February 24, 2020 - 10:38pm EST by
2020 2021
Price: 11.50 EPS 0 0
Shares Out. (in M): 110 P/E 0 0
Market Cap (in $M): 1,260 P/FCF 12 10
Net Debt (in $M): 1,100 EBIT 180 200
TEV ($): 2,360 TEV/EBIT 13 12
Borrow Cost: General Collateral

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  • I'm not short but you should be



Short with ~25% downside, PT $10. While we share many of the market’s negative views on the stock, we believe that the market is underestimating the cannibalization of HSAM’s business as VFC grows. The market incorrectly views Vets First Choice as a software platform even though it comes at significantly lower gross margins than SaaS businesses


Covetrus Overview

Company Overview

  • Covetrus was created in 2019 through the merger of Henry Schein’s Animal Health Group and Vets First Choice

  • Leveraging Henry Schein’s relationships with ~100k vets in 100+ countries (~90% of the ~28,000 vets in the US and ~70% of the ~70k+ vets in Europe/Asia) and VFC’s technological platform, Covetrus aims to serve as the “operating system” of a vet’s practice

    • Legacy supply chain coordinates purchasing activity for vets and supply chain logistics to ensure efficient delivery to a fragmented customer base for manufacturers

    • Practice management software (“PIMS”), which has ~20k customers, provides back-office support (client communications, appointment management, payment processing, etc.)

    • VFC provides prescription management, improving compliance and providing vets with e-commerce capabilities

  • Over 5,000 employees globally, including a salesforce of 1,200+, 500 of which are in the US

  • Headquarters in Maine

Covetrus Value Proposition

Challenges Facing the Vet Business

Henry Schein Animal Health Business Overview

  • Business Overview

    • Henry Schein’s Animal Health Group is one of the three leading global distributors

    • Relationship with ~100k vet practices, supported by a sales force of 1,200 people

      • Relationship with ~90% of the ~28k practices in the US, and ~70% with the vet practices in Europe and Australia/New Zealand

      • Smaller but growing presence in Asia

    • 50+ distribution centers (16 in North America, 23 in Europe and 10 in APAC)

      • Patterson has ~100 properties across US, Canada and UK (mixture of fulfillment, storage and offices)

      • MWI fulfillment centers in US and UK

    • HSIC also cross-sells practice management software, with ~20k clients

      • >50% market share

      • Shift from on-premise to hybrid/cloud will yield subscription-like SAAS revenues; currently represents 8.2% of total PIMS customers

  • Competitive Landscape

    • HSAH is one of three leading players in the animal health distribution space, competing with MWI (acquired by Amerisource Bergen in 2015) and Patterson

      • The US market has consolidated significantly, with the 3 companies controlling ~80% of the $5.8B US market

    • The US market has consolidated quite significantly, with ~50 smaller competitors controlling ~60% share 15 years ago

      • CVET has acquired 8 businesses since 2014

    • The $10bn global animal health companion market is relatively more fragmented than the US, with ~30% of the market controlled by companies outside top 3

      • ~50% of HSAH net sales are intl, versus ~20% for Patterson and ~10% for MWI (as of 2014)

    • As of 2017, HSIC estimated a 20% market share in Europe/Australia and <5% in Brazil

  • Vendor concentration

    • While HSAM doesn’t disclose vendor concentration, vendor concentration appears high based on comps

      • Vendor concentration reduces negotiating leverage, and more recently has led to manufacturers bypassing distributors and selling directly to vets

  • Fragmented yet consolidating customer base

    • Unlike the drug manufacturing industry, the veterinary business remains highly fragmented

    • HSAM has relationships with ~100k vets globally, including ~90% of the ~28k vets in the US

    • Through their acquisition of Banfield, VCA, Bluepearl and Pet Partners, Mars now has close to ~2,000 animal hospitals throughout the US and remains the largest player (~7-8% of the total market)

    • However, given favorable demographic trends, there has been significant M&A and consolidation within the industry

      • Mars acquisition of Banfield and VCA

    • Numerous PE activity consolidating the vet hospital industry

Vets First Choice Business Overview

  • Business overview

    • VFC is a prescription management software founded by Ben Shaw in 2010

      • Based on a study of 4,800 of their vet partners, compliance increased 2-4x, providing incremental sales for a revenue stream that is important and highly valuable to their customers

      • Rx represents ~20% of a vet’s revenues, and comes with 40% gross margins

    • VFC has >8,700 customers all located within the US

    • Provides whitelabel solutions to provide e-commerce capabilities to its vet partners

      • The platform has subscription-like characteristics, with cohorts typically showing steady and consistent ramp with time

    • While VFC doesn’t charge an install or subscription fee, it is estimated to take 20-25% of all retail sales that is generated through the platform and comes at significantly higher gross margins than the traditional supply chain business

    • VFC has guided to ~$0.5-$1M of revs per customer long-term

  • VFC has been gaining share vs competitors

    • Although VFC simply serves as an agent in an Rx transaction, its economics are tied to the pharmaceutical sales of its vet partner

    • Competes with online pharmaceuticals (CHWY, PETS), retail (WMT) and Vetsource, which provides whitelabel, home-delivery solutions similar to VFC

    • Integration with HSAM creates stickiness and competitive advantage

Illustrative VFC Economics to Vets

Companion Heath Industry Overview

  • Demographic trends driving growth in the industry

    • A number of demographic trends, including growing pet ownership rates (~68% vs 58% 30 years ago) and spending for pets

    • The pet industry is relatively more recession-resilient, growing 6% according to the APPA (vs PCE -1%)

      • However, according to VCA SSS and IDXX visit growth, there does appear to be some sensitivity to recessionary environments

  • HSIC has sized the US companion animal supply market at $5.8B, and the global market at $10B+

  • In-clinic visits have witnessed a slowdown

  • E-commerce remains small but gaining share

    • PETS grew sales 3.5% in FY19, however sales declined 8.5% in the June quarter

    • While CHWY doesn’t disclose Rx sales, total revenues grew 68% in FY19 and 45% in the May quarter

HSIC Spin-Off and Events Post Spin-Off

  • The transaction was structured as a RMT, whereby HSIC merged its Animal Health business with VFC

    • HSIC retained a 63% stake after taking into account $1.2bn special dividend paid by CVET, while VFC retained a 37% stake

Implied Valuation

  • Animal health comps trade around ~15x, and other distributors trade around 8-12x

  • E-commerce comps tend to trade ~2-3x while SMB SaaS trades 8-10x revenue

Strategic Rationale

  • Combining HSAM’s supply chain and practice management capabilities with VFC’s prescription management platform provides an integrated offering that should enable CVET capture market share

  • Leveraging HSAM’s salesforce of 1,200+ should enable VFC to further penetrate domestically and expand internationally

  • Pure-play animal health business warrants a premium multiple

  • Compelling synergy opportunity that includes:

    • VFC penetration domestically and internationally

    • VFC platform revenue growth as adoption increases

    • Share capture in legacy business through cross-selling

    • Shifting agency business to VFC platform

    • Cost synergy realization

Situation Overview

  • Complex and messy financials that missed both topline and profit expectations

    • Results included partial quarter of VFC, comparison issues due to cost allocations as part of HSIC, FX

    • Revenue recognition for traditional relationships shifting to agency

    • Loss of Mars (announced Jan 2019, $100m FY19 impact on topline but limited impact on profit) and manufacturer in APAC (rumored to be Zoetis) impacting topline growth

  • Delayed Q1 earnings due to the complexity of carve-out financials, creating concern

  • Concerns over long-term outlook given poor fundamental trends, slowdown in growth in the industry and online players (e.g. Chewy) ramping and taking share within the industry

    • Losing share to other Patterson and MWI, where revenue growth remained more robust

  • EBITDA guided down from $235-$250m to >$200m due to weak North American market, $40m infrastructure investments ($10-15m of which recurring) due to carve-out and accelerating R&D investments behind VFC platform

  • VFC performance continues to remain robust and guidance reiterated; however, SSS slowed from 22% to 16% from Q1 to Q2

  • Technical pressure from spin-out and distribution to HSIC shareholders

  • Heavy debt load ($1.2B debt @ 5.3x leverage, 4.4x credit-defined)

  • CEO Ben Shaw subsequently bought ~$25k worth of shares in the open market on 8/21 (<1%)

Investment Thesis

  1. Schein legacy supply chain business has shown a dramatic slowdown in growth as the in-clinic business seems to be losing share to alternative channels (e.g. online, retail), and HSAM seems to be underperforming peers in the industry suggesting possible share loss

  • Alternative channels present a risk to the status quo supply chain ecosystem

    • In-clinic visitation has slowed recently highlighted by IDXX’s visitation trends

    • Big retail outlets (PetSmart, Petco and Walmart) have recently expanded retail commitment to pet pharmacy and have initiated their own online initiatives

      • PetSmart / Chewy partnership in July 2018

      • Petco / Express Scripts home delivery partnership November 2018

      • Walmart announced online pharmacy in May 2019

  • Online represents ~10% market share today, with retail ~30% and veterinary clinics 60%; lags other product categories by quite a wide margin

  • The Fairness to Pet Owners Portability Act requires veterinarian’s to provide subscriptions to pet owners to source medications across alternative channels

    • Has led to a ~50% increase in the % of vets that write prescriptions for online retailers

  • CVET’s recent performance seems to suggest market share loss in the legacy business

    • Adjusting for revenue recognition impact of agency shifts and the customer loss, North America and Global underlying growth in Q1 was +0.4% and +1.8%, respectively, and +0.1% and -0.6%, respectively, for Q2

      • This compares to Patterson internal sales growth1 of +4.1% and +0.5% for Q1 and Q2, respectively, and +1.3% and +0.7% for IDXX visit growth

    • While HSAM Domestic Supply Chain business outperformed both Patterson and IDEXX visits by 200-800bps, the trend reversed and the business has been underperforming since Q4 2018

    • There are several possible explanations of the underperformance: pricing pressure in a competitive market, merger creating disruption, disruption created from misaligned salesforce incentives (discussed later)

  • The market has been weaker than historical, however HSAM has underperformed peers

  1. While VFC provides CVET with a compelling growth platform in the e-commerce channel, it is likely to be cannibalistic to their existing supply chain business

    1. Misaligned incentives with salesforce may limit near-term growth potential for VFC

  • The success of VFC is cannibalistic to the legacy supply chain business

    • While VFC has an opportunity to grow, the market overlooks the potential for cannibalization in the Supply Chain business

    • Theoretically, the VFC platform’s promise of driving incremental sales at higher contribution margins should be value accretive to CVET

    • The theoretical example below contemplates a hypothetical P&L if all of HSAM’s supply chain business were to migrate to the VFC platform, VFC were to capture 20% of market share from its legacy competitors and generate an incremental ~$200m revs from its practices

    • Street continues to model the legacy business to continue to grow L/MSD, despite VFC continuing to rapidly grow at a ~33% CAGR over the next few years

      • Based on this example, VFC would be expected to generate ~$80m of incremental gross profit, which still falls short of Street modeling

      • As discussed later, we think there may be additional pressure that could drive incremental downside driven by market share gains and sustainability of VFC’s take rate

    • The change in the economic model of the business may lead to other disruptions within the business

      • Given the multiyear ramp for the VFC platform and transformation of the underlying business model, it would be interesting to see how the salesforce is compensated and whether adverse incentives have been created that deter optimal behavior

  1. A confluence of factors, including industry-wide pricing erosion, manufacturers bypassing distributors and veterinary consolidation, limits pricing power and poses margin risk longer-term

  • The Supply Chain business faces numerous challenges, including pricing pressure, manufacturers bypassing distributors and vet consolidation; MAP pricing may help pricing pressure but extenuates manufactures going direct

  • Increased competition driving price erosion

    • The emergence of online players (e.g. Chewy) and alternative retail channels within the pharmacy market has created pricing pressure within the industry

      • PetSmart / Chewy partnership in July 2018

      • Petco / Express Scripts home delivery partnership November 2018

      • Walmart announced online pharmacy in May 2019

    • Industry-wide pricing seems to have plunged since the introduction of new online pharmacies from Chewy and other national retail chains

      • PETS growth significantly began to decelerate since mid-2018

      • According to research and channel checks (see Appendix), Chewy prices remain 30-40% below

    • There remains numerous opportunities for price reductions across the supply chain

    • PETS and CHWY have talked about price stabilization going forward due to MAP

      • A recent Raymond James web scraping analysis of Chewy websites suggested prices increased anywhere from 20-30%, however would still remain below vet prices

  • Manufacturers increasingly going direct to customers

    • To better control prices, manufacturers are increasingly going direct-to-consumer to implement MAP

      • Zoetis recently announced intentions to further invest in new distribution channels and direct-to-consumer programs to leverage new channels and control pricing

    • Zoetis recently announced to terminate its distribution to HSAM in APAC

    • With the consolidation of vet practices and the emergence of multinational companies in the industry, fragmentation reduces and enables manufacturers to bypass legacy distributors

  • Veterinary consolidation poses longer-term risks

    • The animal hospital market has been very fragmented but has seen increasing consolidation

      • Mars acquisition of Banfield and VCA in 2017 for 18.2x LTM EBITDA

      • Ares acquisition of National Vet Associates in 2014 for 13x

      • KKR acquisition of PetVet Care Centers in 2017

      • Morgan Stanley investment in Pathway Pet Alliance in 2016

      • Oak Hill acquisition of VetCor in 2018

  1. While the VFC platform has impressively taken share versus competitors and adoption has grown nicely, VFC’s economics seem high and may face risk longer-term


  • Veterinary consolidation poses longer-term risks

  • VFC’s revenue share of 25% drives significant value for CVET however also appears to be high and may be sustainable to competitive pressure over time

  • While most platforms have take rates <15%, VFC provides merchant services through home delivery and logistics that most other marketplaces don’t provide

    • Amazon, which provides fulfillment services to its merchants, charges take-rates of ~17-20%, which is 25-30% below VFC’s pricing

    • Unlike other platforms that have gained scale and developed a moat through customer acquisition / scale advantages, VFC faces competition from Vetsource and Midwest (see Appendix for channel check commentary) which may limits pricing power of the platform and may compress pricing in the future

    • Although purely speculative, if Chewy’s online pharmacy fails to gain traction, it is possible they change their economic model to provide

  • Other developments, including industry-wide pricing pressure and vet consolidation, may also pressure VFC take-rates longer term


  1. While VFC provides a compelling value proposition to the vet, it’s attractiveness to customers still lags behind other platforms and channels which offer greater convenience

  • While VFC provides a clear value proposition to vets that others in the market don’t provide, it’s value proposition to consumers still lags alternative channels 

    • Many of the top reasons that consumers shop online highlight headwinds to the VFC platform

      • According to a recent study conducted by Packaged Foods, the primary reasons that pet owners shop online are motivated by pricing and quick delivery

    • While VFC provides a compelling value proposition to veterinarians by growing compliance and enabling them to participate in e-commerce, the success of the platform equally requires consumer adoption

      • Compared to Chewy and the other major retailers, the VFC platform cannot and has not competed on price and delivery

        • Prices within the vet channel are 30-40% higher on average than Chewy according to channel checks

        • 80% of Chewy shipments fulfilled one-day, 100% within two days; VFC shipments reportedly take 5-9 days

        • Incremental investments may be required to match the convenience that other platforms provide to consumers

      • The most compelling value proposition that VFC provides to customers – the ease to refill their prescription – is cited as one of the less important factors that drive consumers online

        • The Fairness to Pet Owners Act makes it easier for customers to transfer prescriptions across other channels

    • Feedback from channel checks (see Appendix) from vet practices corroborate the consumer survey findings

    • Interestingly, while new practice initiations and initial cohort ramp remains robust, VFC SSS decelerated meaningfully from 22% in Q1 to 16% in Q2, a pretty significant deceleration for a business that has steady and stable economics

    • Street expects $700m of VFC revenues by 2022, which assuming a 25% take rate would imply ~$2.8B of GMV through the platform, yielding a market share of ~30% (assuming $10B TAM)

    • Primary reasons why consumers shop for pet products online

  1. Leverage may limit capital allocation and investment opportunities

  2. We believe that the stock remains expensive on various valuation methodologies given the fundamental outlook of the business, however admittedly would like to see a better risk/reward


  • SOTP analysis valuing the VFC and Supply Chain business separately suggests downside. VFC has similar financial profiles (similar rev growth and gross margins) as CHWY, which would imply ~2.5x ‘20E sales for VFC and ~6-8x ’20E EBITDA for Supply Chain

  • Sum-of-the-parts implies upside to current stock price despite estimates being below consensus

    • Supply chain business warrants a 6x EBITDA multiple; competitors trade at 8-9x, however Supply Chain ex-growth and ceding market share to peers

    • Technology / VAS business, a smaller contribution to the consolidated enterprise value, warrants a multiple within the 10-15x multiple range given where precedent HCIT transactions have gone and how animal health businesses trade

    • The VFC business should trade similar to CHWY (~2.7x), given similar gross margins (~45%) and topline growth of the businesses; while CHWY has higher losses, VFC is earlier stage and CHWY in better strategic position. Upside case has premium multiple closer to where comps trade

  • At current prices, assuming the VFC business warrants a 2-3x revenue multiple, the implied EBITDA multiple for the Supply Chain business would be ~7-10x

  • Conversely, if the Supply Chain business is being valued at a 6-8x EBITDA multiple, it would imply a ~2.5-3.5x revenue multiple for VFC


  • Precedents have typically gone for mid-teens; however, the industry has evolved significantly since the last distribution deal in 2015, and VFC is a unique asset


  • VFC continues to gain further market share amongst vets and takes more share

    • Compliance gains expands TAM

  • Normalization of near-term softness within in-clinic trends

  • International roll-out of VFC platform gains further traction than expected

  • Cross-selling helps Supply Chain business capture share

  • Chewy and other alternative channels fail to gain traction amongst vets and consumers

  • Manufacturers mitigate further pricing erosion by implementing MAP guidelines



  • Further ramp of CHWY, AMZN and other retail channels capabilities in pet medication, creating pricing and market share competition

  • Manufacturers continuing to go direct to consumers

  • Competition to VFC platform, pressuring pricing

  • Investment requirements due to ongoing salesforce investments by manufacturers and distributor competitors, as well as e-commerce competitors continuing to invest in pet medication and fulfillment capabilities

  • Vet consolidation

    • Vet partnerships with CHWY

  • Zoetis or other manufacturers going DTC

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.



  • Further ramp of CHWY, AMZN and other retail channels capabilities in pet medication, creating pricing and market share competition

  • Manufacturers continuing to go direct to consumers

  • Competition to VFC platform, pressuring pricing

  • Investment requirements due to ongoing salesforce investments by manufacturers and distributor competitors, as well as e-commerce competitors continuing to invest in pet medication and fulfillment capabilities

  • Vet consolidation

    • Vet partnerships with CHWY

  • Zoetis or other manufacturers going DTC

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