Drugmaker Pfizer Set To Spin Off Animal Pharmaceutical Unit

Investor's Business Daily

THE BUZZIt's been a while since anyone tried to raise $2 billion on the IPO market. But Zoetis is not your typical IPO.

The company comprises the animal-health business of giant pharma Pfizer (PFE), which has been selling off some of its non-core divisions to make up for its lost blockbuster drugs. With more than $4 billion in annual sales, Zoetis is the global leader in its $22 billion industry. And the recent friendly receptions for the IPOs of Norwegian Cruise Line (NCLH) and Bright Horizons Family Solutions (BFAM) suggest that investors these days like industry heavyweights even if they aren't the fastest-growing companies out there.

"I think investors are generally favorable because the company has products that are benefiting from positive secular trends," said Les Funtleyder, author of "Health Care Investing" and an investment adviser with Poliwogg. "Also, it doesn't come with the same risks as traditional drugs.

Analyst Mark Schoenebaum with ISI Group says he's also heard a lot of interest in the IPO from his clients. But he says some parts of the business model are still in a "black box," with little information on how it's cutting costs to fuel its considerable margin expansion.

THE COMPANYLike its parent, Zoetis specializes in drugs. About a third of its revenue comes from anti-infectives, a quarter from vaccines, and the rest from parasite killers, food additives and other products. Two-thirds of revenue come from the livestock market, with the rest from companion animals.

The business model differs from that of human drugs in some important ways, however.

Animals don't have health insurance, so payment comes from the pockets of pet owners who do it for love, and farmers and ranchers who are calculating their return on investment. As a result, the business doesn't tend to produce blockbusters, with marked-up prices fueled by marketing campaigns.

However, animal drugs aren't under the same patent rules as human ones, so drug developers don't face the same issues with generic competition.

Given its size, the company is unsurprisingly very global, though nearly 40% of sales still come from the U.S. The second-largest market is Europe, Africa and the Middle East, with more than a quarter of sales, with the rest divided between Asia-Pacific and the rest of the Americas. Zoetis' management has said they expect emerging markets to drive growth, as the rising middle class in places like China and Brazil both eat more meat and have more money to pamper their pets.

Historically, the company has been highly acquisitive, both in terms of outright company buyouts and licensing deals for new drugs.

RISKS/CHALLENGESPfizer is going to get all the proceeds from the IPO, while Zoetis is going to end up with $3.65 billion in debt. Pfizer will maintain a controlling share of the company, though it's expected to spin off the rest of it eventually.

The company's M&A has complicated year-to-year comparisons with historic results. Although Zoetis reported double-digit sales growth in 2010 and 2011, its "base" revenue growth is in mid-single digits, according to the prospectus. Even with that, 2012's growth represented a slowdown.

Schoenebaum also noted in his analysis that the company's way of dividing its geographies lumps together emerging markets with developed ones, making it difficult to see how fast the crucial markets are growing. However, he was disappointed that the Canada-Latin America and Europe-Mideast-Africa regions are reporting growth below the company average, despite their emerging-market components.

The agricultural market faces cyclical pressures on farmers' spending, as well as weather-induced downturns. The trend towards organic farming also might threaten the use of antibiotics and food additives for livestock, though currently organic food still accounts for only around 1% of all food production.

THE RESULTSWith no M&A going on, 2012 was a fairly slow sales year for Zoetis. In the first nine months, revenue rose 1.7% to $3.16 billion. Margins continued to grow however, with net income soaring 87% to $446 million.

USE OF PROCEEDSAt the midpoint of the range, the offering of 86.1 million shares would raise $1.94 billion. After the underwriters take their cut, all the proceeds will go to Pfizer.

THE MANAGEMENTJuan Ramon AlaixChief executive and directorJoined Pfizer in 2003, with the buyout of his previous employer, Pharmacia Spain. He became head of the animal-health unit in 2006.

Richard PassovExecutive vice-president and chief financial officerServed as Pfizer's treasurer from 2001 to 2012, after joining the company in 1997.

Sandra BeatyExecutive vice president of corporate affairsHas held various positions at Pfizer since 1996, including SVP of Public Affairs and chief of staff to the CEO.

Zoetis Inc.Madison, N.J.

(973) 660-5000zoetis.comLead underwriters:JPMorgan, BofA Merrill Lynch and Morgan StanleyOffering price: $22-$25Expected date: Jan. 31Ticker: ZTS

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