0% Dechra experienced in the last 5 years. These forecasts suggest strong future growth, which is higher than what is projected for the industry. These forecasts are also reflected in the company’s valuation, especially if looking at the multiples.
In terms of profitability, Dechra’s performance worsened in 2022 as its net profit margin decreased from 11.4% to 5.5%. The deterioration in profit margin may reflect the high inflation, economic uncertainty and lower consumer confidence. However, it is difficult to estimate how much of the margin decrease in caused by these short-term factors since there are probably some long-term structural changes and inefficiencies contributing to it. Dechra’s operating margin of 8.64% is also below the industry average, which had been consistently around 20% in the past (Dechra Pharmaceuticals PLC, 2023). Furthermore, ROI of 3.06% and ROE of 5.42% (Financial Times, 2023) would be generally considered quite low, even in highly competitive industries. The ROE of Dechra is in fact approximately equal to the returns of the FTSE 100 index, which generated average annualised returns of 5.40% since 1984. Thus, profitability seems to be a weakness of the company and presents both challenge but also great opportunity for EQT. Given the operational excellence EQT will bring to Dechra’s business, increasing profitability may the core aim of management after the takeover.
The partial explanation of the low profitability may lie in lower business efficiency which is highlighted by the asset turnover ratio of 0.50 and inventory turnover of 1.67 (Investing.com, 2023). These ratios are low compared to inventory turnover of between 5 and 10 for most industries but also to inventory turnover in pharmaceutical industry which had been around 3 for the last couple of years (CSIMarekt.com, 2023). The implications of these figures are that Dechra may not manage its working capital as well as its competitors, making this a suitable area for improvements which would also translate to higher profitability.
Dechra’s capital structure presents a solid mix of debt and equity with a 60.7% debt-to-equity ratio. This, together with an interest coverage ratio of 6.4X (Investing.com, 2023), suggests good financial health of the company. The current ratio of 2.73 and quick ratio of 1.27 (Investing.com, 2023) are a sign of good liquidity of a company that gives it a significant level of strategic flexibility which can be highly beneficial in current high-interest environment. In the long-term, Dechra’s capital structure also gives EQT the opportunity to increase a firm’s leverage as current debt level can be still increased without a significant increase in bankruptcy-related risks. Hence, this strategic financial flexibility may be one of the key drivers of the future growth of Dechra.
Dechra has a P/E ratio of 101.7, which is well above the peer average of 35.6 and the entire industry average of 19.7 (Simply Wall St, 2023). The P/E ratio was arguably strongly influenced by the news regarding the takeover, but even in the past 3 years, P/E ratio of Dechra has always stayed within the range from 60 to 100. The high P/E ratio suggests markets expect strong future earnings growth while maintaining high quality and low risk of these earnings. Thus, there is probably a general expectation of Dechra outperforming the industry. However, even with market pricing in the future potential, the company still seems to be overvalued, as Dechra’s P/E ratio is almost triple of its peers. Similarly, P/S ratio of 5.7 also suggests overvaluation of the company.
The model assumes a Terminal Growth Rate (TGR) of 3%. This assumption was made considering the prospects for economic growth in the United Kingdom in the long term with the possibility of economic difficulties in the near future.
Regarding the other assumptions in the model, the Tax Rate of 25% is derived from new regulations in the UK that increased the corporate tax from 19% to 25% earlier this year. The projection for the tax expense as a percentage of EBIT, however, was taken as an average from previous years to take into account the possible tax benefits from debt.
Market assumptions were retrieved from external analytic sources. The risk-free rate of 4.4% (MarketWatch, 2023) was taken as the coupon rate on the 10 year UK treasury bill, the market risk premium is assumed to be 5.7% (Statista, 2023), and the company equity beta is 0.9315 (Financial Times, 2023a).
Given the developing nature of the business, we can expect a high, industry-exceeding year-on-year revenue growth rate amounting to 7.7% (Simply Wall St., 2023).
We used historic information to derive financing assumptions for Dechra. As such, the cost of debt was calculated by considering the average ratio of interest expense to total debt over the previous years, additionally taking into account the recent interest rate hikes in the UK to increase the discounting factor.
Given these assumptions, the WACC calculated for the DCF is 7.76%, which values the company at £3.832bn with an implied share price of £31.8, in comparison to the market share price of £37.30 and around £27 before any announcements regarding the deal were made. EQT closed the deal at £38.75 per share (Financial Times, 2023b), indicating that they see an even more optimistic growth opportunity with this company.
Risks and Prospects
Dechra is a global veterinary pharma business present in 26 countries, with over 2400 employees (LSE 2023). Ranked seventh globally by revenue, Dechra has made leaps and bounds in transforming from a wholesale distribution firm to a global pharma player. Interestingly, however, this deal has emerged in the midst of a deal-making slump as banks have been unwilling to lend in light of macroeconomic outlook. Furthermore, the £ 4.5 billion deal is one of the largest leveraged buyouts to ever take place in Europe (Kelly and Louch 2023). This brings us to examine the promise Dechra holds.
From EQT’s perspective, this deal holds a number of advantages. First, EQT has a stronghold within the pet sector. EQT owns IVC Evidensia, a UK vet clinic chain, and has stakes in ManyPets and Zooplus (Kelly and Louch 2023). The addition of Dechra, “a high quality and leading company operating in the attractive animal health pharmaceuticals market,” to this portfolio is tactical (LSE 2023). EQT sees potential in the vet pharma market, which it expects to grow in the long-term as a result of increasing pet ownership, medical innovation and a greater focus on animal care within the family. Statistics support this as more than half of the world’s population is estimated to have a pet, and 70% of US households (Dechra’s largest market) owned pets as of 2021 (HealthforAnimals 2022). However, the current animal health market does not reflect this optimism. In both Europe and the United States, wholesalers have been cutting Dechra medicinal product stock, materializing in a profit reduction for the company (LSE 2023). This risk is a major one – the reliance on longterm consumer trends for growth.
Public companies are generally cheaper than private counterparts, and London-listed companies are usually discounted in comparison with similar businesses in the US (Kelly and Louch 2023). This in itself makes the Dechra acquisition slightly more favourable for EQT, coupled with the fact that the offer was closed at a discounted per share price due to Dechra’s profit warning.
Overall, this deal possesses significant risk in its reliance on a market that cannot necessarily be predicted, as economic hardship is pushing pets out of homes (Norris and Hastings 2023). Nonetheless, this deal can be viewed with cautious optimism as Dechra is a leader in its sphere and combined with EQT’s existing pet portfolio, can reach new heights.
Conclusion
EQT’s acquisition of animal health company Dechra, in one of Europe’s largest take privates of the year, comes across as a strategically sound move. EQT seeks to build its well-established prominence within the pet sector with this £4.5 billion acquisition, riding on a long-term wave of increased pet ownership, medical advancements, and a greater focus on pets, particularly in untapped emerging economies. The deal is peppered with risk rooted in market dynamics of lower demand for Dechra’s products, and this risk is long-standing given the elasticity of pet-related products in times of economic crisis. Nonetheless, Dechra’s global reach somewhat soothes such risk. With EQT’s expertise in the pet sector, and Dechra’s recognized dominance, the outlook on this deal is largely optimistic for both parties.
References
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