(Bloomberg Opinion) -- The latest European buyout is another stark expression of the gulf between the value that stock-market investors see in an asset and the price that private-equity firms will put on it. The 3.7 billion-euro ($4.3 billion) deal for Zooplus AG is essentially a bet that the online pet-supplies retailer can undergo a transformation in private hands that wouldn’t be possible as a listed business.
The price is 85% over Zooplus’s three-month trading average before an earlier, lower offer was agreed to in August, and more than five times the company’s value before the pandemic hit. This is a wager that people will hold onto the pets they’ve acquired in lockdown — and that existing online trends for buying doggy treats and hamster wheels will accelerate.
Adjust for the cash on the balance sheet, and the 3.6 billion-euro transaction value equates to some 44 times the company’s expected profit next year as measured by earnings before interest, tax, depreciation and amortization. Bricks-and-mortar rival Pets at Home Group Plc trades at 10 times the same metric, although larger, faster-growing U.S. peer Chewy Inc. is on 81 times.
The heady price is the result of an auction between buyout firms Hellman & Friedman and EQT AB. Rather than push each other higher, they’ve paired up like two bonded guinea pigs. Moreover, they’ll settle for a 50%-plus-one-share holding rather than full control — the new normal in German M&A. Clearly, at this level, they could end up with more than that.
Having a simple majority holding rather than around 75% would constrain the owners from loading up Zooplus with debt as in a conventional leveraged buyout. That’s somewhat academic, though. The firm’s profits are so weak that it could scarcely support much borrowing relative to the overall size of the transaction.
A private-equity deal would typically aspire to take out at least double the equity invested after, say, five years. If Zooplus’s owners can’t use leverage to amplify their returns, they’ll need a plan to almost double the size of the business itself. That will mean turbocharging revenue and lifting profitability. Sales are forecast to be 17% higher this year versus last, while Ebitda margins are currently 4%.
If Zooplus can sustain that level of growth, and lift margins to 5%, Ebitda would hit around 230 million euros after five years. Assume the company would then command a 28-times-trading valuation (in line with the more mature European e-commerce retailers like Allegro.eu SA and Zalando SE), it would be worth 6.4 billion euros on a debt-free basis. This also rests on the belief the pet craze does not abate.
If Hellman & Friedman and EQT could also extract some dividends along the way, that would stack up as a reasonable — if not stellar — private-equity investment. But it’s not clear how much scope there’ll be to take cash out in the short-term. To sustain current levels of expansion will require restructuring and hefty investment in marketing. Margins are going to have to suffer before they get better. Still, away from the glare of public markets, transforming Zooplus in this way might just be possible.
Buyout firms want people to believe they don’t make returns just by using borrowed money, and genuinely invest in building up what they buy out. This time, they’ve got a chance to prove it.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.
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